By Petra Loer and Sid Luckenbach
Vintners and growers of winegrapes often emphasize the value of vineyard terroir, a French term for the contributions of the distinctiveness of a certain location in wine quality. Yet what’s not often realized is what boosts the prestige of vineyards in one area over those in another also can be a big bonus in tax savings.
An American Viticultural Area, or AVA, is a grape-growing region distinguishable by geographic features and defined by the federal Alcohol and Tobacco Tax and Trade Bureau. Appellations are of county, state or nation size.
The California appellation has 111 AVAs, often called subappellations. Napa County has all or parts of 17, including Napa Valley; Sonoma County, 15; Mendocino County, 10; and Lake County, five. All five counties contain parts of the North Coast AVA.
Due to the abundance of various regions and wine types available to consumers, labels serve as important differentiators in the wine-selection process. As such, grapes and wine from well-known AVAs can command significantly higher prices than their non-AVA counterparts.
Writing off an AVA
On Aug. 10, 1993, Congress enacted Section 197 of the Internal Revenue Code, providing for a 15-year amortization period for certain intangible assets. Generally to qualify, the intangible asset must have been acquired after the enactment date and held in connection with the conduct of a trade or business. In the past, some practitioners may have questioned whether appellations fall within the guidelines of Section 197.
In October 2010, the national office of the IRS released a chief counsel memorandum concluding that the right to use an AVA designation, or appellation right, upon a purchase of a vineyard is considered a license, permit, or other right granted by a government unit — rather than an interest in land — and is, therefore, an amortizable asset under Section 197. The amount of the vineyard’s fair value allocated to the right to use the AVA designation is amortizable over a period of 15 years.
For example, upon the purchase of a vineyard, value may have been assigned to depreciable assets such as vines, trellis, buildings and irrigation systems, and the balance of the purchase price may have been allocated to land. This may have resulted in an existing AVA either not being considered or being included in the value of the land. In either situation, no current tax deductions in the form of amortization would have been taken.
For taxpayers who acquired vineyards after the enactment date and who did not separately allocate value to existing appellation rights, an automatic change in method of accounting may be available. This would allow taxpayers to deduct, in the year of change, the entire balance of accumulated amortization related to the appellation right — a catchup of prior missed deductions — with the remaining unamortized amounts available for amortization in future years.
For example, on Jan. 1, 2005, Taxpayer A completed the acquisition of vineyard Property B for a total of $5 million. The property cost included vines, buildings, an appellation, machinery and equipment, irrigation systems, trellis and land. Taxpayer A, however, has not taken deductions related to AVA rights related to the purchase.
A valuation expert then determined that the fair value of the land acquired included appellation rights of $1.5 million, which would provide annual tax amortization of $100,000 over a 15-year period. Assuming a combined federal and state tax rate of 40.7 percent, the calculated annual amortization tax benefit would be $40,700, or $610,500 over 15 years amortization period.
For the 2010 year, Taxpayer A elects to change its accounting method. Since the change is deemed effective as of the beginning of the tax year, Taxpayer A would be able to deduct $500,000 in “catch up” deductions related to the appellation rights, providing a tax benefit of $203,500 — a considerable tax savings. Beginning in 2010, Taxpayer A would also be able to recognize the related amortization expense of $100,000 per year for each of the next 10 years (a 15-year total amortization period) totaling $1 million and providing a tax benefit of $407,000.
Petra Loer and Sid Luckenbach are San Francisco-based managing directors in the valuation practice of independent tax consultancy WTAS (wtas.com). They work with businesses and individuals on valuation of closely held businesses, business interests, intangible assets, intellectual property, debt instruments, and derivatives. WTAS has valuation experience with vineyards, including appellation values, as well as accounting-method changes.
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