Income Tax advice for Timeshare owners
by Dave McClintock (CPA)
This Timeshare Advice article discusses Income tax information as it relates to your Timeshare. Written by TUG member DaveM (a CPA and Timeshare owner) it is provided to you completely free by the Timeshare Users Group!
Selling your Timeshare – Gains & Losses
Any profit on the sale of your timeshare is taxable. If you sell at a loss, the loss is normally not deductible.
Profit on sale is treated as capital gain, subject to favorable tax rates if owned for more than one year. For gain purposes, your cost is generally your original cost, plus additions for the following items: (1) closing costs incurred when you purchased your timeshare, (2) the portion of your annual maintenance fee (for all years owned) allocated to capital reserves or used specifically for capital improvements (such as a new roof), and (3) any special assessments for capital improvement purposes which you paid. This amount should be reduced by any depreciation expense in years you rented the timeshare.
If you (and/or relatives or friends) use the timeshare, exchange it or let it go unused, a loss on sale will be personal and not deductible, just as a loss on the sale of your home or your car would not be deductible. Even though your intent might be to hold it as an investment, your personal use results in no tax loss being allowed upon sale.
If you regularly rent the timeshare to others, a loss on sale might be an allowable business loss. If you have an allowable business loss on sale of your timeshare, it is deductible as an ordinary (non-capital) loss.
If you expect to sell at a loss, should you convert the timeshare to rental property to ensure deductibility of the loss?
It isn’t that simple. If you convert property from personal to rental/business/ use, the basis (i.e., cost as determined for tax purposes) for determining gain is what you paid, as described above, just as if you hadn’t converted to rental use. However, the basis for determining loss is the lower of cost or fair market value on the date of conversion to rental use. Fair market value is to be determined based on the value in your market (i.e., the resale market), not the price you paid to the developer.
Thus, for example, if you buy a timeshare from a developer for $12,000 and the resale value when you convert to rental use is $4,000, that $4,000 is what you should use as your basis (or tax cost) for determining loss on sale if you sell it while holding it for rental use. As explained in the Rental Income section below, that would also be the value used for claiming depreciation.
In addition, the IRS might disallow the loss if you sell the timeshare before renting it for several consecutive years, since isolated transactions (such as renting a timeshare unit for one week) generally do not convert a personal investment into a business investment for IRS purposes. Also, no loss on sale would be allowed if you convert it back to personal use before selling.
Deductible Items (e.g., Taxes and Interest)
Unless you rent your timeshare to others, you might have no deductible amounts related to the timeshare.
However, if the property taxes applicable to your unit are billed separately to you (such as in California), those are deductible. They should also be deductible if your resort shows them as a separate item on your maintenance fee billing. However, if you have to seek out the tax amount applicable to your unit by examining the financial statements, the taxes are not deductible.
A few owners can deduct the interest expense on a timeshare loan. The interest is deductible only if the loan is secured by the timeshare as a mortgage and you deduct no other mortgage interest except on your primary home. Note that most timeshare loans don't qualify because they are written as consumer loans rather than as mortgages. Similarly, interest expense on credit card debt used to finance the purchase would not be deductible.
If your timeshare was financed with a home equity loan on your personal residence or by refinancing your mortgage on that residence, the interest is generally deductible, subject to certain limitations.
Can you deduct interest on loans for more than one timeshare? If you have a mortgage on your primary residence, interest paid on loans on multiple timeshare properties would not be deductible, since interest in connection with only one property other than the primary residence can be deducted. But suppose the multiple timeshares are all at one resort. You might reasonably view these multiple timeshares as one "residence". The tax rules aren’t clear on this issue.
Forget about trying to use your timeshare in your business to get depreciation, MFs and other deductions. There is a rule in the tax law that prohibits any business deduction pertaining to an "entertainment facility". Timeshares fit into that category. There are a very few narrow exceptions to this rule.
Your annual maintenance fee is not deductible. This annual fee for utilities, pool care, lawn care, other maintenance, management, and other expenses can be compared to similar expenditures that you might incur on your primary residence, which are also not deductible.
Donating your Timeshare To Charity
A frequent question at TUG is, “Should I donate my timeshare to charity?” That often translates to, “I can’t sell my timeshare and have been told the tax benefit may exceed the sales price on the open market.” The answer is "Yes!", if you have a charitable motive and "No!", as it relates to that expected tax benefit.
If donating a deeded timeshare, the deductible contribution amount will normally be equal to the Fair Market Value (FMV) on the date of donation. That’s the price that an arms-length buyer and seller in the timeshare resale market would agree upon, not what the developer is charging for that same week. If the FMV exceeds $5,000, you’ll need a written appraisal that meets IRS guidelines. If the sale of the property would have resulted in a short-term gain, the FMV must be reduced by this amount.
