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American Viticultural Area Valuations Offer Potential Tax Savings for Wineries

American Viticultural Area Valuations Offer Potential Tax Savings for Wineries

Producers and consumers place great value on where their wine grapes are grown. The famous wine-grape producing areas—such as Napa Valley, California, and Walla Walla, Washington— have come to be publicly associated with quality.

However, many wineries are surprised to learn this perceived quality can be quantified and used to offset tax liabilities in the years following a vineyard purchase. The more prestigious the land area, the greater the potential savings.

This complex process includes an American Viticultural Area (AVA) valuation, and the potential tax savings can be significant. Here’s what wineries and vineyard owners need to know about the process to potentially benefit from the savings opportunity.

What’s an AVA Valuation?

An AVA is a geographic area where wine grapes are produced, as defined by the Alcohol and Tobacco Tax and Trade Bureau (TTB). As of June 3, 2020, there are 248 established AVAs in the United States, with 139 in California.

An AVA may have an intangible value associated with the quality of the grapes produced within it. Unlike land, producers may be able to amortize the value of this asset for tax purposes, but doing so requires a valuation to determine the intangible value of the AVA.

Intangible Value

Simply put, the intangible value of a production area results from the perceived value of the wine and wine grapes produced there. This value comes from a number of factors, such as established root stock, weather, soil quality, and consumer preference.

Wineries are only allowed to claim their wine was produced in an AVA if the following conditions are met:

  • 85% of the grapes used to produce it were grown there
  • The wine is registered with the TTB

Grape Pricing Comparison

Prices paid for grapes from different regions can vary dramatically. The graphs below illustrate 2019 bulk grape pricing in California, as reported by the US Department of Agriculture (USDA) for different crush districts.

Grape Pricing Comparison

For example, in the Cabernet Sauvignon grape pricing chart, we can see that in district four—which is Napa County—the median price of Cabernet Sauvignon grapes was approximately $9,000 per ton.

This can be compared to the median of district 10—which includes the Sierra Nevada Foothills counties such as El Dorado and Amador—where the median price for Cabernet grapes was $1,625 per ton.

Potential Tax Benefit

When a buyer purchases a vineyard, the AVA intangible creates a potential tax savings by amortizing the AVA value in the 15 years after the purchase occurs.

If an AVA intangible isn’t measured at the time of a purchase, an AVA valuation can still be performed and the amortization expenses can be retroactively applied to recognized deductions not taken in prior years.

Amortization

Amortization is the gradual recognition in income of a capital expense over a specific period of time. It’s typically associated with intangible assets—like trademarks—or, in this case, AVAs.

Essentially, it expenses the intangible value of the AVA associated with the land. This option allows vineyard owners to put some of the money they’ve spent to acquire land in a highly desirable AVA back into their businesses.

AVA Valuation Methods

If you purchase a vineyard, you can’t depreciate or amortize the value of the land used to grow the grapes. There’s a distinct separation between the AVA value and the value of the land.

Quantifying the AVA value happens through a complex process known as an AVA valuation. The resulting amount is what vineyards are able to claim for amortization.

There are a few different methods used to determine the potential AVA value.

With and Without

This method involves looking at two scenarios in which vineyards producing the same grapes of similar quality are compared. One vineyard is within a particular AVA, and one isn’t.

By comparing different prices of the grapes produced in each area and the subsequent effect on projected cash flows from the vineyards, the AVA’s intangible value can be calculated.

Relief from Royalty

Estimating a hypothetical avoided royalty or licensing fee is a common way to value tradenames. Distinguishing that a wine is made with grapes from a specific AVA is much the same as marketing that wine with a specific trademark.

While we know AVA designations can’t be licensed, wine brands, as well as brands for other similar products, can be. Comparing the licensing and royalty fees that might be paid by wineries wishing to use different brand names on their packaging offers many insights into the potential value an AVA designation could offer.

Generally, the more profit a winery can produce by licensing a brand, the higher the value of the associated intangible asset.

Vineyard Land Sales

Also known as the market approach, comparing the sale records of different vineyards offers an indirect way to quantify the effects of an AVA designation on land value.

While the price of vineyards can be impacted by many factors, these designations can have a significant impact on comparative vineyard value. The goal is to separate the cost of the land from the value provided by the AVA designation.

Getting Started

With owners making claims about AVA value due to the potentially significant tax savings, the IRS and states are increasing scrutiny on these claims. The larger the claim, the more likely an examination could occur.

Making a well-supported claim should be the ultimate goal. Utilizing multiple valuation methods, providing the appropriate documentation, and working with an advisor with deep industry expertise can help the process move smoothly.

Next Steps

For more information about AVA valuations and how they could help your winery save money, contact an accounting or consulting professional.

Donovan Trone has worked in finance and research since 2009, performing valuations services for operating companies, partnerships, and limited liability corporations for mergers and acquisitions and financial reporting. He can be reached at (408) 558-4320 or donovan.trone@mossadams.com.

Alex Luke has worked in data processing and analysis since 2013. He has extensive experience in data solutions, marketing and business, and valuations analysis. He can be reached at (425) 961-7029 or alex.luke@mossadams.com.

Assurance, tax, and consulting offered through Moss Adams LLP. Investment advisory services offered through Moss Adams Wealth Advisors LLC. Investment banking offered through Moss Adams Capital LLC.

5 Things to Know about R&D Tax Credits for Vineyards and Wineries

5 Things to Know about R&D Tax Credits for Vineyards and Wineries

by Travis Riley, CPA & Partner and Josh Harbin, CPA & Senior Manager – Moss Adams

R&D is often associated with technology and life science companies from Silicon Valley and San Francisco or head less than 100 miles north into the wine country or any other appellation across the United States, and you’ll find the same trend toward innovation being applied to the ancient practices of grape growing and winemaking.

