Yacht Charters Taxes:
Discussion, Issues & FAQs

Financial Analysis | Tax Issues FAQ

You will find hereafter information on common tax issues for charter boat owners. For all intents and purposes, this information has been edited to be completely anonymous, in respect to all names, as well as the Charter Company names. This section is ONLY INTENDED TO INFORM the readers and cannot be regarded as advice or incitation of any sort. Sail-on-Line.com cannot be held liable for any use of this information nor for its accuracy. Lastly, the reader of this material is strongly advised to seek guidance from his/her tax advisor, as each tax situation is different for each boat owner. We have actually located a tax advisor who has helped several boat owners and charter companies with boat ownership tax issues. His name is Robert Shindler, CPA in Sarasota, FL. You may contact him directly. (Note: This is NOT paid advertising or endorsement.)

Financial Analysis Discussion

 John H., a Chief Financial Officer by vocation, is aharing his approach to the financial analysis of an investment in a Charter Company vessel. Different aspects are discussed to analyze the investments, and their potential outcomes.

An investment in a Charter Company vessel in charter service can be considered, from a financial point of view, in three fundamental ways:

1. A way to sail in many, some exotic, locations around the world at a financial cost that you won't know until the end of the program and the disposal of your boat. All financial costs should be considered, including interest on your investment. The cost of sailing is likely to be less than if you had chartered, but certainly not free. Any tax advantages you have enjoyed are taken into account, but will be recaptured when you sell your boat.

2. An investment, pure and simple. You will credit the investment with a value for your owner sailing... but probably not at full charter rates. You will know the return on your investment ONLY when you sell the boat and your tax deferrals come due, but the single biggest variable in that calculation will be the value of the boat at the end...which is subject to a wide range depending on the market at that time. In most cases, you will find the pretax equivalent return to be positive, but less than T-bills. However, it could vary from a small negative return to... the highest I've seen was about 11% pretax equivalent per annum.

3. A way to acquire a nice, big boat at a reduced effective cost, and enjoy some nice perks in the meantime. You won't sell the boat, so there will be no tax recapture (at least not until you eventually dispose of her, and then only to the extent that real depreciation has not caught up with her tax basis). You will credit the calculation with a value for your owner sailing, but most likely at a significant discount to standard rates. Putting ALL financial factors into the equation, including interest on your investment, most owners find that the all-in cost of the 4-year-old boat ranges from 50% to 65% of the price when it was new. How does this compare to chartering (but not as often) for four years and then just going out and buying a, e.g.4-year-old Oceanus 440 or an out-of-charter M445? The typical Charter Company owner's experience is that his boat's effective price IS cheaper, but not by a huge amount. But do we love those perks in the meantime!

The latter analysis is revealing when applied to the Charter Company#2 5/50/100 plan. That's where the buyer puts 50% down, does nothing but uses the owner weeks for 5 years, getting no revenue, and then owns the boat free and clear. The effective cost of the 5-year-old boat consists of:

• The 50% down payment; plus:
• Interest on that down payment (or foregone investment return) for 5 years, compounded.  Even at 7% Treasury rates, compounded, one could have earned another 20.5% of the vessel price; minus:
• The value one places on the owner's sailing, which for most people would be about 6%-10% of the new vessel price.

Since the agreement is, for tax purposes, either a lease or some kind of a time purchase plan, there is basically no material tax advantages. The final effective cost would be 61%-65% of the new vessel price. However, there is not much risk on this deal, except the risk that Charter Company #2 will stay economically viable and the vessel won't be attached in a bankruptcy, etc.

Tax Issues/FAQs

Second Home

A personal boat of the type we're discussing would qualify as a "second home", and the interest on a purchase loan secured by the vessel would be deductible. A charter boat is not a "second home" since it is income property, depending on your specific deal, either in a business activity or under a lease.

The yacht does not HAVE to be treated as a second home that you are renting, but it CAN be treated that way. You can also treat it as a business with active participation rather than a rental. There are no hard and fast rules to this determination, but there are either of two "safe harbors" that allow an activity that exchanges use of property for money to be treated as NOT a rental activity: the first is that the average period of charter is less than seven days OR the second is that the business/taxpayer offers substantial personal services along with the rental, and these services can be subcontracted. The situation of charter boat owners in large fleets meets both of these safe harbors in most cases. A non-rental treatment is important if one wants to take tax losses against other income. Some active participation in selling charters, etc., would also help.

