Consider your tax breaks
Issue 3 : Nov/Dec 1998
Our lives are rich with opposing forces, dilemmas we continually face and cope with. One of the most onerous examples is the need to earn wages and pay taxes in order to enjoy that life’s-blood we call boating. This grubbing for shekels is hopelessly intertwined with the replenishment of our souls. Can it be made less painful? Yes. In fact, I’ll show you an extra $10,000 or $15,000 that you may have for your project. Read on, fellow sufferer.
Let’s talk about ways to make sure you pay no more than your fair share when the tax man cometh … ways you may not have realized were there … ways you may have thought were available exclusively to land-lubbers. We’ll talk only about Uncle Sam and his merry band of IRS elves. But each state also has tax laws that must be considered on their individual merits. In addition, you have to be able to itemize your deductions; if you’re claiming the standard deduction, these savings won’t apply.
We will discuss three aspects of federal income tax law that can save you hundreds or thousands of dollars each year. No “creative” schemes, no shaving the facts, no innovative (and untested) approaches. Just solid U.S. tax code.
Savings Number One — Your Boat is a Second Home
Your boat is considered a second home by the IRS for tax purposes. Their sole stipulation is that it must have a sleeping facility (berths), kitchen facility (galley), and bathroom facility (head). There is no minimum time that you have to spend on board each year nor even a requirement that the boat be in the water. It just has to have those facilities. As a second home, the boat mortgage or boat loan interest is deductible from your taxable income. If you secure a loan to rebuild an older boat using the boat as collateral, that is equivalent to a mortgage, and the interest on that is deductible above and beyond the primary boat loan used for purchasing it.
As an example, with a $40,000 secured boat loan on a qualified boat, you would be paying approximately $4,000 per year in interest at 10 percent. If your income is in the 28 percent tax bracket, your savings would amount to 28 percent of that $4,000 or $1,120 per year. Congratulations! Uncle Sam just bought you a VHF and a GPS and filled the cooler with refreshments. Next year you can let him buy you new lines or cushions with your savings. Additionally, any personal property tax that your state may impose on your “second home” is deductible.
An alternative savings can be realized if you have purchased real estate with a dock for your boat. The same rules apply: purchase payment interest is deductible on the real estate, IF the property is used to secure the loan and IF the real estate has the qualifying facilities. Your real estate needs to have sleeping, eating, and bathroom accommodations to qualify as a second home. Also, any improvements that you make to your property (i.e., build a dock, run utilities to the boat, build a sidewalk or driveway, etc.) will have deductible interest if you get a second mortgage on the property to secure the loan. And like your boat or primary home, any general real estate taxes are deductible also. Please note that special assessment taxes are generally not deductible.
Note the word “alternative” in the above paragraph. The IRS says you may only take the income tax deductions from two homes: your primary residence and one other. The only way you could take the deductions from financing a boat and some accompanying real estate would be if the deductible mortgage were against one or the other … and as long as it has the qualifying facilities.
As a different option, you may choose to simplify your life by taking out a second mortgage (home equity loan) on your primary residence and using the money to buy a boat, waterfront property, new sails, or anything else. And the interest on the loan will be tax deductible, if you are itemizing deductions.
Concerns with this approach are first that you may not have enough equity in your home to borrow all the money you need, second that an additional mortgage secured by your primary home will make it too easy to overlook some important items on your new purchase — such as titles, recordings, surveys, and insurance — and third that your home and boat are inextricably linked for the length of the mortgage.
Specifically, if assets have to be divided due to divorce, death, or disaster, the simplifying and expedient feature of a single property carrying the mortgages may become a liability instead. In some situations, it can be an advantage for each component of your life to carry its own financing without obligating or risking your primary residence.
Savings Number Two — Use for Business Purposes
If you are in a marine-related occupation and if you use your boat in conducting business, you can offset your income from that business by the operating expenses for the boat prorated for the amount of time it is used for business vs. the amount of time it’s used for pleasure.
