VO Financial Talks About Timeshare Tax Consequences
What VO Financial Thinks Every Prospective Owner Should Know About the Purchase, Use, and Disposition of Timeshares
VO Financial has explained that Timeshare ownership is a frequently misunderstood segment of the vacation industry that provides consumers with opportunities to travel to luxurious destinations but comes with significant financial pitfalls for the unwary. This article will provide an insider’s access to critical issues that each prospective purchaser should know about before making an ownership decision, of which timeshare developers probably would not discuss in earnest. Issues to be addressed include a synopsis of the timeshare industry’s history, a summary of the benefits and disadvantages of timeshare ownership, and an analysis of the tax issues timeshare owners should know about that are caused by the use and disposition of their timeshare.
II. The Evolution of the Timeshare Industry
Timeshares originated in the French Alps during the 1960s, when ski resorts began to offer travelers the opportunity to stay at the same resort every year for an advance fee without the need to purchase the property outright. The idea spread to the United States in the 1970s, first and predominantly in Florida, and was embraced in large part because of the oil crisis in 1973, which led many consumers to cut back on expenses and large purchases and made travel more expensive. In particular, the decrease in the purchase of vacation properties, including condominium units, led developers to sell off not only individual units within a resort complex, but also fractional ownership of each individual unit. Soon, resort developers began to realize the true profit potential of timeshare. Although a consumer could purchase an interest in a vacation property for a fraction of the cost of outright ownership, the developer could sell each fractional interest in individual units for a cumulative price that far exceeded the cost to purchase an individual unit outright. Through the 1980s, the greed is good mentality spawned questionable sales tactics that haunt the timeshare industry to this day. Although state legislatures gradually began to pass consumer protection laws to regulate the timeshare industry, and reputable developers including Disney, Marriott, and Four Seasons entered the timeshare industry in the 1990s, the industry as a whole continues to face the challenge of dealing with a tarnished reputation caused by the unscrupulous developers that focus more on the bottom line than consumer protection.
III. Timeshares are Defined by Complexity
According to Black’s Law Dictionary, a timeshare interest is an interest purchased in a timeshare plan that grants the purchaser occupancy and right of use to accommodations, facilities, or recreation sites. Timeshare plans include interests purchased in any arrangement plan, scheme, or similar device, but not including certain exchange programs, whereby a purchaser in exchange for consideration receives a timeshare interest for a specified period of time that is less than a full year during any given year, but not necessarily for consecutive years, and which extends for a period of more than three years.
Consumers must know exactly what they are purchasing because there are varying legal rights and obligations depending on the type of timeshare purchased. Timeshares typically come in one of three forms: (1) fee simple ownership interests; (2) lease-type arrangements that permit a right to use; or (3) point systems in which purchasers buy points to use throughout a timeshare developer’s resort network rather than an interest in a particular unit of a development. Fee simple timeshare ownership interests are the most common form of timeshare ownership in the United States. Fee simple timeshare ownership provides the most rights to the timeshare owner, who receives an undivided interest in fee simple for an exclusive right to occupy a designated unit for a specified time period. A purchaser of a fee simple timeshare ownership receives a deed to the property and the rights that accompany deeded ownership, including title to the property, the right to rent, sell, bequeath, or otherwise dispose of the property. Developers that sell fee simple timeshare ownership typically offer either a fixed week, which provides the owner with a guaranteed use of the unit for a specific week during the year, or a floating week, which provides the owner with flexibility to use the unit during a specific time period or season depending on availability. Under a right to use arrangement, the timeshare owner does not receive a property interest, but rather the right to use the timeshare unit for a specified period of time, after which the right to use is extinguished and reverts back to the developer. Thus, in comparison to a fee simple timeshare ownership, a right to use timeshare provides an owner with a license that is governed solely by the terms of the contract rather than property law. The third type of timeshare ownership is a points system, which is structured similarly to a right to use rather than a fee simple ownership because it grants a purchaser the contractual right to use the property for a certain amount of time each year during a specific time of year for a specified number of years. However, points systems also grant purchasers advanced flexibility to access a developer’s entire network of resorts rather than an individual unit at a set location. As will be explored herein, fee simple timeshares provide tax benefits that are typically not available to purchases that are governed by contract.
