Tax Rules That Allow Tax Deductions for Your YachtTax Planning
Qualifying for tax deductions on a yacht or other luxury boat requires tax knowledge.
First, you need to use the yacht more than 50 percent for business transportation.
Once you meet the “more than 50 percent” test, your potential tax deductions include fuel costs, insurance, repairs, dock or slip fees, caretakers’ salaries, hurricane storage, and depreciation (including Section 179)—all of which are limited by tax rules on luxury water transportation.
Second, the yacht is an entertainment facility. Tax law treats entertainment facilities harshly, so you need to seriously consider providing no business entertainment on this yacht. This should be easy to do because business entertainment is no longer deductible, thanks to the Tax Cuts and Jobs Act (TCJA).
Use Your Yacht More Than 50 Percent for Business Travel
Tax law gives you two reasons to use your yacht more than 50 percent for business travel:
- Possible escape from the entertainment facility rules (discussed later)
- Escape from the penalties that apply to listed property
Tax law classifies yachts and other pleasure boats as “listed property.”1 Therefore, you must use your yacht more than 50 percent for business purposes in order to:
- Qualify for accelerated depreciation
- Qualify for bonus depreciation
- Avoid depreciation recapture in later years
- Qualify for Section 179 expensing and avoid recapture in later years
Say Goodbye to the Tax Law Entertainment Facility “Punishment”
Before the TCJA, even if you used your yacht 100 percent for business, one business entertainment use could sink your deductions.
But the TCJA did away with business entertainment tax deductions. That’s bad news, but not for the yacht where even a single business entertainment could have destroyed the deduction.
Planning note. The IRS in its regulations stated, “A facility used only incidentally during a taxable year in connection with entertainment, if such use is insubstantial, will not be considered a ‘facility used in connection with entertainment’ for purposes of this section or for purposes of the recordkeeping requirements of Section 274(d).”
Tax Deductions for the Business Transportation Yacht
The entertainment facility “punishment” does not apply to a yacht used solely for business travel.
Obviously, if the yacht is used solely for business travel, you don’t have any entertainment that triggers the entertainment facility rules.
For example, you could have a business office on an island and a business office on the mainland—say, in the Seattle, Washington, area—that would require water transportation for you to get to or from the island. You could do this on a yacht.
More Than 50 Percent
Here’s another real-life example. There’s a general insurance agent in Florida who takes his agents to three business meetings a year. One business meeting is in Bermuda, and the other two business meetings are in St. Thomas.
He gathers his agents—he’s a general agent, so he’s got some 25 other agents working for him—and piles them on his yacht and takes them to the meetings, which occur on land at a hotel. On these trips, he uses his yacht for business transportation. He never uses the yacht for business entertainment.
At the end of a typical year, he has 80 percent business use and 20 percent personal use of the yacht. He may deduct all of his yacht costs for the 80 percent business use, subject to the luxury water transportation limits discussed later in this article.
Possible Entertainment Facility Escape with Business Transportation
In 1978, lawmakers enacted the killer entertainment facility rules. Even though that’s a long time ago, there has not been much action in the courts or at the IRS on this subject.
There are a few cases that involve yachts. In one case, the court said:
The slightest use of a facility in connection with an activity which is of a type generally considered to constitute entertainment, amusement, or recreation operates under the text of section 274(a)(1)(B) to disallow any deduction as to that facility.
In another case, James Gordon argued that his boat was not an entertainment facility because he used it only incidentally during the year in connection with entertainment. He lost his deduction for the boat.
Fatal flaws. James Gordon and the others who lost their yacht tax deductions did not claim business transportation for their yachts. Had business transportation been part of the mix, the courts may have seen things differently.
IRS position. In TAM 9608004, the IRS ruled that the taxpayer who used his airplane 80 percent for business transportation and 20 percent for tax-deductible business hunting trips with customers could deduct 80 percent of his airplane.12 The one taint of entertainment did not hurt this taxpayer.
In this ruling, the IRS noted that the airplane fell under the non-deductible entertainment facility rules, but the IRS regulations contain a specific “carve-out” for business transportation. The IRS went on to note that an airplane used for both entertainment and business is deductible to the extent (not “if”) the airplane is used for business
transportation not related to entertainment.
Legislative history. Probably the best barometer is the legislative history behind the 1978 enactment of the killer entertainment facility rules, which says:
The Act provides that no deduction is allowed for any expenses paid or incurred with respect to a facility which is used in conjunction with an activity which is of a type generally considered to constitute entertainment, amusement, or recreation.
Generally, the term “facility” includes any item of real or personal property which is owned, rented, or used by a taxpayer in conjunction or connection with an entertainment activity. Thus, expenses incurred with regard to entertainment facilities which are disallowed include yachts, hunting lodges, fishing camps, swimming pools, tennis courts, and bowling alleys. Facilities also may include airplanes, automobiles, hotel suites, apartments, and houses (such as beach cottages and ski lodges) located in recreational areas. However, the deduction is not affected unless the property is used in connection with entertainment.
Expenses of an automobile or an airplane used on business trips will continue to be allowed.
. . . the disallowance rule does not apply to the extent allocable to that portion of the facility which otherwise qualifies as one which is not an entertainment facility, or to the extent that a facility, with respect to which expenses ordinarily would be denied as deductions, qualifies under one of the above exceptions. Similarly, expenses incurred
with respect to certain transportation facilities, for example, automobiles and airplanes, are allowable to the extent allocable to travel undertaken primarily for the furtherance of a trade or business even if the taxpayer engages in some entertainment activities during the business trip.
Recommendation—Plan A. Use the yacht only for business transportation and personal use. Do not use it for business entertainment. (The TCJA gives you the incentive to not use the yacht for business entertainment since you receive no deduction for such entertainment.)
Recommendation—Plan B. If Plan A is impossible and entertainment is part of the mix, hope that the IRS or a court will read the legislative history in a light favorable to your mixed use, as the IRS did for the airplane.
Tip for Plan B. When you have business and entertainment activities on the same day, try to ensure that the business part lasts longer than the entertainment part, so the day is obviously a business day. Alternatively, if entertainment time exceeds business time but the business time is a matter of consequence—for example, a contract signing—that day could be a business day. In short, try to arrange your activities so the law treats all days as business days.
Luxury Water Transportation Limits
Now that you have gone to the trouble to qualify your yacht for deduction, you face one final hurdle.
Tax law places a daily limit on deductions for business transportation by water. The luxury water limit is double the highest per diem for federal employees traveling in the United States.
The luxury water limits can change monthly. During 2020, the lowest luxury water travel limit was $760 a day and the highest was $988. Say that your yacht expenses exceed the daily limits and that you used your yacht 45 days for business transportation. At the lowest limit, your yacht deductions would be $34,200 (45 x $760). Not a bad payoff for a little tax knowledge.
If you are looking to deduct your yacht, make sure that you use it more than 50 percent for transportation and don’t use it for business entertainment.
Since the TCJA does not allow a deduction for business entertainment, your incentive is to not use your yacht for this purpose.
Once you qualify your yacht as a mode of business transportation, you next need to consider how the luxury water travel rules will limit your deduction.