JMIH & Boats / Another interesting point that is not well publicized
Can you deduct your boat? Read on...
By Chris Caswell
Getting money back from the government because you own a boat. Now there's a dream harbored by every boat owner. The fact is, your boat may provide tax savings, but you need to be careful and savvy to take advantage of the deductions. If you're like most people, you probably think that simply writing the word "boat" on your tax forms is an invitation to an audit. Fortunately, that's not always true, although tax experts agree that those who do write-off boating expenses are scrutinized more closely. The key is to get good-really good-tax advice and to stay within what the experts refer to as "IRS safe harbors." These are objective and reasonably well defined exceptions to the general tax rules.
We talked to several experts, including one who literally wrote the book on boating tax deductions, to get a clear picture of what you can, and can't, do on your tax forms. Here's their advice.
In general, there are three ways you can use your boat or yacht to recoup some of your tax dollars. The most popular safe harbor is the second home mortgage interest deduction. It elicits the least amount of IRS scrutiny. More than a half million pleasureboat owners in the U.S. qualify for this deduction. "For tax purposes, many boats qualify as second homes, in the same way that land-based vacation condos and mobile homes do," says Elaine Dickinson of BoatU.S. Government Affairs. "If you have a secured loan on the vessel, the IRS allows a tax deduction on the interest paid on the loan." (A secured loan is one where a lending institution holds the boat as collateral for the loan.)
It may surprise you to learn what qualifies a boat as a second home. The IRS definition is anything with basic living accommodations, such as a sleeping space, a toilet and cooking facilities. Almost any boat with a cabin meets that definition. But, if your boat is rented to others for even a single day, to legally claim the deduction, the government expects you to also use it as a residence, which usually means spending at least 15 nights aboard each year. And you may need documentation to prove it.
Of course, there will always be people who try to stretch the limits of the tax laws. Many boats that are claimed as second homes spend much of the year on trailers in the owners' driveways, and the government seems unaware. "The second-home deduction is too fuzzy for the IRS to crack down," says Keith Ashdown, vice-president of Taxpayers for Common Sense, a watchdog group. Even so, tax experts agree it's not good practice to take risks. A center console with a mattress on the deck and a barbecue on the rail won't qualify for the deduction. Note that the IRS will only recognize one second home on your tax forms. If you're already deducting a beachfront condo or a mountain cabin, you have to decide whether to keep that deduction or switch to your boat.
In case you're 1040-challenged, you report the loan interest for your second home/boat on "Schedule A, Itemized Deductions." Though some marine lenders do it anyway, the law does not require them to report interest on 1098 forms as it does for real estate lenders. If you do receive a 1098 form from your lender, you should report the amount on Line 10. If you don't, enter the amount on Line 11 and provide lender details. Similar to real estate taxes on your home, you can deduct personal property tax on your boat, and beginning in 2004, you can choose to deduct the larger of state income taxes or sales taxes paid during the year, including sales tax on a boat, car or airplane.
Another way to deduct boat expenses is through what some experts call the vacation home charter position. Instead of reaching into your pocket of after-tax earnings to pay dockage, maintenance, insurance and loan payments, you can put your boat into a managed charter program that enables you to write-off the expenses against charter income. Granted, this strategy is not doable or desirable for everyone, but it provides big advantages if your circumstances are right. First, you gain a new source of tax-sheltered earnings to defray costs. Second, you can rely on someone else to maintain the boat and relieve you of this chore. Third, depending on which state you live in, it may be possible to avoid paying sales tax on the initial purchase price of the boat. Finally, the boat remains available for your personal enjoyment.
But here, boaters and their accountants begin to encounter unfamiliar tax waters where the safe harbors are not so clearly marked. According to Texas-based Certified Public Accountant Mike Kimball, author of the book Tax Guide for Business Yachtsmen (www.yachtstaxadvisor.com), many boaters understandably assume the same tax rules that apply to their businesses or real estate investments will apply to their yacht charter activities. Says Kimball: "They are sometimes surprised to learn that the IRS requires them to account for the number of days of business and personal use each year as it does for cars and airplanes, or that regardless of the extent of the owner's involvement in his agency-managed charter activity, it will always be treated as a passive activity." It seems many boaters are either uninformed or misinformed about these critical legalities.
Gary and Darlene White of Kirkland, Wash., are boat owners who were surprised when the IRS disapproved their deductions. The couple had a 42-foot boat with a Northwest charter company for several years and had been deducting losses on boats since the early 1990s. All of these were carefully documented and included such normal expenses as advertising, licenses, legal fees and utilities. But when the case went to court, the judge ruled that boats are leased properties, which means they don't produce active business income or active losses. In the tax law lingo, the losses are passive and cannot be deducted against active income like money earned on a job. Passive losses can be deducted up to the break-even point but not beyond, so the Whites were ordered to repay $5,000 for two tax years. While this case can't be cited as authority in other cases, it may have long-term ramifications.
A third way to deduct boat expenses is to use a yacht for corporate activities. When it comes to business use, tax laws are cut-and-dried; all the subtlety is gone, and it's the company versus the government. When a corporation buys a yacht, it must prove that the yacht is used for business purposes, and that, according to Kimball and other tax experts, can be a bare knuckles fight. After all, it's one thing to justify a company limousine, another thing entirely to write-off all the costs of a $10 million yacht.
The most common and defensible corporate activities include incentive awards for both sales people and clients, but this safe harbor is technically not for entertainment use.
One corporate buyer recently stationed its yacht in a faraway harbor in an area where the company does considerable business. There it will serve primarily as a hotel for visiting company executives, and secondarily to entertain clients. The company expects to have no problem justifying the use and, in fact, if a company executive uses the yacht privately, he will be expected to reimburse the company.
According to the tax experts, there are boat owners who are not taking full advantage of some existing tax regulations. Here's a sample situation: A person buys a yacht and bases it near his business. He may not know that he is allowed to rent the yacht occasionally (no more than 14 days a year) for corporate activities, such as meetings with clients or other business functions. By doing so, the company can deduct 100 percent of the costs incurred in the use of the yacht, which might include moorage, crew and other fees. The best part, however, is that the owner of the yacht doesn't have to report the income since a second home can be rented for up to 14 days.
Whether you have a 20-foot cuddy cabin on a trailer or a multimillion-dollar megayacht, there are a variety of ways that you can use your boat to reduce your tax liabilities. Just be sure to get good advice from an expert and document everything carefully. Then, you'll have the satisfaction of knowing that the government is giving you money back.