No matter the type of timeshare purchased, however, all timeshare owners face the common expense of annual maintenance fees which are allocated to each owner to pay for the ongoing expense of property taxes, utilities, onsite management, recreational amenities, and of course maintaining and improving the resort. The amount of maintenance fees typically depends on the amount of ownership purchased. Prospective purchasers should be aware of the expected maintenance fees, which can be raised by the developer each year, and are a significant expense that an owner must pay even if they have paid for their ownership in full and even if the owner is unable to use their timeshare because of physical or financial concerns.
IV. Other Purchase Considerations
A timeshare provides a consumer with significant travel benefits that warrant mentioning. Consumers who purchase a timeshare are typically guaranteed a pre-paid vacation at a luxurious destination of their choice that otherwise might be beyond their financial reach of vacation ownership, and, as explained in more detail herein, the owner of the timeshare may be able to deduct interest on indebtedness and real estate taxes if the property is classified as a vacation home, and other expenses may be deductible if the property is classified as mixed-use or rental property.
The disadvantages of timeshare ownership, however, are numerous. As discussed above, a timeshare developer can increase annual maintenance fees at any time, even if the standard of luxury at the resort is in decline. There are also hidden costs and regulations that surprise many timeshare owners after the purchase, including exchange fees for point systems as well as expenses for amenities, transportation, lodging, and entertainment that a timeshare owner likely does not consider before making the purchase and later makes the timeshare less enjoyable. Most significantly, the timeshare developers that value profit over consumer protection have created a system of unscrupulous and aggressive sales tactics that often lead consumers to purchase significantly more timeshare ownership than the consumer needs or can afford to spend on vacation. Resort developers utilize a variety of advertising techniques, including direct-mail, telephone solicitation, and owner-referral programs to get consumers’ attention. The actual sale frequently takes place at the resort itself while a consumer is on vacation, after the consumer is led on a tour by a member of the resort’s marketing or sales staff who showcases the benefits of owning a timeshare. After the tour, consumers are often overwhelmed during lengthy grind sessions with aggressive salespeople, who are trained by the developers to utilize a variety of unscrupulous tactics, including today-only, hard sale, and bait and switch tactics, misleading promises of tax benefits, prizes, and eligibility for benefits and upgrades, and misrepresentations about the resort itself in order to get the consumer to agree to the sale on the spot while the consumer is still on vacation and eager to get back to relaxation. Other unscrupulous sales tactics often include telling prospective purchasers that their timeshare will appreciate in value, that the developer will help the owner rent out the timeshare, that a reservation can be guaranteed at any time the owner decides to travel, that the maintenance fees will not increase, that the developer will buy back the timeshare, that the developer will help the owner sell the timeshare, and that the salesperson will be the timeshare owner’s representative for life. Unfortunately, most timeshare purchasers realize that they have been deceived after the honeymoon phase ends, the glamour fades, the bills start rolling in, the three to ten day rescission period that would allow the owner to cancel their contract has passed, the salesperson is nowhere to be found, and as a result, the owner is stuck in a financial nightmare with no end in sight. The problem is increased when the owner attempts to sell the timeshare. Despite the frequent promise by timeshare developers of an active and productive resale market, supply is in significant excess of demand, and as a result, timeshare owners frequently are only able to recover a small fraction of their original purchase price on the virtually non-existent secondary market, and the sale may not occur until after paying a dubious resale company up to several thousand dollars and waiting a significant amount of time because timeshare developers’ initial sales tactics are far more effective than those used by individuals in the resale market. Timeshare owners desperate to avoid continuing maintenance fees frequently list their timeshare for sale for $1 on auction sites including eBay. Therefore, prior to making a purchase, the consumer should perform due diligence, including at the very least reviewing the contract to ensure that all promises made by the salesperson are contained in the terms of the contract itself.
