There's No Place Like.... Your Boat

David Reitze is a second-generation boater – his dad was a Navy Captain. So, David knows his way around boats. And owning his own mortgage brokerage, he seems to also have a pretty good grasp of the numbers – particularly when it comes to designating his yacht as a second home.

One of the nice things about owning your own boat is the IRS will let you call it a second home. As long as your boat has a sleeping platform, toilet and cooking facilities, and some indication that you stay overnight on the thing at least 14 days a year, you’ve got yourself a second home (the same holds true for an RV or trailer).

Now, of course, if you already have a second or vacation home then you can’t designate your boat as such. But David Reitze doesn’t see why you would want a vacation home when a boat can provide so much more. But more on that later….

First, let’s talk about the numbers.

A few years back, David wanted to upgrade his 43 foot yacht to something a tad nicer. He purchased a well-fitted 47 foot yacht that seemed to meet his needs perfectly. And, by declaring his new yacht as his second home, he was able to reduce his income in the following year by $19,200 (deducting the interest paid on his boat loan – think of the mortgage interest deduction on a home). What’s more, he was able to deduct the annual state registration fee of $3,600.

But the beauty doesn’t stop there. Deducting interest and fees associated with his newly purchased yacht was instrumental in reducing David's income sufficiently to drop his tax bracket from 39 percent to 36 percent – saving him, pardon the pun, a boatload of money.

Think about that for a second… purchase a new yacht that will provide your family with countless hours of fun and memories – and drops you a tax bracket at the same time.

That, my friends, is Funvesting!

But, lest we focus solely on the financial side of life, listen to what gets David really excited.

With two young children, David can’t say enough about the virtues of having his boat as his vacation home. Every weekend he gets to take his kids to a new port of call. You can’t do that with a vacation home. For New Years, David sailed the family and their yacht to Seattle and dropped anchor in the one of the local harbors. It cost him about $40 a day. Contrast that with a nice suite in Seattle on New Years Eve that will run you about $400 a night. Finally, property taxes on a beachfront vacation home are astronomical. With a boat, you already own waterfront property - without the sky-high property taxes!

And, as David Reitze is so fond of saying, “You can change the location of that waterfront property anytime you decide to set sail.”

Exchange Your Vacation Home And Avoid Capital Gains

In a recent revenue ruling, the IRS has provided a safe harbor to allow certain owners the possibility of completing a 1031 exchange on their vacation home.

Getting its name from its section in the IRS code (section 1031(a)), a 1031 exchange provides that "no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of like kind that is to be held either for productive use in a trade or business of for investment."

Simply put, you can exchange a business or investment asset for another a similar business or investment asset and never have to recognize any capital gain. In theory, you can continually exchange your asset and defer the gain in perpetuity (forever).

However, one cannot simply go out and swap properties. To qualify for the special tax treatment, you must comply with a variety of requirements in terms of the timing and structure of the deal. Fall outside these requirements in any particular and your special tax treatment is blown. In other words, don't try this at home.

And, up until recently, the IRS said, "Don't try this on your vacation home."

Well, now they've provided a safe harbor where, if you qualify, you can complete a 1031 exchange on your vacation home! The issue comes down to whether you can qualify your vacation home as a business or investment asset. Most would consider a vacation home as an investment, but the mere fact that you expect your vacation home to increase in value over time does not qualify it as an investment asset in the IRS' eyes (believe me, somebody already tried and failed at that).

The issue is whether the IRS feels your vacation home is used more for business or pleasure. If your vacation home is used solely or mostly for your own personal benefit, then you will not be able to use a 1031 exchange. However, if you rent out your vacation home, you may be able to use the 1031 exchange - and still use your vacation home for personal enjoyment!

Here's what the IRS stipulates. To use a 1031 exchange, you must:

- own the vacation home for 2 years prior to the exchange.
- rent the vacation home for 14 days or more in each year prior to the exchange.
- limit the personal use of your vacation home to less than 14 days or 10% of the rental usage.
- apply the same above standards for the "replacement property" you plan to exchange your current vacation home for.

In short, if you can use your vacation home as a rental property, the IRS will let you continue to use it personally (within limits) and use the 1031 exchange when you want to change or upgrade your property's location - thus keeping the tax man at bay at least for a few more years until they decide to come out with another revenue revelation.