Video from a local web camera showed thick black smoke billowing above the yacht and surrounding dock area.
Local fire and sheriff's officials responded, as did the Coast Guard. No one was hurt.
Photos from the aftermath of the fire showed the blackened shell of the multi-million dollar yacht partially submerged and surrounded by oil booms.
Gaye Levy, who lives a short distance away from the harbor, said black smoke continued to flow into the sky even two hours after the fire began and officials had advised those in the area to close their windows and stay inside.
"You can certainly smell (the smoke) here at the house," Levy said. "Started coughing and eyes burning so there's definitely a lot of smoke in here."
There is no official word on the cause of the fire but it appeared to be an electrical fire, officials said. Those responding to the fire were able to move other nearby boats out of the way and no other boats were damaged. The Coast Guard is working to get as much diesel off the boat as possible.
Witnesses say the boat was brand new and for sale with a list price as much as $8 million. A website listing the yacht for sale says the boat is equipped with a master stateroom, a guest stateroom and crew quarters.
Levy said the Ocean Alexander dealer brings in luxury yachts and leaves them at Roche Harbor for the summer as model boats for potential buyers.
Watch: Fire engulfs luxury yacht