Other purchase considerations should include the age, location, and amenities of the timeshare resort, the reputation of the timeshare developer, the size and frequency of use of the timeshare unit, the length of the contract, the perks of ownership, the down payment required, the interest rate and availability of financing, the purpose of use (vacation, rental, mixed-use), the rental and resale market for the particular resort, and state and federal consumer protection laws available to the purchaser. Of note among these additional considerations, purchase prices are often inflated well in excess of a unit’s true value to account for the developer’s marketing costs, which can account for 50 to 60 percent of the purchase price. Also, traditional financing is often unavailable to purchasers, even those with the best of credit, because the value of a timeshare cannot serve as collateral to cover the losses on a defaulted loan. As a result of the difficulty of obtaining traditional financing, most timeshare developers offer in-house financing with rates that are significantly higher than the rate charged on a traditional mortgage and typically exceed 12 percent with terms of five to ten years. Although possibly tax deductible, as discussed below, the interest expense obviously adds a significant cost to timeshare ownership that purchasers must consider. Further, state and federal consumer protection laws have become more prominent in response to consumer complaints about the unscrupulous practices. Since the majority of timeshares in the United States are located in Florida, the Florida Vacation and Timesharing Act was among the first consumer protections to be passed and still remains among the most effective. The protections afforded by the Florida Vacation and Timesharing Act include the right of a purchaser to file a civil action against a developer or other entity or individual in violation of the Act, the requirement of mandatory disclosures in purchase contracts, and the unilateral right of a purchaser to cancel the purchase contract until midnight ten days after the later of the execution date of the contract or the date when the purchaser received the last of the documents that the developer was required by the Act to disclose. Finally, tax consequences arising from the use and disposition of timeshares are often overlooked considerations that a consumer should know about before making a timeshare purchase. The remainder of this article is dedicated to that purpose.
V. Tax Consequences Based on the Various Uses of a Timeshare
The tax treatment of timeshare use is based on the type of timeshare purchased and the extent to which the property is used for personal versus rental use. The tax treatment for fee simple timeshare interests is summarized in the following table.
|Personal Use||Mixed Use||Rental|
|Criteria||Unlimited personal use, and rented at FMV for less than 15 days per year for all unit owners combined||Rented at FMV for 15 days or more per year and personal use greater of 14 days per year or ten percent of rental days for all unit owners combined||Rented at FMV for 15 days or more per year and not used for personal use for more than greater of 14 days per year or ten percent of rental days for all unit owners combined|
|Rental income recognized?||No||Yes (Form 1040 – Schedule E||Yes (Form 1040 – Schedule E)|
|Deductible expenses||Yes – interest and property taxes||Yes – allocation between rental and personal use required: (1) rental expenses (in order) (a) interest and taxes, (b) expenses not affecting basis (e.g., utilities, maintenance), (c) expenses affecting basis (e.g., depreciation); (2) personal expenses: interest and taxes||Yes – allocation between rental and personal use required: (1) rental expenses (in order) (a) interest and taxes, (b) expenses not affecting basis (e.g., utilities, maintenance), (c) expenses affecting basis (e.g., depreciation); (2) personal expenses: interest and taxes|
|Type of expense deduction||Itemized deductions (Form 1040 – Schedule A)||(1) Rental expenses: deduction for AGI (Form 1040 – Schedule E); (2) Personal expenses: (a) interest is itemized deduction assuming second residence; (b) taxes are itemized deduction (Form 1040 – Schedule A)||(1) Rental expenses: deduction for AGI (Form 1040 – Schedule E); (2) Personal expenses: (a) no interest deduction since not a second residence; (b) taxes are itemized deduction (Form 1040 – Schedule A)|
|Rental loss permitted?||No||No, but excess rental deductions may be carried forward over to future years||Yes, but may be limited by passive activity loss and hobby loss rules|
A. Tax Treatment of Personal Use of a Timeshare
As demonstrated by the table above, timeshare properties that are used exclusively for personal use receive the least complicated tax treatment, with only qualifying mortgage interest and property taxes as allowable deductions. The deductibility of fee simple timeshare mortgage interest depends on whether the timeshare is deemed a qualified home as governed by the interplay between sections 163(h)(3) and 280A of the Internal Revenue Code (IRC). First, under IRC section 163(h)(3)(B)(i), the timeshare debt must be incurred in acquiring a qualified residence and must be secured by a qualified residence. Thus, the documents the timeshare owner receives upon purchase using a mortgage must indicate that the indebtedness is secured by the timeshare. Further, the Internal Revenue Service (IRS) will treat the timeshare as a qualified second residence under IRC section 280A(d)(1) if the timeshare is used exclusively for personal use, or, if it is rented out during the year, the timeshare is used by the owner for the longer of more than 14 days or more than ten percent of the number of days during the year that the timeshare is rented at a fair rental. The IRS takes the position that timeshare owners should count their days of use and rental of the timeshare unit only during the time they have a right to use it or receive any benefits from the rental of it. If the timeshare debt is incurred in acquiring a qualified residence and is secured by a qualified residence, and the timeshare property is treated as a qualified home, the owner will be able to deduct the interest under IRC section 163(h)(3)(B)(2) if the owner’s aggregate acquisition indebtedness to purchase primary and secondary homes does not exceed $1,000,000. If the timeshare owner purchases the timeshare with the proceeds from a home equity loan secured by the owner’s primary residence, and the timeshare is a qualified home under IRC section 280A(d)(1), the interest on the home equity loan may still be deductible under IRC section 163(h)(3)(C) provided the home equity loan used to purchase the timeshare does not exceed $100,000. However, mortgage indebtedness that is incurred to purchase right to use and points systems that are not tied to a fee simple deed are likely ineligible for favorable tax deductions because they are not secured as required by IRC section 163(h)(3)(B)(i) and therefore cannot treated as property interests that qualify for second home mortgage interest deductions. One way to solve this problem is to purchase the right to use timeshare interest with funds acquired from a home equity loan that qualifies for deduction on the first $100,000 of debt under IRC section 163(h)(3)(C) regardless of what is purchased with the home equity indebtedness.
