Americans are using alpacas as tax shelters, Sen. Jeff Flake, R-Ariz., has warned in a new report, drawing outraged denials from an outspoken cottage industry and renewing a controversy over the cute but contentious creatures.

Flake argued that owners are writing off the cost of buying alpacas along with related improvements to their property as business expenses. While the federal government allows taxpayers to deduct business expenses - such as for hardware, software, tools and materials - there has long been doubt about whether alpacas are a legitimate business proposition.

Critics of the alpaca industry say that by allowing owners to write off their expenses, the government is, at best, subsidizing an exotic pet - and at worst abetting promoters who hype alpacas as an investment opportunity in order to increase the value of their own herds.

Economists suspect that hyping may have played a role in the alpaca investment bubble last decade. In 2005, the average male sold at auction fetched over $70,000, implying significant savings for purchasers who used the tax exemption intended to stimulate business investment. The creatures, smaller cousins of the llama, were being pitched to buyers as an about-to-boom industry, promising the market for alpaca fleece was on the cusp of taking off.

But those making the pitch often owned and sold alpacas themselves. By ginning up demand, they were able to inflate the price of their own animals' offspring, even if those herds would never generate significant revenue, industry observers say.

And like all bubbles built on speculation, it eventually burst: One study found that the price of male alpacas collapsed about 80 percent between 2005 and 2011 as speculators realized the creature was not commercially viable livestock.

Now, Flake and others are once again examining advocates' claims about alpacas' economic promise.

"The underlying rationale that we want to encourage investment is quite a stretch when it's applied to alpacas," said Richard Sexton, an agricultural economist at the University of California at Davis and one of the authors of that study. "You're getting people to buy into this proposition that you can raise and sell alpacas, and the industry is going to grow, and it's going to prosper and it's going to make money."

"The IRS has given a tax advantage to people who own alpacas," Flake said on "Fox & Friends" last week. The provision for alpacas was one of several unrelated provisions that Flake described as costly loopholes in his report.

The country's commercial alpaca herd numbered 141,000 in 2012, according to the Agriculture Department's census that year - the most recent for which reliable data are available. (The Alpaca Owners Association, a trade group in Lincoln, Nebraska, claims to have registered 250,000 alpacas in North America, but the figure does not account for exports or deaths.)

The association issued a lengthy statement arguing that the industry has a promising future and that demand for fleece and other alpaca products is set to rise. Promoters have never succeeded in establishing a commercial market for alpaca wool, although they regularly advertise the tax benefits of owning alpacas.

"The market for fiber is very spotty, and to this day, there's no real commercial processing," Sexton said. "It's just a very thin market, in terms of whether you can sell that stuff at all."

Alpacas "are treated like any other livestock including cattle, hogs and sheep" for purposes of taxation, said Bud Synhorst, the Alpaca Owners Association's executive director. He went on to compare the deduction for alpacas to deductions that small businesses enjoy, such as those for equipment and other expenses.

"Sen. Flake was unprepared to talk about the tax code as it relates to the alpaca industry," Synhorst's statement read. "I am stunned that the senator would go on national television without all of the facts about the North American alpaca industry!"

Flake did not help his case with the alpaca community when he narrated a video accompanying the report that appeared to be a parody of a televised appeal from an animal shelter. The video called on viewers to help him protect alpacas that were being "abused." In this context, the abuse referred to abuse of the tax code, and the shelter was a shelter from the IRS - an elaborate tax-policy joke of dubious taste and questionable comedic value.

Precise data on how much revenue the federal government gives up as a result of deductions for alpacas are not available, and Flake's report relies on anecdotal evidence. Given that commercial sales of alpacas totaled just $32.6 million in 2012, according to the Agriculture Department, the total taxes avoided likely would not exceed $10 million annually, Sexton said.

Whatever the exact figure, he said, it is a "minuscule" amount in the context of the federal budget, where the price tags are in billions. And while Sexton agrees that taxpayers who write off expenses associated with alpacas are abusing the system, he says the problem is a difficult one to solve. He does not believe the IRS should have the authority to decide what kinds of investments are likely to be profitable, and which are likely to fail.

"Then you've got the government effectively stepping in and trying to say what investments are legitimate," Sexton said.

In a statement, Flake responded by arguing that federal authorities should collect more detailed data on how exemptions for business are being used, so they know when the wool is being pulled over their eyes.

"I recognize there are alpaca owners and ranchers who run legitimate businesses related to the animals that are not driven solely by tax benefits," the senator said. "But when breeders associations so aggressively advertise the tax breaks as a selling point for alpaca ownership, it does raise questions."

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Keywords: alpaca, jeff flake, investment bubbles