Better Yacht Donations Without IRS Risk

Better Yacht Donations Without The IRS Risk

We encourge charitable donations. Anyone considering a yacht donation should be commended. But what if it could be a "yacht" more rewarding & with less risk?

Before donating a yacht, why not see if YES has a better deal- for you, the broker, and the nonprofit & without the IRS risk of many yacht donation programs?

YES Can Be Your Ensured Sale: More Rewarding With Less Risk

YES has a standing commitment to purchase yachts as part of Net Worth Neutral yacht ownership that ensures clients preserve their net worth and at least break even on yacht ownership & the yachting lifestyle.

While each transaction is uniquely designed to the priorities of the seller, they do share common terms.

That includes buying at their price that is sufficient to make them whole. Then we agree on terms like: how best to allocate resources, how much profit to make, how fast & which charities to support.

In almost all scenarios, a YES structured purchase would be more rewarding for everyone - and with less IRS risk - than the conventional yacht donation programs currently promoted by many nonprofits.

Consequently, YES is now open to purchase yachts of non clients that meet our criteria. Why not sea what YES can do for you?

So What's The IRS Risk Of Yacht Donations?

To start: Economic Substance, Substance Over Form & Re-characterization

IRS Risk

Unfortunately, the legitimate practice of yacht donations is too often hijacked. For a number of reasons, and over a period of time, many yacht donation programs have devolved into fertile ground ripe for various tax schemes that often go something like this:

A yacht owner has a yacht he wants to sell and contacts a yacht broker. The yacht owner lists the yacht with the broker whereby the yacht owner is responsible for a commission if the yacht sells or is donated. The commission is usually at least 10%.

After some period of time, the yacht owner becomes frustrated as the yacht will not sell at a price acceptable to the yacht owner.

Clearly the market value of the yacht is less than the owner is willing to acknowledge.

The yacht broker, who is compensated only by commission upon a sale or donation according to the listing agreement, realizes that the yacht owner has an unrealistic opinion of the yacht which is apparently above market prices.

Since the yacht seller and the broker recognize that the market value of the yacht is below what the yacht seller wants, the yacht broker suggests making a donation of the yacht to a participating charity.

The yacht broker explains a yacht donation program whereby the yacht owner can deduct from his taxes the appraised value of the yacht this year- subject to certain regulations and limits - and if necessary can carry the donation forward.

Conveniently for the yacht owner, the yacht broker already works with a team of cohorts that includes the required appraisers and charities that are familiar with the program, which would welcome the donation and do not care what the yacht owner claims as the donation value of the yacht. The donation value of the yacht is supposed to be the Fair Market Value (FMV) but is really between the yacht owner, the appraiser, and the IRS. In fact, the nonprofit shouldn't be involved in those discussions at all.

As more thoroughly explained below, the key to much of the attractiveness of a yacht donation largely depends on the valuation.

If the yacht owner is able to obtain a favorable donation value for the yacht, the ultimate economic value of the donation for the yacht owner can be closer to his asking selling price AND can immediately stop the cash outflow from paying any operational costs, crew, captain, dockage, insurance, etc as those costs will be paid by the nonprofit after the donation.

Furthermore, most participating nonprofits will agree to pay all yacht broker fees and commissions there by relieving the yacht owner / donor of the fees he would otherwise be obligated - which is usually 10%.

For the scheme to work requires a favorable appraisal. But how favorable of an appraisal is too favorable? Where do you draw the line? Where does the IRS draw the line? What's the difference between a Fair Market Valuation, a Favorable Valuation, and a Fraudulent Valuation?

In addition to the yacht owner and yacht broker, to make the tax scheme work requires two co - conspirators; a participating appraiser and a willing nonprofit.

The nonprofits agree not to actually "sell" the yacht within three (3) years in an attempt to game the tax code.

If a nonprofit sells a donated item within three years from the receipt of the donation, the donor's charitable donation will be reduced from the Fair Market Value (FMV) which the donor claimed as a tax deduction to what the nonprofit actually received from the sale of the donated item.

This tax scheme hinges on the nonprofit not disposing of the donated yacht by "selling" it BUT instead entering into what it asserts is a charter / lease with a purchase option.