Taxpayers who use their timeshare exclusively for personal use are also permitted by IRC section 164(a)(1) to deduct the real estate taxes allocated to their timeshare. These property taxes are typically included in the annual maintenance fees paid by timeshare owners, so taxpayers should be careful to ask their developer for a breakdown of the real estate taxes that are included in the annual maintenance fees. Many developers will provide this information to timeshare owners in an annual statement.
If available, deductions for mortgage interest and property taxes are treated as itemized deductions from adjusted gross income (AGI) and are reported on Schedule A of Form 1040, but the itemized deductions may be subject to the high-income phase out under IRC section 68(a) or the alternative minimum tax (AMT) under IRC section 55.
B. Tax Treatment of Mixed-Use Timeshares
Once a timeshare owner begins renting out their timeshare, they step into a much more complex tax arena that is filled with complicated calculations and daunting practical dilemmas. Timeshare owners can qualify for mixed-use treatment under IRC section 280A if they rent out their timeshare unit at fair market value to an unrelated party for 15 days or more per year and use the timeshare unit for their own personal purposes for more than the greater of: (1) 14 days per year; or (2) 10 percent of the total days rented. When determining the rental and personal use days for the 15, 14, and 10 percent cutoffs, IRC section 280A(d)(2)(A) requires the timeshare owner to include the combined use of all owners of a given timeshare unit. Consistent with Proposed Treasury Regulation (Prop. Reg.) 1.280A-3(d)(3)(iii), the IRS interprets IRC section 280A(c)(5)(B) as requiring expenses to be allocated based on total days occupied as opposed to 365 days. However, in the leading court case on this issue, Bolton v. Commissioner, 694 F.2d 556 (9th Cir. 1983), the Court of Appeals for the Ninth Circuit of the United States held that deductible expenses should be allocated to rental use based on total days in the year, creating the possibility for more personal use deductions because of a smaller rental use allocation. Counting the amount of rental days for an entire dwelling unit is often a compliance problem because an individual timeshare owner would have a hard time determining how many days the unit is rented out by the other owners of the timeshare unit. The total number of rental days is not provided by the timeshare developer, and most timeshare owners do not know the other owners of the timeshare unit. As a result, a reasonable approach in the absence of this information may be to allocate expenses between personal and rental use based on a given owner’s personal and rental use percentages for the year.
Timeshare owners who purchase units for mixed use must track and allocate expenses between personal use and rental use and are precluded from deducting a loss in connection with the rental activity. Expenses allocated to personal use are deducted as would be deductions for timeshares used exclusively for personal purposes. Expenses allocated to rental activity, however, must be deducted against rental income in the order required by Prop. Reg. 1.280A-3(d) as follows: (1) expenses otherwise deductible independent of rental activity (qualified mortgage interest and property taxes); (2) expenses attributable to the rental activity that do not result in a property basis adjustment (including advertising, utilities, repairs and maintenance, commissions paid for collection of rent, and insurance premiums); and (3) expenses attributable to rental activity that result in property basis adjustment (depreciation). Since no rental loss is permitted to be recognized for mixed use property, pursuant to Prop. Reg. 1.280A-3(d)(1), the allocable portion of expenses attributed to rental activity cannot exceed the rental income for the taxable year. The ordering process and no-loss restriction for rental deductions in mixed used property make it very unlikely that a timeshare owner will be able to deduct expenses for depreciation. However, IRC section 280A(c)(5) permits timeshare owners to carry over any rental expenses that are not permitted to be deducted in the current year to offset rental income in subsequent taxable years.