However, many in the wine industry fail to utilize R&D tax incentives offered by federal and state governments. For wineries and grape growers, the potential tax savings could be significant. This article outlines key information to help wineries and grape growers benefit from this savings opportunity.

But first, what is the R&D tax credit?

The R&D tax credit is available to companies developing new or improved products or processes, including software, that results in increased performance, functionality, efficiency, reliability, or quality.

It’s a dollar-for-dollar tax saving that directly reduces a company’s tax liability. There’s no limitation on the number of expenses and credit that can be claimed each year. If the R&D credit can’t be used immediately or completely, any unused credit can be carried forward for up to 20 years (or indefinitely for California tax returns). In addition, previously filed tax returns can typically be amended for up to three years to claim the R&D credit retrospectively, providing an avenue to recoup previously paid taxes.

A new or small business may be eligible to apply for the R&D tax credit against their payroll tax for up to five years starting in 2016. The R&D credit is available both at the federal and state level, with many offering an R&D credit to offset state tax liability.

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To help break down this complex topic, here’s a list of common questions vineyards and wineries have about the R&D credit.

1. How much can a company save with R&D tax credits?

Companies can receive a credit refund of up to 11% of their qualified expenses, depending on a number of factors. Generally, the more a company spends on qualified R&D, the higher the credit they’ll receive, with taxpayers receiving a larger credit if they increase R&D spending year over year.

2. What is qualified R&D?

Qualified R&D ultimately depends on whether the activity meets each element of the four-part test established in the tax code. These criteria include:

  • Elimination of uncertainty. The activity is undertaken to discover information intended to eliminate uncertainty about the capability, method, or design of a new or improved product or process.
  • Process of experimentation. The activity involves one or more alternatives intended to eliminate that uncertainty, and the conduct of a process of evaluating the alternatives (through modeling, simulation, or a systematic trial and error methodology).
  • Technological in nature. The process of experimentation must rely on hard sciences, such as engineering, physics, chemistry, biology, or computer science.
  • Qualified purpose. The activity relates to a new or improved function, performance, reliability, or quality of a product or process.

3. What vineyard and winery activities qualify for the R&D credit?

Vineyards and wineries often aren’t aware that many of the activities they perform—potentially at each stage of the winemaking and grape growing process—could meet this qualification.

Following are some specific examples of R&D activities that have qualified for the credit.

Testing or Evaluation

  • Geological plot characteristics, including soil, water, and climate conditions
  • Rootstocks, varietals, and clones for optimal cultivation in the vineyard
  • Fermentation methods to improve wine quality, flavor profiles, or economic efficiencies
  • Filtration methods to improve wine quality

New and Improved

  • Formulations for vine and soil nutrient management
  • Pruning and training techniques for optimal production
  • Techniques or formulations for pest and disease management
  • Methods to treat harvested grapes prior to sorting and destemming

Design or Development

  • Irrigation systems and water management techniques
  • Trellising systems for the desired canopy
  • Systems, structures, or techniques to improve harvesting processes
  • Automated sorting and crushing processes or equipment
  • Methods or systems to manage wastewater
  • Fermentation methods, processes, or techniques
  • Clarification methods or techniques, including improvements to fining and filtration processes
  • Product formulations for desired flavor or aroma profiles
  • Subterranean wine cave improvements
  • Bottling and packaging processes

4. What types of expenses can be included?

If a company determines the work it’s conducting likely qualifies, identifying related expenses is the next consideration.

Most expenses fall into three categories: wages, supplies, and contractor expenses.

Wages

Qualifying employee wages can include Form W-2, Box 1 or pass-through income subject to self-employment tax. This would include individuals performing qualified research, as well as those that directly support or supervise the research. The rules specify that if an employee is 80% qualified, 100% of their wage can be included to calculate the credit.

Supplies

Qualifying equipment and materials related to the research process can include the following:

  • Some large-scale prototypes and pilot models
  • Tangible property (other than land or depreciable property) that’s used in qualified research, including grapes, fining agents, corks, bottles, barrels, barrel staves, testing supplies, and batches of wine used in experimental blends

Contractor Expenses

Payments to contractors can be eligible, contingent on rules, including:

  • Expenses paid would be eligible if the same services were performed in-house
  • Contractors must be performing an activity that would have qualified if performed by employees
  • The taxpayer must be at risk in the sense that their payment isn’t contingent on the contractors’ results
  • The taxpayer must retain substantial rights—shared rights or greater—in the results

5. What’s the next step to apply for the R&D credit?

Each company’s goals, values, and resources are unique, which makes it important to develop a customized project plan to identify, calculate, and support your company’s R&D credits and activities.

If you think your company may qualify for the R&D credit, the first step is to collect preliminary information about your company’s potential qualified activities. That information is used to develop an estimate of the credit benefit your company could receive as well as identify other R&D-related tax planning opportunities so you can make an informed decision about whether an R&D credit analysis is worthwhile for your company.

With recent increased IRS scrutiny around R&D credits, it’s also crucial to understand what’s necessary to substantiate a credit claim. To learn more about R&D tax credits, see Five Misconceptions about Tax Credits – And If You Qualify or request a credit benefit estimate to see how much your company could save.

Travis Riley is a partner at Moss Adams. He has provided research tax credit studies to companies claiming R&D credits since 2006. He can be reached at (916) 503-8242 or travis.riley@mossadams.com.

Josh Harbin is a CPA and senior manager at Moss Adams. He has provided research tax credit studies to companies claiming R&D credits since 2012. He can be reached at (916) 503-8241 or josh.harbin@mossadams.com.