Keep in mind that he nonprofit is highly motivated to monetize the donation as soon as possible - not only for the funds it stands to receive for it's operations, but since the donation, the nonprofit is incurring monthly operational expenses. So until the yacht is disposed of, the yacht donation is an a resource drain and a negative event.

Consequently, to relive it's cash flow burden as soon as possible, the nonprofit may well dispose of the donated yacht at a price that is substantially below the current market value and the true current FMV and in all likelihood is significantly less than what the donor claimed as a charitable donation and tax deduction as a result of his favorable appraisal.

Economic Substance & Re-characterization

The Economic Substance Doctrine is closely related to the Substance Over Form Doctrine and the Step Transaction Doctrine. They are legal principles in U.S. tax law that allow the Internal Revenue Service (IRS) to challenge transactions that while one the surface may appear to technically comply with tax laws, lack a genuine economic purpose beyond tax avoidance or to claim or illegally overstate deductions and then to re-characterize the transaction to properly reflect the economic reality.

The primary purpose and objective of these and other doctrines is to enable the IRS to determine the true economic reality of a transaction over its mere legal form.

Charter Lease With Purchase Option Or An Installment Sale?

What happens if the IRS challenges a yacht donation by re-characterizing the nonprofit's lease purchase option not as a lease but actually as an installment sale that occurred not 3 years after the donation but on the day the charter lease purchase option was executed?

The Donor's donation value would then be reduced to the Net Present Value (NPV) of the monies received and / or to be received from future lease payments by the nonprofit.

For example, consider a scenario where the Donor made a yacht donation with the required appraisal for $1,000,000.

After the donation, the nonprofit wants to quickly dispose of the yacht and eliminate the monthly carrying expenditures of insurance, dockage, maintenance, etc. And in all likelihood as is so often the case with most of the yacht donations - the yacht owner / donor had been unable to sell the yacht anywhere close to the current market value- otherwise he would have done so.

Thus, to minimize their costs and to obtain some revenues as soon as practicable, rather than continue to attempt to sell the yacht, the nonprofit agrees to a charter with a lease purchase option at significantly below the current market value of the yacht.

After the donation, the yacht owner / donor has no input or control over any price or terms which the nonprofit may enter into a charter lease purchase option.

For this example, suppose the nonprofit enters into a lease purchase for $500,000 with 40% down, 40% over three years and 20% after 3 years.

Depending on the discount rate chosen and the cost of capital, and even with the $200,000 down payment, the NPV of what the nonprofit actually receives will be substantially less than the claimed value by the yacht owner donor. Under this structure, the non profit will receive the first year a $200,00 down payment plus $67,000 of first year payments, $67,000 of second year payments and the third year payments of $67,000 plus another $100,000 or 20% if the lease purchase is exercised.

With a 10% discount factor, the NPV of that "charter lease with purchase option"- what value the nonprofit actually receives from the donation would be $423,000 - substantially less than the $1,000,000 charitable donation claimed by the yacht owner donor.

In this case- if the IRS were to challenge this transaction or recharacterize the lease as an installment sale- the yacht donor would have to reduce his claimed charitable donation from the $1,000,000 to only what the nonprofit actually received - $423,000.

And as explained below, depending on the donor's effective tax rate, the actual value of the donation to the donor will be substantially less.

The IRS Re-characterization Risk

So what are the chances that the IRS challenges a yacht donation by re-characertizing the nonprofit's lease purchase option not as a lease but actually as an installment sale that occurred not 3 years after the donation but on the day the charter lease purchase option was executed?

Every transaction is fact and circumstance specific. So what any yacht owner contemplating donating a yacht should really be concerned about is what is the chance the IRS would challenge your donation? What might the consequences be of such a challenge?

Obviously, the greater the disparity between what the donor claims as the donated FMV of the yacht and the NPV of what the nonprofit actually receives as a result of any subsequent sale / lease of the donation - one would think the greater the likelihood that the donation would be challenged by the IRS.

The yacht donor and his yacht broker should have a good idea as to what the true market value of the yacht is- especially if they have been trying to sell the yacht. The yacht owner after working with a "qualified appraiser" should also have a pretty good idea of the value he plans to claim as a charitable deduction.

However the donor has no control or influence - or at least he shouldn't under IRS regulations - as to what the nonprofit may receive from it's ultimate disposal of the yacht. Not the price nor the terms of any charter lease purchase option or sale as the case may be.

