Have a formal business plan.
If you plan on producing quality grapes, it could take up to 3 to 5 years before you harvest your first commercial crop (proceeds exceed harvesting costs). This creates a problem, because the IRS generally expects any new business that is not a hobby to start making profits within 3 years. Your best defense against hobby loss attacks by the IRS, is a good business plan, and genuinely running your vineyard like a business.
A good business plan serves three purposes:
- It proves to the IRS that you are taking the winery business seriously, and that your intention is to make profits.
- It helps with managing your business.
- It helps your CPA complete your tax returns (If the business plan also includes historic financial statements.)
Here are some great resources to use in developing your business plan:
In the business plan, we recommend using the same expense and capital asset categories as the IRS requires. This allows you to use the actual and projected costs to estimate the timing of your related tax deductions.
Take all available deductions.
This sounds easy, but many farmers miss out on significant tax deductions because of poor purchase price allocations.
A portion of your vineyard’s purchase price should have been allocated to appellation rights, and this is very often not done. A portion of your purchase price should also have been allocated to previously existing vines, trellises, irrigation, roads, fences, and other Section 179 qualifying property. Everything but the soil is potentially tax deductible. Any of these omissions can usually be fixed, and catch-up deductions can be taken.
You will need a well supported appellation rights valuation and purchase price allocation for catch-up and future deductions.
Here are some extracts from the IRS’s Vineyard and Winery Audit Guide issued to its field staff:
“Review the land/depreciable assets in the vineyard allocation. Did the taxpayer purchase the land with the vineyard already planted? Was the allocation made pursuant to an appraisal?”
“Amortization of Appellation Values: This issue might arise in conjunction with the purchase of a vineyard. The taxpayer would hire an appraiser to make purchase price allocations between land and other depreciable assets (vines, trellis systems, irrigation systems, etc.).”
We provide the above appraisals. Please contact us for more information about these valuations.
A vineyard should use the cash-method of accounting for tax purposes.
If your vineyard operations are currently being reported on for tax purposes using the accrual method of accounting, change to the cash method!
This provides simplified accounting and tax planning opportunities. This will be considered a “negative Section 481 adjustment,” which means that you get to deduct the difference between the old and new method of accounting entirely in the year that you make the change.
This change from accrual to cash method for tax purposes is an automatic change for farmers, and there is no processing fee charged by the IRS.
Please keep in mind that the above is for tax purposes. Accrual based accounting should still be applied for the purpose of comparing your vineyard’s performance to your business plan.
A vineyard should opt out of I.R.C. 263A.
A farmer that is eligible to use the cash-method of accounting, has the option to opt out of the inventory capitalization rules of I.R.C. 263A. It is important that this option is chosen in the first year that it becomes relevant (year vines are planted), because if the opportunity is missed, a change in accounting method request needs to be applied for. This is not an automatic change, and IRS processing fees apply.
Choosing to opt out of I.R.C. 263A allows the farmer to deduct preproduction period costs, and the costs of maintaining the vines after the first commercial harvest. If this option was not chosen, the preproduction period costs would have had to be capitalized into the vines, and the cost of maintaining the vines would have had to be capitalized into the grapes.
Further Tax Planning Advice for Starting a Vineyard
We provide tax consulting and filing services to vineyards in California, USA. Contact us, and we would be happy to talk you through the options, and tailor a service for you.