Tax strategies for yacht buyers

Tax strategies for yacht buyers

Wednesday, 7 August 2019 / Published in News

If you are an American tax-payer, chances are you’ve come across the phrase “active yacht ownership”. This post is designed to clarify what it is and how it may apply to your personal situation. Additionally, there are other strategies that may be available to you outside of an “active business”.

While we point out and discuss the possible merits and challenges associated with the tax implications of yacht ownership, this is not intended to provide tax advice, only a professional accountant or financial advisor acting in a fiduciary capacity should advise you. If you haven’t found a knowledgeable CPA to help you navigate yacht ownership, or making your vessel available for charter, please contact us and we will gladly send you several recommendations.

Business structure

How you choose to operate your business, whether in your own name or through a dedicated corporation, will impact on what depreciation you are able to take, if any. The choice is yours, however holding title to the yacht in a corporate entity, either a limited liability company, partnership or corporation, for example, reduces your legal exposure and financial risk. Holding title through a legal entity may also trigger tax consequences and advantages not available to individuals.

Regardless of the potential tax benefits most people will choose an LLC or another Corporate entity to reduce their personal liability associated with the yacht.

Defining active yacht ownership

The phrase “active yacht ownership” refers to the strategy of purchasing a yacht and placing that yacht into a charter program to generate income, thus reducing the cost of yacht ownership. The program allows for some personal use of the yacht at the discretion of the owner.

In certain circumstances, additional tax credits are available beyond the “traditional” deduction of day-to-day business expenses. The tax benefits available may vary and may or may not be applicable to your particular scenario.

To test your active participation in the business, the IRS has defined a number of criteria that one must meet before the additional deductions may be legally taken legitimately. These criteria include, but are not limited to:

  • The ability and intent to make a profit (or “hobby loss rule”, explained below)
  • The owner must perform at least 100 hours of work each year on the business, and more than any other one person related to the yacht’s activity (for purposes of the 100-hour test, a taxpayer’s spouse’s participating in the activity is treated as participation by the taxpayer).

Such hours of work constitute “material participation” in the business and may include: 

  • attending boat shows, and
  • maintaining the business’s website, and 
  • travel for physical inspection and testing of your yacht, and
  • getting to know the intended sailing grounds for the purpose of promoting the charter business of your yacht. 

Active Participation is very different from a passive activity (such as real estate rentals). Generally, any rental activity is deemed a passive activity, without regard to what extent the taxpayer participates in the activity. Your yacht business is not a rental activity if:

  • The average period of customer use for the property is seven days or less;  
  • The average period of customer use for the property is 30 days or less AND significant personal services are provided on behalf of the property owner for making the property available for use by customers.
  • Extraordinary personal services are provided by or on behalf of the owner of the property in connection with making the property available for use by customers.

Expensing through Section 179

One of the incentives available when actively participating a business is a section of the IRS code called “Section 179”. It was designed to help small businesses as they set out to buy or lease new or used equipment. It allows a taxpayer to deduct the cost of certain types of property on their income taxes as an expense, rather than requiring the cost of said property to be capitalized and depreciated.

As of January 1, 2018 under section 179(b)(1), the maximum deduction is capped at $1,000,000 per year. Which means that a taxpayer may elect to deduct up to $1,000,000 of the value of the yacht per year.

If you are mindful of the IRS guidelines and seek the competent advice of a knowledgeable CPA, your charter yacht operations may qualify as an active business eligible to take advantage of this and other sections of the code.

The hobby loss rule (Section 183)

Section 183 of the IRS code, also known as the “hobby loss rule”, limits the losses that can be deducted from income which are attributable to hobbies and other not-for-profit activities. Generally, losses which occur in for-profit activities are not limited and can be used to offset other income from other activities. But the Section 183 limitation curtails those deductions when the activity is deemed a hobby.

It is generally accepted that if one makes a profit 3 out of 5 years, the activity is not considered a hobby. However, the code does not state that a profit MUST be made for 3 out of 5 years in order to clear the hobby loss rule.

