Under the analytical framework of sustainable livelihoods, we establish the evaluation indicator system for farmers' livelihood capital, to evaluate the current livelihood capital and livelihood diversification for different farmers in the Dai nationality region of Xinping County in the Yuanjiang dry-hot river valley area, and discuss the relationship between livelihood capital and livelihood diversification. Studies have shown that the mode dominated by agriculture, supplemented by non-agricultural activities, combined with breeding, is the commonly used livelihood strategy for farmers in this region. As farmers change from pure agriculture to non-agriculture, their total livelihood capital and non-agriculture livelihood diversification index will increase, while agricultural livelihood diversification index will increase. In the meantime, their livelihood activities gradually shift from agricultural to non-agricultural ones, which is mainly reflected in the combination of both agricultural and non-agricultural activities. Regression analysis on livelihood capital and livelihood diversification shows that natural and physical capital is the basis of realizing agricultural livelihood diversification. Farmers with rich natural and physical capital will prefer agricultural livelihood strategies. While financial and human capital is driving force for farmers' transition from pure agriculture to non-agriculture.