Right to Use (RTU) timeshares and non-deeded points timeshares are tangible personal property to which additional rules apply. If the charity’s use of the property is unrelated to its primary function (for example, if sold at an auction), the FMV must be reduced by the amount of any gain that would have resulted had the property been sold by the taxpayer.
So, why can’t the tax benefit justify a donation? It’s relatively simple. FMV is normally the same as what you would sell your timeshare for. Since the highest federal tax bracket is 35%, you’re better off selling and pocketing the cash. For example, if you sell your timeshare for $1,000 (the FMV), you’ll have $1,000 in your pocket. If you donate the timeshare, your deduction should be $1,000 and your federal income tax savings would put, at most, $350 (35% x $1,000) in your pocket.
Keep in mind that appraisals aren’t cheap (most cost $500 or more) and the cost of the appraisal isn’t considered a charitable contribution.
Another frequent question is, "Can I get a tax deduction if I donate the use of my week to a charity?" The answer is “No”. IRS regulations won’t allow a charitable deduction for the gift of a right to use property. Donate the use of a week because you are charitable, but you can't deduct any value associated with the use of the week.
Rental Income and Losses
If you rent your timeshare, you can deduct all current expenses, including depreciation, advertising, rental commission and maintenance fees against the rental income.
Special assessments for remodeling, roof and furniture replacement and similar expenditures would not be deductible. Special assessments for repairs and unexpected current expenses might be deductible, depending on the nature of the expenses. Travel expenses to check on your timeshare will normally not be deductible because, as discussed below, your timeshare rental won’t qualify as a “business”, as is required for such a deduction.
How do you calculate depreciation expense? If your timeshare is newly purchased, you can base your claimed depreciation expense on your purchase cost. However, if you have previously used your timeshare for personal purposes (including an exchange or use by friends or family), you must base your depreciation on current value - which means resale value - as of the date you convert to rental use.
Assume the cost or value to use for depreciation is $5,000. The first year's deduction, based on an IRS table, should normally be 3.485% of that amount, or $174.25.
If deducting expenses from rental income results in net rental income for the year, it's taxable. If you have a net rental loss, you cannot deduct the loss. How come?
First, it's certainly legitimate to deduct rental expenses to offset rental income. However, with timeshare rentals, there are some significant limitations if you incur a loss.
Assuming that like most timeshare owners, you typically rent to tenants for one week or less at a time, your rentals don't qualify as a "rental" business. A special section of the Income Tax Regulations prohibits treating your loss as a “rental loss” if the average rental period for a particular tenant is seven days or less.
Even most tax advisors are not aware of this rule. Your tax advisor can review §1.469-1T(e)(3)(ii)(A) of the Temporary Income Tax Regulations. This regulation is also referred to in IRS Letter Ruling #9505002, which gives an indication of the IRS position on this issue as it relates to timeshares, as discussed above.
So what happens to the loss if it's not treated as a business rental loss? It falls into the passive activity loss rules of §469 of the Internal Revenue Code. Those rules prohibit deducting such losses except against other passive activity income. Such income is narrowly defined and doesn't include, for example, dividends, interest or other investment income.
Thus, you're pretty much stuck with carrying over such losses to use against positive taxable income from your rental activities in future years. You can also deduct any carryover losses related to a rental property in the year you sell that timeshare.
There are a number of complex rules that could change the result here - including the vacation home rules, rules relating to renting to tenants for longer than one week at a time, etc.
Vacation Home Rules
Wouldn't the vacation home tax rules apply to a rental gain, allowing you to avoid reporting the income, because you rented the property for fewer than 15 days? No, the vacation home tax rules will usually not apply. Thus, you must report the rental profit - whether you own one week or a number of weeks.
The vacation home rules apply only if you use the "vacation home" for at least 15 days each year for personal purposes. A timeshare can qualify as a vacation home. However, unless you own at least four weeks at a single resort, using at least three of the weeks for personal purposes, you can't take the benefit of excluding the income from renting the fourth week, because there is no practical way that you could use your timeshare for at least 15 days and rent it out to others.
Thus, in almost every situation, you must report the rental profit. You can also offset losses from some rentals against profits on others to minimize your net taxable income, but deducting a net loss is still subject to the rules above.
The Final Word
Many tax return preparers improperly handle the last two topics, dealing with rental losses and the vacation home rules. Consider taking a copy of the pertinent sections of this article to your tax advisor.
The conclusions in this article are the opinions of the author, and are not intended as a substitute for that of your personal tax advisor. Make sure you get professional advice when preparing your tax return.
If you have any additional questions, please mosey on over to our Timeshare owner forums, they are completely free and you can find tens of thousands of other owners in this community of knowledge!