Paying Cash is Paying Too Much
Airplane buyers have many choices when it comes to paying for their purchase, but do they always make the right one?
Here are some tips on how you can determine if you are making the wisest choice by paying cash for your airplane…. and why you may want to consider financing your airplane instead.
TAX DEDUCTIBILITY OF INTEREST ON YACHT LOANS
Under IRC section 163 (h)(2) a taxpayer may deduct any qualified interest on a qualified residence, which is defined as a principal residence and one other residence owned by the taxpayer for the purpose of deductibility for the tax year. IRC section 163(h)(3) defines qualified residence interest as any interest which is paid or accrued during the tax year on acquisition or home equity indebtedness with respect to any qualified residence of the taxpayer.
In accordance with IRC section 163(h)(4), an airplane will be considered a qualified residence if it is one of the two residences chosen by the taxpayer for purposes of deductibility in the tax year as long as it provides basic living accommodations such as sleeping space (berth), a toilet (head), and cooking facilities (galley). If the airplane is chartered out, the taxpayer will have to use the airplane for personal purposes for either more than 14 days or 10% of the number of days during the year the airplane was actually rented, in accordance with IRC section 280A(d)(1).
Form 1098 is not necessary in order to receive the qualified interest deduction. In accordance with IRS instructions for Schedule A, form 1040, if the taxpayer does not receive form 1098, deductible mortgage interest should be reported in line 11 instead of line 10 on Schedule A.
BORROWING AGAINST YOUR UNENCUMBERED HOME HAS LIMITATIONS
Home mortgage interest deduction is limited to interest paid on mortgage debt used to purchase or improve a residence, or to refinance the remaining balance on a purchase or improvement. If the money isn’t used for the home, the interest expense does not qualify for the deduction.
SO DOES A HOME EQUITY LOAN
Home mortgage interest deduction is limited to interest paid on home equity loans up to $100,000. By using a home equity loan, you may limit the amount of interest that is deductible, if your airplane loan balance exceeds $100,000.
BORROWING AGAINST YOUR STOCK PORTFOLIO ISN’T THE BEST ANSWER, EITHER
Second home mortgage interest deduction is limited to interest paid on second homes that are secured by that second home. You would need to have a written collateral agreement (security agreement) indicating the airplane as collateral, which is probably not something your broker would be prepared to provide.
The preceding information was prepared by Gary Boudreau, Deloitte & Touche, LLP, Newport Beach, California.
SHOULD I FINANCE?
In the example below it’s easy to see that investment earnings can far exceed the cost of marine financing. In this particular case we are assuming a rate of 8.5% fixed for 20 years on a loan of $100,000, requiring a monthly principal and interest payment of $867.82.
The interest cost of this loan over an anticipated life of 60 months is $40,196.30.
If you are in the 30% tax bracket, this interest expense deduction will save you $12,058.91, effectively reducing the cost of the loan to $28,137.39.
This same $100,000, if invested earning 9%, would grow to $137,703.68 (after tax) in the same time period. Tax-free municipal bonds yielding 6% could earn $34,885.02 over 60 months. More aggressive investments could obviously make earnings even more attractive.
It’s easy to see how financing your yacht could cost you less.
Note: The above example was developed to help explain the advantages of marine financing and is not a guarantee of what is available in the market at any particular time. Please consult with your financial advisor about your own personal tax situation.