The structure of any charter lease purchase may invite the IRS to re-characterize the transaction as sale.

Factors That May Influence The IRS Re-characterization Risk

So what are some of the factors the IRS often considers when re-characterizing a purchase option lease as a sale?

The IRS analyzes these transactions based on the "substance over form" doctrine, meaning they look at the economic reality of the transaction rather than just its legal form. The IRS can re-characterize a lease as a sale for tax purposes if the economic substance of the transaction indicates a transfer of ownership rather than a true lease.

Perhaps the single greatest tell of the true nature of the document is what's called the "probability of exercise." If the circumstances suggest it is highly likely the lessee will exercise the purchase option, the greater the argument for sale re-characterization.

Here are just some of the key factors the IRS considers which may increase the likelihood of the IRS Re-characterization:

1. Economic Substance and Intent:

Substance over Form: The IRS looks beyond the legal form of the agreement to the actual economic reality of the transaction.
Intent of the Parties: The IRS examines the parties' intent at the outset of the transaction, considering if they truly intended a lease or a sale.

2. Lease Terms and Options:

Bargain Purchase Option: A purchase option at the end of the lease term for a price significantly below fair market value suggests a sale.
Uneven Rent Payments: Rent payments that are artificially high in the early years and then decrease may indicate a financing arrangement rather than a true lease.
Lessee Acquiring Equity: If the lessee is effectively building equity in the property through rent payments, it may be deemed a sale.

3. Indicators of Ownership Transfer:

Lessee Bears Risks and Rewards of Ownership: If the lessee assumes the risks and rewards associated with ownership, such as responsibility for maintenance, insurance, and taxes, it may point towards a sale.
Substantial Improvements by Lessee: Significant improvements to the property made by the lessee can be an indicator of a sale, as the lessee may only recoup the investment by exercising a purchase option.
Significant Option Payment: If the option payment is substantial compared to the property's value, it can indicate a strong intent to purchase.
Rent Credits: Allowing rent payments to be credited toward the purchase price makes exercising the option more attractive.
Improvements by Lessee: If the lessee makes substantial improvements to the property that would be forfeited if they don't exercise the option, it suggests they're likely to purchase.
Fair Market Value Option Price: A purchase option price that is significantly below the anticipated fair market value at the time of exercise makes the option highly valuable and increases the likelihood of it being exercised.
Equity Build-up: Lease payments structured in a way that effectively builds equity for the lessee in the property, even if not directly credited, increases the incentive to purchase.
Short Lease Term: A short lease term with a purchase option that can be exercised quickly after the lease begins may suggest the parties intended a sale from the outset.

After any reasonably fair reading the proposed charter lease purchase options proposed by most nonprofits to quickly dispose of the donated yachts and the costs thereof, it becomes crystal clear that from the outset,the intent of the nonprofit is to sell the yacht relieving them of the burdens of ownership and that the lessee fully expects to exercise the option at the end of the lease.

What's A Yacht Donation Really Worth To A Donor- Best Case?

Donor value

The value of a non cash charitable donation largely depends on the interplay of several factors including but not limited to:

the donor's effective tax rate,
the classification of the nonprofit,
the donor's basis in the asset to be donated,
the Fair Market Value (FMV) of the donated asset .

Determining the value and limits of charitable donations is not always clear. It depends on what's being donated, by whom, and to what kind of nonprofit or charity classification. Limits range from 20 - 50%.

For our discussion purposes, and without getting too wonky, we simply presume the best case most valuable scenario.

Thus, to find the maximum value to a yacht owner of a potential yacht donation, simply take the allowable donation FMV value, and multiply it by the tax payer / donor's effective tax rate. With annual donation limits, it may take several years to finalize.

The tax code allows for the maximum donation of non-cash assets in any one year to be limited to 50% of the tax payer's Adjusted Gross Income (AGI). In case the value of the donation exceeds the annual donation limit, the donation can be carried forward to future years.

For example, if the donor's AGI is $1,000,000, the maximum annual donation is $500,000. If the AGI is $10,000,000, the maximum annual donation is $5,000,000.

Donation value

If you don't already know your effective tax rate, it's easy to find using online calculators.

But generally speaking, the higher the AGI the greater the effective tax rate since a greater percentage of the income is taxed at the higher tax rates.