Wait! Don’t groan and turn the page, it’s not hard at all! Document the usage with your ship’s log. You do keep a ship’s log, don’t you? Record the business activity conducted (demonstrated new high-tech marine widgets, showed prospective customers waterfront property for sale, etc). Record the persons/clients/customers who were on board. Divide each day used for business by the total number of days the boat is used for the percentage of operating expenses you may claim.
Example:
Boat is used for business 49 days in 1998. Boat is used, in total, 153 days in 1998. 49 days divided by 153 days equals .32 or 32 percent.
If your boat operating expenses for 1998 were $8,200, then business operation equals 32 percent of the total $8,200 expenses ($2,624), if the business conducted, in part, by boat operation put you in the 28 percent bracket, then you just saved 28 percent of $2,624 or $735. The savings probably just filled your diesel tank and chart locker.
Examples of operating expenses that can be prorated between your personal and business uses are:
- Slip/marina fees.
- Slip utility bills (water, electricity, phone, garbage collection, etc.).
- Repairs to boat and/or slip.
- Boat insurance.
- Fuel/propane supplies.
- Security system/service costs.
- Annual licenses, fees, stamps, inspections.
- Operating supplies (flares, life vests, charts, tide tables, etc.).
- Depreciation.
Some words of caution:
The business conducted should be marine-related. If you are a chef and consummating a contract for fresh produce, don’t meet on board your boat and call it business. The IRS makes it quite clear that you cannot deduct the cost of using a boat, plane, or flying saucer for entertainment. Business, yes; entertainment, no.
Along the same lines, deduction of food and beverages as operating expenses can be justified under some circumstances, but I wouldn’t go there.
Savings Number Three — Limited Rental Income
Uncle Sam has blessed us with this last generosity: if you rent or charter your boat or boat/property for two weeks or less per year, the income is not taxable. This is considered casual rental by the elves and does not have to be reported. For example, if your floating palace chartered for two weeks at $1,000 per week, your income would be $2,000. If you are in the 28 percent bracket, you just saved a nifty $560. This will buy you breakfast for two at the Beverly Hilton or onboard groceries for a month … two months for me.
As with all tax issues, the secret to staying out of hot water is to carefully document, log, record, and itemize, and to save the information to substantiate the claimed deductions for at least seven years. Since you should be saving most of this information, anyhow, it’s a small effort for big returns. There are many more tax issues, especially for business purposes, that are beyond the scope of this article. Some, like depreciation methods, offer significant savings and deserve their own article.
When deducting interest paid on a boat mortgage, a boat second mortgage, a slip condo or real estate mortgage, a condo/real estate second mortgage, or a primary residence mortgage, use Schedule A, Itemized Deductions. If your lending institution doesn’t supply you with a standard mortgage Form 1098 for your boat interest (and most won’t), you will need to supply the bank’s name and identification number on your return if claiming that deduction.
When claiming business expenses as self-employed, use Schedule C. When claiming business expenses as an employee, use Form 2106.
It seems that there is always a “bottom line” to financial pieces. For me, the term often carries with it the connotation of wretched news for the reader. Preferably, articles with good news should contain a “top line.” Similarly, explanations of stupefying accounting methods should have a “numb line.” Instead, this article has been all good news.
How does a story on saving a lot of dollars have anything to do with mariners focused on maintaining and restoring older boats? It means fewer corners to cut. Or maybe that extra teak grating is now within reach. Upgrading your tankage became doable. If you want to get serious, an annual $1,800 savings would equate to $150 per month which could be leveraged to finance about $14,000 in needed improvements using an equity loan, of course, for more savings. Money makes an excellent restoration tool.
We do need to pay our taxes to pay for the country’s infrastructure. But we don’t have an obligation to pay more than our fair share. So don’t. If you have some moral objection to getting back your rightful dollars, send them to the Old Sailors’ Home in Seattle. My friends, this is a tax story with a good ending: a top line. Smooth journeys and a happy gurgling wake.
Thank you to Sailrite Enterprises, Inc., for providing free access to back issues of Good Old Boat through intellectual property rights. Sailrite.com