To the extent that deductions are permitted for mixed use property, a timeshare owner must report the rental income and deductions on Schedule E of Form 1040. The portion of property tax expenses allocable to personal use may be taken as an itemized deduction on Schedule A without restriction. The portion of mortgage interest allocated to personal use may only be deducted if the timeshare owner’s personal use is sufficient to qualify the timeshare for the second residence classification. In order to deduct the portion of mortgage interest allocated to personal use, Temporary Regulations (Temp. Reg.) 1.163-10T(p)(3)(iii) and (p)(6) permit the timeshare owner to use only the timeshare owner’s rental days, not the combined rental days of all owners of a given unit.
C. Tax Treatment of Rental Only Timeshare Use
The circumstance will be very rare that a timeshare owner will be able to classify their use as rental only. In order to be classified as a rental only timeshare under IRC section 280A, the timeshare unit must be rented at fair market value to an unrelated party for 15 days or more per year and not used for personal purposes for more than the greater of: (1) 14 days per year; or (2) 10 percent of the total days rented. If a timeshare owner can meet the test for classification as rental only, then all rental income from the property must be included in the timeshare owner’s gross income, all eligible expenses attributable to the timeshare owner’s rental activity may be deducted, and the timeshare owner may report a net loss for the rental activity. However, interest expense allocable to the personal use may not be deducted because the timeshare owner could not classify the timeshare as a qualified second home under IRC section 280A(d) (requiring personal use to be more than the greater of 14 days or ten percent of rental days). In contrast, property taxes allocable to the personal use may be deducted without restriction because there is no requirement to use the timeshare for a certain period of time in order to qualify for real estate tax deductions. Despite the efforts set forth above to elaborate on the tax consequences for rental only use of timeshares, extensive discussion of rental only classification for timeshares is from a practical perspective virtually needless, because IRC section 280A(d)(2)(A) and Prop. Reg. 1.280A-3(f)(3) require the timeshare owner to consider not only his or her own personal use but in total the combined personal use of all owners of the timeshare unit. Thus, as discussed in the previous subsection of this article, the significant majority of timeshare owners that rent their timeshare units should consider the tax consequences of mixed use timeshares.
If nothing else other than to meet the page number requirement of this article, just kidding, it should be noted that in the event that a timeshare does qualify for eligibility to be treated as a rental only use, passive loss and hobby loss deduction limitations restrict the timeshare owner’s ability to record a net loss for their timeshare rental activity. Timeshare rental is deemed a passive activity under IRC section 469, which restricts timeshare owners from deducting the expenses of timeshare rental activity in excess of rental activity income. The timeshare owner may carry over expenses of timeshare rental activity that are in excess of the current year’s passive rental activity income to offset passive rental activity income in subsequent years for as long as the taxpayer owns the timeshare interest. Similarly, in the event that the timeshare owner is not deemed to be engaged in the rental activity for profit, the hobby loss rules under IRC section 183 limit the deduction of expenses to the extent of income from the rental activity.
D. Basis Adjustments for Depreciation and Capital Improvements of Timeshares
A timeshare owner’s tax consequences may change from year to year depending on the use of the timeshare, and, as a result, the availability of depreciation against the adjusted basis of the timeshare is an important but often overlooked consideration when a timeshare qualifies for mixed use or rental only use tax treatment. Pursuant to IRC sections 1016 and 167, such allowable depreciation lowers the adjusted basis of the timeshare and results in an increased gain or decreased loss on disposition of the timeshare.
Whereas depreciation adjusts a timeshare owner’s basis downward, the adjusted basis may also increase in the event the timeshare owner is required to contribute to capital improvements of the timeshare property. Timeshare developers will occasionally assess a flat fee to timeshare owners to cover major repairs or improvements to the resort. These payments are not immediately deductible, but instead are required to be capitalized and result in an increase to the timeshare owner’s adjusted basis. Similarly, the portion of annual maintenance fees that is allocated to a capital reserve account will also increase the timeshare owner’s adjusted basis. Timeshare owners will recover the basis increase through future depreciation if allowable or upon disposition of their timeshare interest.
V. Tax Consequences Based on the Various Dispositions of a Timeshare
The tax treatment of timeshare disposition depends on the type of disposition, whether it be by sale, gift, bequest, charitable contribution, foreclosure, abandonment, or deed in lieu of foreclosure. The tax treatment for dispositions of timeshare interests is summarized in the following table.