For example, the effective tax rate on an AGI of $1,000,000 is about 35%. The effective tax rate on an AGI of $10,000,000 is about 39%.

However, it's well established that many of the more affluent pay little to no federal income tax.

Thus, its also possible that yacht donors could have other tax strategies that substantially reduce their effective tax rates.

Consequently, for any specific yacht owner, a yacht donation may have substantially less value than it might have for other yacht owners.

Nevertheless, generally speaking, the greater the AGI - and the greater the effective tax rate then the greater the tax savings will be from making a donation.

Conversely, even with a high AGI, the lower the effective tax rate- the less value there is in making a charitable donation.

Let's Consider Two Scenarios

Consider two scenarios of yacht owners contemplating a yacht donation:

An AGI of $1,000,000 considering a yacht donation of a $1,000,000 yacht
An AGI of $10,000,000 considering a yacht donation of a $10,000,000 yacht.

Scenario 1

AGI of $1,000,000 is limited to a maximum first year deduction of $500,000. Multiply the deduction amount times the effective tax rate of 35%.

The actual first year cash value of the tax savings is only about $175,000.

Adding insult to injury, in many cases the donor has to pay a 10% yacht broker fee on the donated value of $1,000,000- that only leaves about $75,000 of actual value to the tax paying yacht owner.

The following year the tax payer can carry forward the balance of his $1,000,000 donation- which provides another $175,000 in actual cash value.

Total value to the yacht owner donating a $1,000,000 is $350,000 over two years - minus any yacht broker commissions or other fees like appraisal and legal to comply with the IRS regulations.

Thus the actual value to the yacht owner is roughly the effective tax rate times the donation value.

Scenario 2

AGI of $10,000,000 is limited to a maximum first year deduction of $5,000,000. Multiply the deduction amount times the effective tax rate of 39%.

The actual first year cash value of the tax savings is only about $1,950,000.

Adding insult to injury, in many cases the donor has to pay a 10% yacht broker fee on the donated value of $10,000,000- that only leaves about $950,000 of actual value to the tax paying yacht owner.

The following year the tax payer can carry forward the balance of his $10,000,000 donation- which provides another $1,950,000 in actual cash value.

Total value to the yacht owner donating a $10,000,000 is $3,900,000 over two years - minus any yacht broker commissions or other fees like appraisal and legal to comply with the IRS regulations.

The actual value to the yacht owner is roughly the effective tax rate times the donation value.

Abusive Appraisals: The Siren Song Tempts The Unscrupulous

Other than the donor's effective tax rate - the most important factor is the donation value of the asset being donated. That is determined by a Fair Market Appraisal - which is ripe for all sorts of abuse and mischief.

How favorable of an appraisal is too favorable? Where do you draw the line? Where does the IRS draw the line? What's the difference between a Fair Market Valuation, a Favorable Valuation, and a Fraudulent Valuation?

This is just too much temptation for many to ignore. The lines between tax avoidance and tax evasion are already often blurry and over time could easily get pushed further and further.

After all, most criminals continue their crimes until they get caught.

Consider the same two scenarios - except let's double the donation by an overly aggressive appraisal that doubles the Fair Market Value of the donated yacht.

An AGI of $1,000,000 considering a yacht donation of a $2,000,000 yacht
An AGI of $10,000,000 considering a yacht donation of a $20,000,000 yacht.

Scenario 1

AGI of $1,000,000 is limited to a maximum first year deduction of $500,000. Multiply the deduction amount times the effective tax rate of 35%.

The actual first year cash value of the tax savings is only about $175,000.

In this scenario, while the donor is responsible for a 10% yacht broker fee on the donated value of $1,000,000- as is often the case let's presume that the nonprofit will pay the broker fee.

The following year the tax payer can carry forward the balance of his $2,000,000 donation- which provides another $175,000 in actual cash value. And he can take this deduction for until the carry forward is consumed.

Thus with the inflated appraisal / donation - the yacht owner's benefit is 4 years of $175,000 for a total of $700,000 for what is REALLY a yacht that is probably less than $1,000,000.

And in most cases, the only reason these yachts are donated is because the owner can't sell them at the price they are asking and they are tired of paying the annual operating cost.

Scenario 2

Now we have an appraisal of $20,000,000, but everything else is the same: AGI of $10,000,000 is limited to a maximum first year deduction of $5,000,000. Multiply the deduction amount times the effective tax rate of 39%.