But the law is there which says that we are not in a rental activity if, basically, the property is only rented on a very short-term basis. And Charter Companies DO provide (on "our behalf") the services of provisioning and outfitting the boat for the charterer, boat usage instruction and sailing area information; transportation services; food and beverage provisioning; chase boat service; etc.

"Foreign Use" Question

It may come as a surprise that wide-body Boeing aircraft owned by US banks/etc. and leased to airlines like TAP Portugal or China Airways are considered US tax property and qualify for accelerated depreciation because they regularly come and go from JFK (the US) and have some services contracted in this country.

Depreciation

In both the "lease" and "business activity" cases, you can take depreciation, but if your agreement is a lease, the depreciation is limited, especially if the property is located outside of the USA.

The depreciation life for vessels is 10 years, not 17. If it is determined that the boat is "foreign use property", you must use straight-line depreciation, taking 5% the first year. If you can support it as US property (owned by US, US-documented vessel, subcontracted with FL company, used a majority of time by US citizens, come and go from US waters (USVI)), then you can use DDB depreciation switching to straight line. This is important for those of you who are planning to keep your vessels, as the depreciation is never recaptured until you sell the boat, and only then to the extent that the boat's final sale price is greater than your depreciated basis. If you plan to keep the boat for quite some time so it will continue to lose market value, it's likely that the extra-accelerated depreciation will be a permanent tax benefit. On the other hand, if you sell the boat at the end of your contract, the extra depreciation will only benefit you temporarily for a couple of years and then have to be given back at the sale, and you might feel that it is not worth it to structure it this way.

What makes an agreement a lease?

If you have a revenue guarantee that looks like it will be relied upon, it's probably a lease. The Charter Company #2 50% down, 100% owner 5-year deal is a lease.  Any arrangements that remove the risk of revenue variance and/or boat utilization from you and transfer it to the chartering company may put you into the "lease" category.

A lease is ALWAYS a "passive activity" for individuals, and therefore you will not be able to offset tax losses against other income, simply carrying them forward until disposal of the activity. If your contract is such that you can support a "business activity", it still may be considered "passive", depending upon the specifics of the contract, and your own individual degree of involvement.

Active Business

Many owners consider their chartering business as "active", since the Charter Company simply manages the boat; they have no revenue guarantees; they are liable for debt payments; they actively promote the boat and sell excess owner weeks, earn referral commissions, and do other things that would be indicia of a business. They use DDB 10-year depreciation, since this is the proper class for this type of vessel, and are not restricted by the "lease" limitations. Their tax losses can be offset against other income. Still, this is a "soft" area of the law, open to audit challenge.

Be sure to read the "hobby rules", which empower the IRS to disallow all "losses" from a business activity if it "was not engaged in for profit". They use a test that requires you to make a taxable profit at least one year out of the first four, or if you don't, the burden of proof is on you to PROVE that the activity is, in fact, legitimately engaged in for profit.

Expenses Allocation

In addition, in all arrangements, you do NOT have to allocate expenses between business and personal unless you use the boat MORE than the greater of (a) 14 days or (b) 10% of the total fair rental charter days. If you do use it MORE, then allocation of expenses between business and personal use comes in, including depreciation, maintenance, misc. expenses in the production of income, etc., based on the ratio of days used by you to days rented.
For example, let's say you used the boat two weeks. 100% of your expenses are deductible because you met the minimum usage tests, regardless of how many days the boat was actually rented to charterers. Now let's say you used the boat four weeks. You failed the test, so a prorate is necessary. Let's say the boat was chartered 200 days. You used it 28 days. You can deduct 200/228 of the applicable expenses.

Another thought: use of someone else's boat on a reciprocal charter doesn't count as personal use of your own boat, so that's one way to keep your usage below the tests.
Save EVERYTHING you do relative to your chartering activity: Internet messages; sales of excess owner weeks and related correspondence; require extra reports from the Charter Company, etc., so as to back up your personal involvement in your business activity.

Your Boat Inspection Trips

The general rule is that the amount of expense related directly to the inspection is deductible. An IRS examiner would expect you to allocate the expense of the trip between business and pleasure, and then he would look at the amount of the business expense for one or more trips to determine the business necessity and reasonableness of the deduction. One trip a year where the deduction is limited primarily to travel expenses is probably OK.

back to top