Method of disposition
|Sale of personal use timeshare||Losses are not deductible; gains are taxed at preferential capital gains rate.|
|Sale of mixed use timeshare||Personal use portion: losses are not deductible and gains are taxed at preferential capital gains rates. Rental use portion: net IRC section 1231 losses are deductible as ordinary losses; gains are taxed at preferential capital gains rate assuming no depreciation recapture.|
|Sale of rental only timeshare||Net IRC section 1231 losses are deductible as ordinary losses, gains are taxed at preferential capital gains rate assuming no depreciation recapture, and previously disallowed passive activity losses are used to increase loss or reduce gain.|
|Gift||Gift tax assessed on donor to extent fair market value exceeds annual gift tax exclusion, donee receives donor’s adjusted basis (increased by any previously disallowed passive activity losses) for purpose of gain calculation on disposition by donee, donee assumes fair market value basis as of date of gift for purposes of loss calculation on disposition by donee if property declined in value when held by donor, and for transfers between spouses or incident to divorce, recipient spouse takes a carryover basis.|
|Bequest upon death of owner||Fair market value on date of death included in decedent’s gross estate and possibly subject to estate tax, and beneficiary gets stepped up basis (fair market value on date of decedent’s death or alternative valuation date).|
|Charitable contribution||Deduction permitted up to fair market value on date of death assuming appraisal obtained, less ordinary income otherwise recognized on sale (depreciation recapture).|
|Foreclosure||Ordinary loss deduction if rental use elevated to trade or business, discharge of indebtedness income recognized unless exceptions apply, nondeductible capital loss if personal use, gain recognized if amount realized on account of mortgage relief exceeds basis.|
|Bankruptcy||No gain or loss recognized.|
|Abandonment / Deed in lieu of foreclosure||No income because fair market value will be reported in excess of debt canceled, and no gain because amount realized on account of mortgage relief will typically be less than basis. Loss not deductible.|
A. Tax Consequences from the Sale of a Timeshare Interest
Most timeshare owners that sell their timeshare interests will be in the unfortunate position of realizing a loss that they cannot recognize for tax purposes. Despite what many unscrupulous developers tell prospective purchasers, timeshare interests have long been known to be an unwise investment for appreciation. The high cost of timeshares purchased from the developer combined with the virtually non-existent resale market leads nearly all timeshare owners to suffer a loss on the sale. Some timeshare developers offer buy-back programs, while other timeshare developers say that they will buy back a timeshare when the developer does not in fact have a buyback program, so timeshare purchasers are cautioned again to read the contract and all its fine print before making a purchase. For those timeshare developers that actually do have buyback programs, they are likely to charge a hefty commission or purchase the timeshare back in exchange for only the timeshare owner’s debt balance, resulting in a net loss to the timeshare owner on disposition in any event. Those timeshare owners who are not able to sell their interest back to the developer are forced to deal with the trials and tribulations of the dubious resale market.
Under IRC section 1001, gain or loss on the disposition of a timeshare is calculated by subtracting the adjusted basis of the interest from the amount realized (cash and other consideration received), net of costs to facilitate the sale. Under IRC section 1011, adjusted basis equals the timeshare’s original purchase cost (including cash paid, debt incurred, and costs to facilitate the purchase), plus assessments or fees paid for capital improvements paid during ownership, minus any depreciation taken on the timeshare. The character of the resulting gain or loss depends on whether the timeshare was classified at the time of sale as personal use, mixed use, or rental only.
As discussed above, most timeshare owners will receive a nondeductible loss because the use of their timeshare is likely to be classified as personal, similar to the sale of an automobile. Under IRC section165(c), losses on personal use capital assets are not recognized for tax purposes unless they are incurred as a result of a casualty or theft, and a sale is not a casualty or theft. In the unlikely event that a timeshare owner realizes a gain on the sale, the gain is characterized as a capital gain under IRC section 1221, and is eligible for long-term preferential tax rate treatment under IRC section 1222 if held by the timeshare owner for more than one year prior to the sale. Timeshare owners will not qualify for the principal residence gain exclusion available under IRC section 121.