The actual first year cash value of the tax savings is only about $1,950,000.

In this scenario, while the donor is responsible for a 10% yacht broker fee on the donated value of $1,000,000- as is often the case let's presume that the nonprofit will pay the broker fee.

The following year the tax payer can carry forward the balance of his $20,000,000 donation- which provides another $1,950,000 in actual cash value- as well as in years 3 and 4.

Total value to the yacht owner donating the yacht now appraised at $20,000,000 is $1,950,000 over 4 years - minus any yacht broker commissions or other fees like appraisal and legal to comply with the IRS regulations - roughly $7,800,000 or about 78% of the real value / asking price pf $10,000,000 and it relieves the owner from the other current operating expenses.

Nonprofits: Patsies, Facilitators, Or Co-conspirators?

The temptation to make fraudulent donations using abusive appraisals only exists because too many non profits either don't know of the potential abuse, knowingly turn a blind eye, are OK with it if the ends justify the means to support their organization, don't think it's much of a problem, or not their responsibility, or in fact actually promote the abuse as they benefit.

In this regard, it might be instructive to think of nonprofits like pawn shops or banks that can be used to launder stolen goods and illegal proceeds.

Much like pawn shops and banks, even the best and most honest present venues where the unscrupulous can exploit. While most pawn shops and banks are legit, some are known to be fences for stolen goods and open to questionable activities. Others prefer to feign ignorance and profit by keeping their eyes closed so they can claim plausible deniability.

The potential for yacht charter donation abuse. When tax fraud becomes the business model.

One of the more common practices that promote and facilities potential abuse is that rather than immediately selling the donated yacht - which could reduce the actual amount that the donor could deduct - many participating nonprofits require a three (3) year charter with a lease purchase option as an attempt to circumvent the 3 year reporting requirement of the tax code.

Why would a charity require a 3 year charter lease purchase versus just selling the donated yacht for immediate cash or via an installment sale?

They admit it's to "protect the donor". Protect the donor - from what? Could it be tax fraud?

Consider how the examples above can change depending on the value of the appraisal.

A yacht owner has a yacht that he would like to sell for $10,000,000. He can't sell it for his asking price as the true market value is somewhat less than the $10,000,000 asking price.

In this example, the best offer is for $5,000,000- which the owner rejects as too low.

The yacht broker suggests a yacht donation - which he helps orchestrate with participating appraisers / marine surveyors and nonprofit.

Using "creative, optimistic, and abusive" criteria, often unreasonably relying on "replacement values', the yacht owner is able to get an appraisal where the supposed Fair Market Value is $20,000,000.

The yacht owner makes the donation to a participating nonprofit of a yacht with an "appraised" FMV of $20,000,000.

The yacht owner with a $10,000,000 AGI gets to deduct $5,000,000 from the first year taxes and for the remaining 3 years until the carry forward is consumed. At the 39% effective tax rate that is a cash tax saving of $1,950,000 for 4 years for a total of $7,800,000.

The non profit has received a donation of a yacht that is valued somewhere between $5,000,000 which was the current best offer the yacht broker could secure and the "appraised: FMV of $20,000,000.

The nonprofit wants to quickly monetize the donation for their constituents and programs and stop paying the monthly operating costs, dockage, insurance, etc.

However if the nonprofit sells the yacht within 3 years of the donation, it must report the sale price to the IRS which would thereby reduce the allowable donation value the donor would be able to deduct from his taxes. Thus to circumvent this 3 year reporting requirement by the IRS - the nonprofit enters a 3 year charter lease purchase option.

Thus the nonprofit enters into a three year charter lease purchase at the current price of $5,000,000 - often with only 40 - 50% down and the balance paid over three (years).

Oh, and the nonprofit usually agrees to pay the yacht broker commission so the yacht owner doesn't have to. In this example, that would be 10% of the original listing of $10,000,000 -or $1,000,000.

So to summarize.

The yacht owner listed his yacht for $10,000,000 agreeing to pay a 10% commission to the broker upon sale. Netting $9,000,000. Under this donation scenario, the yacht owner nets $7,800,000 over four years, and is immediately relieved of the current operational expenses of dockage and insurance, etc. Considering how long the yacht has been for sale, the current offers he has or has not received, this could be a satisfactory alternative.

