Can Your AVA Reduce Your Taxes?

IRS ruling allows vineyard owners some appellation-based deductions

by Jane Firstenfeld
Calistoga AVA
Although the IRS has ruled that under some circumstances the value of an AVA may be amortized over a 15-year period, that value will vary with the appellation's prestige and the premium paid for the property. After years of contention, Napa County's newest AVA, Calistoga, was launched earlier this year by county supervisor Diane Dillon (from left), U.S. Rep. Mike Thompson, Karen Cakebread, Laura Zahtila and Bo Barrett.
Washington, D.C. -- A Chief Counsel Advice ruling issued Oct. 8 by the IRS appears to allow some vineyard owners to depreciate the added value provided by a recognized American Viticultural Area designation. But the ruling is as yet unproven: It will not apply to everyone, and everyone who wants to utilize it should seek professional advice, experts explained.

The five-page ruling states the issue at hand: “When Taxpayer purchased a vineyard that is located in an American viticultural area, is the amount of the purchase price allocated by Taxpayer to the right to use the AVA designation an amortizable § 197 intangible?”

The conclusion follows: “For § 197 purposes, the right to use an AVA designation is a license, permit or other right granted by a governmental unit, and is not an interest in land. Therefore, the right to use an AVA designation is a § 197 intangible, and the amount of the vineyard’s purchase price allocated by Taxpayer to the right to use the AVA designation is an amortizable § 197 intangible.”

William Schlinkert
William J. Schlinkert
For translation and context, Wines & Vines spoke with attorney William J. Schlinkert, partner, Wine Industry Practice Group and Tax Practice Group with Farella Braun + Martell in San Francisco. Section 197, he explained, was entered into the IRS Code in 1993. It determined that certain intangible assets (e.g., goodwill), were amortizable over a 15-year period. Also included were “licenses, permits and other rights granted by a government unit.”

“Section 197 is clear: It does not apply to the actual land. Zoning, water rights are considered interests in the land,” Schlinkert said. “Which is an AVA more like: an intangible or a land asset?” That issue, he said, has remained a simmering dispute for many years.

The recent ruling demonstrates the IRS’ determination that in fact, an AVA is a license or permit issued by a government unit, the Alcohol and Tobacco Tax and Trade Bureau (TTB). Although untested, this indicates that, Schlinkert said, someone purchasing vineyard property now could allocate some of the purchase price to the actual real estate, and some to the intangible value of the AVA. The latter allocation would be deductible over 15 years.

But, he cautioned, if you owned the vineyard in 1993 (before section 197), and it was in a previously established AVA, the ruling would not apply, and your AVA-allocated value would not be amortizable. On the other hand, since that time, “Lots of vineyards have changed hands, and lots will in the future. In many cases, a very significant percentage will be deductible,” Schlinkert said.

He cited studies determining that AVA value could account for as much as 50% of the purchase price, “depending who does your appraisals.” Although no one has yet to test the ruling, and, “It’s not clear whether the IRS will look kindly” on this deduction, “When people come in with a reasonable appraisal, the IRS has been reasonable,” Schlinkert reported.

The new ruling is not only applicable to new purchases, he said. “If you bought after 1993, it may be that you can classify this as a change in method of accounting and deduct up to this point.” The considerations for future purchases and people who already own vineyards will be different.

It remains to be seen just how much tax relief the ruling will afford vineyard owners/purchasers. Taking advantage of it will require consultation with qualified appraisers and/or tax accountants.

Schlinkert, however, termed it, “The biggest tax ruling to hit the wine industry in a long time. It’s stunning. It involves large potential numbers. It will be interesting to see how the IRS responds when people begin allocating to an amortizable permit.”

Banker adds his two cents
Rob McMillan
Rob McMillan
“This is an interesting and complex ruling,” agreed Rob McMillan, founder of the Silicon Valley Bank Wine Division, St. Helena, Calif. “The benefit to the buyers is they will get to deduct from income, the AVA premium over a 15-year time frame. Not all purchases in an AVA will qualify for that treatment, though, which is important to understand.

“It depends, among other things, on the premium paid for a vineyard. If the buyer got a ‘good deal’ in the purchase, there may not be enough value to allocate to the AVA for the purchase accounting, even in the highest-value AVA. In lesser AVAs it might be hard to establish a premium in the first place, even if the buyer paid a significant premium over the average vineyard prices.”

So, although grapegrower groups typically invest years and thousands of dollars to establish new AVAs and sub-appellations, this may not pay off in tax deductions, at least in the immediate future.

Will the ruling affect lending practices? According to McMillan, “If a premium can be established by the CPA, that deduction is a non-cash expense that should reduce the operating tax liability. That cash savings can be used for debt service payments and allow a buyer to justify a higher purchase price.

He offered an example: “For argument’s sake, presume a premium of $2.5 million on a $10 million purchase can be established. That premium is amortized over 15 years and gives an annual deduction to the vineyard owner of $166,666. At a 40% marginal tax rate, that’s a tax savings of $66,666 per year.

“Instead of going to pay taxes, that savings could instead go to loan payments, and qualify that property for about $1,500,000 in higher loans. It has an additional benefit in reducing the basis on the property, which could be a benefit in estate planning.”

Will the ruling stimulate vineyard sales? “In an efficient market, an improvement in ROI (return on investment) -- tax-driven or otherwise -- should stimulate rational buyers acting on economics. But the high end of the vineyard business is far from efficient,” McMillan said.

“Further, a percentage of buyers are swayed by the love of the business, and don’t always behave rationally when it comes to deal economics. Buyers and sellers can at times speak very different ideas of deal economics,” he observed. “If I had to guess, I’d say don’t anticipate a land rush -- maybe a land crawl?”
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