There are thousands of American taxpayers who deduct expenses in connection with operating a motor yacht or luxury sailing craft. Indeed, there are legitimate tax write offs in connection with yacht ownership but perhaps there are also equally as many which are not so legitimate. Just about everyone out there deducts sales tax paid as a tax write off when you first buy your yacht. If you consider purchasing the yacht as a second home, mortgage interest may also be deductible tax write off. But you may want to steer clear of yacht charter businesses with lots of losses unless you are an experienced sea captain who has withered many a storm at sea. So if you own a yacht and you are curious as to whether or not there are legitimate tax write offs for boating enthusiasts stay with us here on TaxView with Chris Moss CPA to find out which boating income tax deductions are hot and which ones are not.
Whether you sail for a living or just plain love the ocean and waterways for motoring your water craft, the key IRS regulation you need to know about is Section 274, added to the IRS Code in the Revenue Act of 1962, prohibiting tax deductions in connection with the operation of a yacht as an entertainment facility. The Joint Committee on Taxation report points out that the 1962 Act requires that a yacht must be used for business, not entertainment. So if you purchase your yacht or yachts through the family business you would have to convince the IRS and ultimately the US Tax Court that your yacht purchase was not an entertainment facility for entertaining customers, but was used strictly 100% for business travel. Even just one instance of entertainment could disallow all deductions for business travel if the Government classified your yacht as an "entertainment facility".. Regarding this specific set of facts, the risk of adverse IRS audit action against you perhaps outweighs the possible rewards for using your yacht exclusively for travel.
Of course you can always deduct yacht expenses if you own a yacht type business like a yacht charter business. Unfortunately, for most of us who are working other jobs or earning money from other investments in the family business, the US Tax court rarely will allow you to deduct yacht charter losses against your other income. Yacht charter losses have consistently been disallowed by US Tax Court for lacking profit motive under Sect 183 including: Ballard v IRS 1996, Magassy v IRS, 2004, Lucid v IRS 1997, Hilliard v IRS 1995, Courbois v IRS 1997, and Peacock v IRS 2002 and lack of material participation under Section 469(c) including Oberle v IRS 1998 and Goshorn v IRS 1993. In all these cases IRS wins you lose.
But there is good news. There are in fact legitimate boating expenses that are safe and relatively easy to deduct on your tax return as long as you consult with your tax attorney to bulletproof the strategy. You can deduct interest secured by the boat under IRS Section 163. You can also use designate your yacht as your primary and exclusive home office for your family business as described in IRS Pub 587.
However, for those of you who want a more comprehensive tax strategy, you can transfer ownership of your yacht to your Family Limited Liability Company and organize a yacht brokerage service which refurbishes high end yachts to sell for a profit. Your business could even use yacht charters as a marketing tool to promote the boating lifestyle to potential customers.. You make your money when you sell the yacht to a family who perhaps chartered your yacht a few months earlier. Your tax and business structure in this case avoids the entertainment facility black hole because you have successfully converted "entertainment" into a brilliant marketing strategy.
To win with this strategy you are expected by the Courts to keep excellent extemporaneous, contemporaneous accounting records and travel logs, and that you maintain accurate cost basis history documentation. The yacht business, furthermore, becomes part of your entire estate plan along with all the other assets transferred to the family LLC for eventually gifting to children and grandchildren with a watertight operating agreement including all the usual discounts and marketability restrictions.
Unfortunately for legendary criminal defense attorney F Lee Bailey vs IRS U S Tax Court the Government won big time against Bailey because he did not keep accurate records for his boat refurbishing business back in 2012. IRS wins Bailey loses. Also see Knauss v IRS 2005 involving a taxpayer who lost big against the IRS simply because he couldn't produce accurate cost basis documentation. IRS wins Knauss loses.
Notwithstanding the record keeping requirements, there are excellent rewards for starting out with a yacht refurbishing business as part of an overall estate plan. If you are set up correctly you can use forward Section 1031 or Reverse 1031 tax free exchange treatment each time you refurbish and then sell your yacht. But be warned, this is a very complex business plan incorporated into an equally challenging estate plan all set up with an entrepreneurial foundation for family unity, protection, and asset preservation. Please consult your tax attorney and qualified intermediary to bullet proof this tax strategy prior to ever filing your tax return.
In conclusion, if you truly love sailing the seas, there are legitimate expenses for boating that can be deducted on your personal or business tax return. But without a water tight business structure, perhaps through a family limited liability company as part of your overall estate plan, your yacht may not be prepared for what lies ahead. Best practice is to get plenty of professional advice before deducting any boating expenses on your tax return. Finally, whatever tax plan you decide on, have your tax attorney disclose the plan openly and honestly to the government as part of your tax return filing to the IRS with plenty of supporting documentation and US Tax court case law. You will be glad you did if you happen to be audited years later. Thanks for joining us on TaxView with Chris Moss CPA.
Chris Moss CPA