Appellation Values and Amortization Benefit

An appellation or American Viticultural Area (AVA) is a grape-growing region distinguishable by geographic features only, the geographic boundaries of which are defined by the Alcohol and Tobacco Tax and Trade Bureau.

California and Napa Valley are appellations that have approximately 76 and 14 sub-appellations within them, respectively. Due to the abundance of various regions and wine types available to consumers, labels serve as an important differentiator in the wine selection process. As such, grapes and wine from well-known AVAs can command significantly higher prices than their non-AVA counterparts.

On August 10, 1993 (i.e., the enactment date), Congress enacted Section 197 of the Internal Revenue Code (Sec. 197) providing for a 15-year amortization period for certain intangible assets. In general, 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. Some practitioners may have questioned whether appellations fall within the guidelines of Sec. 197. In October 2010, the National Office of IRS 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) and is therefore an amortizable asset under Sec. 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.

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 accumulated amortization related to the appellation right (a catch up of prior missed deductions) with the remaining unamortized amounts available for amortization in future years. We have outlined an example below.

On January 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 determines 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. With an assumed combined federal and state tax rate of 40.7%, the calculated annual amortization tax benefit would be $40,700 or a total of $610,500 over the 15-year 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 expenses of $100,000 per year for each of the next 10 years (a 15-year total amortization period) totaling $1 million and providing tax benefit of $407,000.

WTAS has significant experience with regard to the valuation issues related to vineyard property (including appellation values) as well as the issues related to accounting method changes.