The yacht broker has received a full 10% commission of the listing price on a yacht that was difficult if not impossible to sell given current market conditions and the seller's objectives.

Even after paying the yacht broker's commission, the non-profit will receive a substantial donation from a new funding source.

There's only one reason why nonprofits require a 3 year charter lease purchase option - as opposed to just selling the yacht at the current market price - that's to provide cover for the fraudulent appraisals- and continue the scheme to secure future donations.

Don't Be Deceived: The IRS May Be Slow, Not Stupid

We are not against yacht donations or suggest that all yacht donations are fraudulent, or that all parties that promote or participate are suspect.

However keep in mind that the most successful and most egregious of offenders, the worst pawn shops and money launderers are so successful because they sprinkle the illegal transactions in with the mix of mostly legitimate transactions.

Promoters claim that some nonprofits have used this structure for years- without problems. That's probably true as there is nothing technically wrong with the structure.

The potential problem rests with the legitimacy of the appraised donation value and the size of the donation.

How long someone has been doing something is of little value. How long a pawn shop has been in business doesn't tell you how many transactions they have done or how many of those transactions might actually have been illegal.

The same is true for those brokers, appraisers, and nonprofits that act like since they have not been caught yet is some type of justification.

Again, there are very specific requirements in order to be fully compliant, and there is nothing improper with making yacht donations. The potential problem comes with overvaluing the donated yacht. It's only a matter of time until a disgruntled employee, divorced spouse, business competitor or just someone looking to collect the bounty for tax fraud blows the whistle.

Large Charitable Donations Are IRS Audit Red Flags

We encourage tax payers to take every deduction for which they are entitled. But keep in mind that it is the tax payer's responsibility to prove they are entitled to every deduction and the amount.

Tax professionals know that one of the red flags for IRS audits are unusually large charitable donations. Unusually large compared to the tax payer's peer group as well as unusually large compared to the individual tax payer's history.

The IRS reports the few high income tax payers make donations exceeding 2-3%. What percent of your income do you usually donate to charity? Probably less than the 50% of your AGI as most yacht donations would create.

While large charitable donations are encouraged by the tax code, they are also more likely to be scrutinized by the IRS. So proper documentation is all the more important.

In case of any donation challenge, the tax payer has the burden of proving the deduction and the value thereof. In case of a yacht donation the tax payer will have to justify the valuation claimed.

This will be in an IRS tax court, with IRS professional appraisers refuting your appraisal, and if applicable your unsuccessful attempt to sell the yacht at the appraised value and the nonprofit's failure to sell the yacht at the claimed donation value.

And if the IRS suspects fraud, there is no statute of limitations as to how far they can go back to audit.

So when making a yacht donation, be prepared to be looked at by the IRS. And playing games with valuations is not wise.

Just because no one has been caught yet is no security for the future. Just look at Son Of Boss and how the IRS has changed on conservation easements.

Better Alternative To Yacht Donations Without IRS Risk

Before making a yacht donation, check with YES to see if we can make a better deal to buy your yacht.

Essentially, our standing offer is your price our terms. Then it's just negotiating acceptable terms. It's almost certain to be better - more rewarding & with less risk - than donating a yacht.

We are not yacht brokers, but we can pay yacht broker fees - much like many nonprofits will pay the broker commissions on donated yachts. Unlike yacht brokers, our relationship extends beyond just buying or selling a yacht. We are in regular and routine contact with our clients, many of whom may become friends and / or partners.

And since we are not yacht brokers, we are not transaction oriented and compensated by commissions. Rather we only make money AFTER our client / partners make a profit.

YES Has Programs To Buy Client Yachts

YES Yacht Executive Solutions has been specifically created with the luxury yacht owner in mind – yacht ownership from the yacht owner’s long term perspective.

Rather than fee or transaction based, our compensation is largely determined by our clients’ long term financial success. In this case, minimizing any adverse impacts that yacht ownership may have on a client’s net worth. Our goal is for yacht ownership to be net worth neutral or even profitable.

We take more of an investment banking philosophy when working with our clients, strategic partners, yacht owners, brokers, and advisors. Not only do we help structure and facilitate transactions that can get to that immediate YES and closed – but we maintain long term mutually beneficial relationships.