We have received many questions about Active Yacht Ownership in the last few months so we decided to present a FAQ section for AYO. I am sure that many of your doubts will be assuaged by these answers but if not, please feel free to give us a call or email us. Also read the article explaining Active Yacht Ownership in more detail.
ACTIVE YACHT OWNERSHIP
Frequently Asked Questions
1. Should I own the boat personally or through a Corporation?
It is always better to hold the yacht in a corporation because it reduces the potential of personal liability (LLC and Sub-chapter S do not have the same rules). When running the yacht as a business where it will be for charter, this is a smart thing to do. If the vessel in placed in an LLC, the tax benefits will flow through to the LLC’s members personally.
2. Can I legitimately benefit from the tax deductions?
If you are actively involved in the business and meet the IRS tests for active participation, then it is a business and you can legitimately take the deductions and benefit from them. You need to show active participation as well as the ability and the intent to make a profit (see below).
3. What sort of active participation is required?
The most common test is that the owner performs at least 100 hours of work per year on the business, and more than any other one person related to the yacht’s activity. If you attend trade shows, do familiarization trips and technical inspection of asset and/or equipment directly related to your business, then you will certainly log far more than 100 hours. Logging 150 hours is always recommended.
4. How do I meet he requirements?
In the course of running the business, attending a trade show such as the Annapolis Boat show where the yacht is promoted for charter activity, one would easily and legitimately log 50 to 75 hours. Apart from the chartering component of the business where the LLC (sub contractor) generates income through the charter company (general contractor), there are other income streams for the LLC such as charter sales where the LLC earns commission from charters sold on its own yacht, as well as other yachts in the fleet. To be effective and facilitate the sale of charters, the owner would need to take "Familiarization" trips to acquire good knowledge of the product being sold, i.e. the cruising grounds (this is much like travel agents traveling to destinations that they promote and sell packages into). One Familiarization trip per year would log a minimum of 50 to 100 hours. It is also reasonable to conduct an annual inspection of the asset, which would require traveling to where it is located; again this would log 50 to 75 hours at the very minimum.
5. Will this structure trigger an IRS audit? There is always the chance of an audit when a large deduction is reported. However, if correct and organized records are maintained at all times (this is really crucial to show the seriousness of the activity) and if the owner does actively participate with the intent to make a profit, then the standard is met and should satisfy scrutiny. A tax advisor participation is strongly recommended as there is no “one size fit all” structure here.
6. What amount of money must I put down to get into a boat management program?
In the Guaranteed program, which does NOT quality for the active yacht ownership structure, the down payment required by most lenders is 20 % of the full purchase price plus 2 months of mortgage payments. In the Performance (aka shared income) program which DOES qualify for the tax benefit structure, it would be the same as above plus the insurance premium (1.5% of hull value).
7. Is the boat insured during the program and how am I protected?
The boat has comprehensive insurance in the name of the owner or the LLC from the time the keels touch the water. If there is a loan, the lender is recorded as the first loss payee and the charter company is noted on the policy for charter operations. The deductible is covered by an additional insurance policy that the charterers pay, so the owner has no exposure to a deductible unless he/she causes the damage.
8. What tax reporting is required?
Your CPA/tax advisor will be able to answer this, but usually the LLC would generate a K1 which would be incorporated into the members’ tax return
9. Do the tax advantages flow through to me personally?
Yes they do.
10. Is there a recapture on the tax advantages when I re-sell the boat?
Yes there is if you sell the yacht outright at the end of the program. The tax rate is at ordinary income. If you keep the vessel for personal use after the program than this should not be an issue. Again check with your CPA for your personal situation. The third alternative is to trade the yacht in and do a "like kind" exchange in which case there is no recapture – similar to a 1031 exchange in real estate.
1. Putting a boat into charter is a passive activity like rental property
No. If you put the vessel into a Corporation, run it as a business and ensure you meet the relevant standards and tests as described above, then it is a small business and is taxed accordingly. Note that if you go into a guaranteed income program with a long term management agreement and receive a monthly guaranteed income, then this is deemed as passive activity and you will not be allowed to generate tax benefits except if there are passive losses that can be offset against passive income.
2. One needs 500 or 700 hours of active participation to qualify
False. The test most commonly used is "100 hours and more than any other one person” involved in the yacht’s activity or maintenance. You will find that the US staff and base staff, who all have different tasks, will never spend more time on your boat individually than you will in a given year. Remember that the trade shows, familiarization trips, asset inspection trip, marketing, contract negotiation (it is best to renegotiate the management contract each year) would result in close to 200h. of active participation, not to mention that all costs are also deductible.
3. The active yacht ownership structure will automatically trigger a tax audit.
It is very unlikely that an audit be automatic, and this is not the experience we have over the last eight years. The issues are: meet the tests and standards, ensure that you are in compliance with the rules, and keep records scrupulously organized. This structure is not for everyone, but if scrutinized and everything is in order then it is unlikely that it would proceed to an audit.
4. You have to make a profit 3 out of 5 years to avoid "hobby loss" rules
The rules state that if one makes a profit 3 out of 5 years. the hobby Loss cannot be applied. To be clear, one does not HAVE to make a profit 3 out of 5. Many CPA's make this statement which is not entirely accurate and interpreted incorrectly. The actual rule is that one be able to demonstrate "the Ability and the Intent" to make a profit, which is clearly the case here.
5. A yacht does not qualify for tax advantages.
The yacht is an equipment that is being purchased and placed into service in a small business that has the ability to make a profit (if well run), which is clearly the intent. The same rules would apply to the owner of a dump truck who sub-contracts to a general contractor: there is fundamentally no difference. The truck would qualify for section 179 and Bonus Depreciation if purchased new. The owner would be actively involved even if there is an employed driver because of contract negotiations, marketing admin etc. and the intent being also to make a profit.
6. Owner cannot use the yacht while it is in the program.
You can use the yacht. It is generally agreed between most CPA's who are familiar with the program that 10% of private use by the owner over and above the familiarization and asset inspection trips are acceptable.