Therefore, the business must demonstrate “the ability and the intent” to make a profit. Expert CPAs make recommendations on how to justify the “ability and intent” to make a profit while running a business of yacht charters. Demonstration of “ability and intent” can be shown through careful research before beginning a charter activity, and demonstrated by drafting a thorough business plan, documenting charter and non-charter activities rigorously, keeping accurate books of account, and also actively promoting the yacht for charter.

Since each tax situation is unique and varies from year to year, we advise all of our clients seek proper professional assistance on this matter prior to engaging in charter activity.

Claiming depreciation within your for-profit boat activity

As explained earlier, expensing under Section 179 is the most accelerated form of depreciation. Section 179 of the IRS allows a taxpayer to expense (or deduct as a current rather than a capital expense) up to their basis in the vessel, currently capped at $1 million per year, of the total purchase price of new and used qualified depreciable assets it buys and places in service in 2018, with certain limits. Those unable to claim this allowance may recover the cost of qualified assets over longer periods, using the depreciation schedule from Sections 167 or 168.

The special allowance under Section 168 has become known as “bonus depreciation”. It is only applicable if the yacht owner and tax payer did not use the property prior to its acquisition and did not acquire the property from a related party. Additionally, a yacht is considered qualified property since it has a recovery period of 20 years or less, however Section 168 will only apply to a new yacht.

At-risk rules

Section 465 of the Internal Revenue Service code limits losses that may be deducted by certain taxpayers engaged in covered activities under section 465. The at-risk rules apply to the leasing of depreciable personal property, such as boats and yachts. Any loss from the covered activity for the year is allowed only to the extent the taxpayer is at-risk with respect to the activity at the close of the year.

Alternative strategy: boat as a second home

A watercraft that has at least one berth, a galley and a toilet can qualify for a mortgage interest deduction as a second home. However, deductions are limited for rentals of a second home used for personal purposes:

  • If renting out the second-home (yacht), the taxpayer must use it himself or herself for the longer of 15 days or 10% of the number of days the yacht is rented out.
  • If a boat is not a personal residence because there are too many rentals or two few personal-use days, it is treated as rental property and all expenses, including interest, are allocated between rental use and personal use. The personal use portion of the interest expense is not deductible because the property fails to qualify as a residence.

Expenses attributable to rental use are deductible but are subject to the passive, activity, hobby loss and at-risk limitations described above.

Exit strategy

Clients looking to acquire a yacht and place it into a charter program should also prepare their exit strategy. It’s critical to understand ahead of time the consequences of terminating the program; one of the most significant events being the recapture, or repayment of certain deductions, at the time you resell your yacht.

Independent advice

One of the factors looked by the IRS in their analysis of how to treat the business, is whether the yacht owner sought independent tax advice outside of the charter operators that promoted the yacht sale in the first place. Therefore, we urge our clients to obtain the guidance of an expert CPA who can guide you through their options and prepare them for a potential tax audit.

Many brokers and management companies do not disclose all of the risks and uncertainties of owning a yacht as a business. In fact, few charter arrangements will satisfy with IRS requirements, and IRS audits are detailed and onerous!

Should you need further assistance, please contact us, we would be delighted to speak with you and your CPA about building a charter program well suited to your needs.

Explore the Navigare ownership programs.

Additional resources

For more information, please review the following. We do not undertake to provide any advice on your tax situation, but these links could help you ask the right questions of your CPA or other tax professional. Please note that the tax code regulations and tests are updated and amended by the IRS on a regular basis, and therefore we recommend that you speak to a tax and legal professional for more information on any of these topics.

Boatinglaw.com, Checklist for Significant Vessel Purchase http://www.boatinglaw.com/maritimearticles/purchaseofavessel.html

IRS Publication 925 – Active vs. Passive Activity https://www.irs.gov/pub/irspdf/p925.pdf

Section 179 (26 U.S.C.A. §179) https://www.law.cornell.edu/uscode/text/26/179

Section 168 (26 U.S.C.A. §168) https://www.law.cornell.edu/uscode/text/26/168

IRS Publication 936 - Boat as a Second Home https://www.irs.gov/pub/irspdf/p936.pdf