I know I haven’t posted anything for quite a while, but I’m still very busy with work. I’m thinking of writing an article about AVA appraisals for one of the trade magazines. At the same time, I’m doing a study on the interplay between appellation, price and reviewer scores for California Pinot Noir. In the meantime, though, I wanted to send out an explanation of what AVA appraisals are and why you’re leaving money on the table if you have acquired a vineyard since 1993, but have not had a valuation done to break out the worth of the AVA. So, let’s go through the who, what, when, where, why, how and how much of AVA valuations and amortizations.
What is an AVA appraisal and why would someone do it?
On August 10, 1993, Congress enacted Section 197 of the Internal Revenue Code (Sec. 197), providing for a 15-year amortization period for certain intangible assets. In October 2010, the National Office of the Internal Revenue Service released a Chief Counsel Memorandum concluding that the right to use an AVA designation, or appellation rights, 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. It is therefore, according to the Memorandum, 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 for a period of 15 years.
What all this means is that, while you cannot depreciate land, a vineyard site in a well-regarded AVA is actually composed of two assets. The first asset is the land and its productive capacity. The second asset is an intangible asset, much like a brand. You can expense this over the course of 15 years, providing a significant reduction in your taxable income, thereby increasing cash flow.
This is the only question in this post that has a definite, widely-agreed upon answer. See, the IRS has said that this is all legitimate, but has yet to give anyone any guidance on the matter. I and others have, however, been pressing them for some ground rules.
How much money can I save with an AVA valuation?
Well, that depends greatly on your vineyard site, your tax bracket and, to some extent, the appraiser. But let’s look at an example. Let’s say that you purchase a $2.5M property in Dry Creek Valley that includes a vineyard site. Your appraiser allocates half of that worth, or $1,125,000 to the vineyard site. The rest of the worth is contributed by a home/home site, excess land and an extant vineyard. Vineyards, of course, are already depreciable, so no AVA valuation is appropriate. Only the land underneath the vineyard is considered. Note: I have not done an AVA appraisal for Dry Creek Valley yet, so I’m pulling numbers out of my, um, barrel.
Anyways, let’s say the AVA appraiser finds that 40% of the site’s value is attributable to the AVA. That means that the vineyard’s land asset is worth $675,000 and the intangible asset is worth $450,000. If you expense the $450,000 over the course of 15 years, that’s $30,000 per year taken off your tax basis. If you are in the top tax bracket (40.7%), then you will reduce your tax burden by $12,210 per year.
The valuation itself should not cost more than about half of this. The return on investment, therefore, is enormous for significant holdings in well-regarded AVAs, but is great even for smaller holdings. What is the maximum than can be attributed to an AVA? The IRS has put no cap on this, but different firms will give you different answers as regards their thoughts. The key is that the calculation be justifiable. My goal is that all of my valuations be more provable than any alternate method.
I plan to go into more detail about this issue in a later article for my blog or a trade mag.
Where does my vineyard have to be located to qualify?
Basically, you have to be in an area that can use an AVA designation that allows your grapes or wine to be sold for a higher price than they would without an AVA designation. The IRS provides no guidance on which AVAs qualify. Again, the assignment of value to an AVA need be justifiable. In any case, borderline situations should just be avoided, as the ROI is too low to justify the risk and possibly too low to justify the expenditure itself, regardless of risk.
When does the vineyard have to have been acquired? When should the valuation take place?
The law was enacted August 10, 1993. Anything acquired after that date is fair game. Obviously, this means that many valuations will have to be done retrospectively. My opinion, however, and your CPA will likely agree, is that, with new acquisitions, the valuation should be done prior to closing and the offer should be made with a breakdown of allocation across the property’s components. Since the seller is assumed to have interests contrary to those of the buyer – and this can affect them for tax purposes – the IRS is much more likely to accept the valuation.
Who does these?
Not too many firms try to perform these valuations. My belief is that you should look for the following in an appraiser (more details in a later article):
The valuation should be done jointly between an appraiser and a financial analyst or CPA.
The appraiser should – prior to the start of the project – be able to ballpark an estimate of the financial benefit without promising anything.
The firm should bid a solid price after gathering all relevant details and properly scoping the project.
That price should vary based on the property. This is likely my most controversial stipulation, as some appraisers out there are more than happy to make apples to oranges comparisons. Those that are based on accounting and business valuation principles and incorporate a deep knowledge of our industry, however, will see that some valuations are more complex and time-consuming than others.
How is the value determined?
This depends a great deal on the appraiser. Many use “comparables” as with a land appraisal. I don’t like this method. It necessitates those “apples to oranges” comparisons I warned you about. Using comps within an appellation is a fine way to help determine land value, as the land tends to be more physically similar and they have the all-important AVA in common. Even then, appraisers must strike a balance between being subjective and ignoring differences between the properties.
For an intangible asset, however, one should value the asset based on the marginal cash flow it can be expected to generate. The purchaser, of course, is buying the asset in order to generate this cash flow. Furthermore, solid data and math can be used to fully justify the appraisal to reduce the threat of challenges from the IRS. In short, it should be valued the way a CPA, MBA or stock broker would value an asset, not the way an appraiser would value land. There are many other details to how this is done, but I’ll leave that for a later article. Feel free to contact me with any questions and to visit my page about VFA's AVA valuation services.
Also, just so you know, I am now on Twitter under the handle @VFA_Consulting.