Timeshare owners that are lucky enough to receive the complex treatment of mixed use property are even luckier to deal with the additional complexity of a deemed disposition of two assets upon sale, one representing the portion allocated to personal use and another representing the portion allocated to rental use. The IRS takes the position that the timeshare owner must allocate not only the sales price but also the basis between the two assets. For example, depreciation would reduce the basis of the portion allocated to rental use and not the portion allocated to personal use. As is the case for losses and gains realized on the disposition of personal use timeshares, the loss that is allocated to personal use upon the disposition of a mixed use timeshare is deemed a nondeductible recognized loss and the gain that is allocated to personal use is recognized and will be eligible to receive long-term treatment if held for more than one year prior to sale. A timeshare owner must initially characterize the loss that is allocated to the rental use as a section 1231 loss, but the loss may eventually be treated as a more preferential ordinary loss for tax purposes after the netting process required by section 1231. Similarly, the gain that is allocated to the rental use portion must be characterized initially as a section 1231 gain, and may eventually be recognized as a capital gain after the netting process required by section 1231. Under even rarer circumstances, timeshare owners may be required to recharacterize a portion of gain recognized as ordinary income under the depreciation recapture rules of IRC sections 1245 and 1250. The treatment of rental only timeshare dispositions is the same as the portion of mixed use timeshare dispositions that is allocated as a rental use asset. In addition, however, timeshare owners who dispose of rental only timeshares may deduct previously disallowed passive activity losses pursuant to IRC section 469(g)(1).
Timeshare owners that are expecting a loss on the disposition of their timeshare and want to benefit from rental use disposition treatment are essentially prevented from converting their personal use timeshare into a rental use timeshare on the eve of sale. Upon the conversion, the timeshare owner must adopt as the adjusted basis of their timeshare the lesser of (1) the timeshare’s adjusted basis or (2) the timeshare’s fair market value on the date of the conversion. As a result, timeshare owners cannot deduct the decrease in value that occurred prior to the conversion.
B. Tax Consequences from the Gift of a Timeshare Interest
Unscrupulous developers commonly misrepresent to prospective purchasers that timeshare owners can give something of benefit to their children or receive a tax deduction for giving their timeshare to charity. Whether the owner is still alive or makes the gift in their will, the gift of a timeshare is often more headache than it is worth to the donor and recipient (donee) because of the ongoing maintenance fees, difficulties selling the timeshare, and the need for tax purposes to determine the timeshare’s fair market value.
In the event a timeshare owner gifts their timeshare interest to an individual other than a spouse while living, the timeshare owner may receive the benefit of the annual gift tax exclusion under IRC section 2503(b)(1). Under IRC section 1015(a), the donor’s basis would carry over to the donee (increased under IRC section 469(j)(6)A) by any previously disallowed passive activity losses) in the unlikely event the donee disposed of the timeshare at a gain, but the donee would take the fair market value at the time of the gift as the donee’s adjusted basis in the likely event that the timeshare declined in value while owned by the donor. Transfers to a spouse while living by gift or incident to divorce will not be subject to any gain or loss to the donating spouse under IRC section 1041(a), nor federal gift tax tax because of the unlimited marital deduction under IRC section 2523(a)(1), and the donee spouse would adopt the donor spouse’s adjusted basis under IRC section 1041(b).
The difficulty of gifting a timeshare interest can also be a headache for timeshare owners considering making a gift of their timeshare interest to a qualified charity because IRC section 170(f)(11)(C) requires formal appraisals to support charitable donations in excess of $5,000 and overvaluations can result in significant tax penalties. The IRS may deny the deduction in its entirety if the timeshare owner fails to substantiate the deduction as required. Under IRC section 170(e)(1), timeshare owners are permitted to take a charitable deduction up to the fair market value of the interest at the time of the transfer (less ordinary income required as depreciation recapture). Among the few timeshare owners that can classify their use as rental, the unwary owner who donates a timeshare that has depreciated in value during their ownership loses the deductibility of a capital loss. A solution may be for the timeshare owner to sell the timeshare and then donate the proceeds. In any event, many charities will not accept a timeshare as a donation because of the ongoing maintenance fees and difficulties in selling the timeshare. A timeshare owner is not entitled to a charitable deduction for donating the use of a week rather the entire timeshare ownership itself.
Timeshare interests are included in the gross estate of a decedent at the value of the interest at the time of the decedent’s death under IRC section 2031 or at the six-month alternative valuation date under IRC section 2032. Depending on the size of the decedent’s gross estate, the value could be subject to estate tax. A recipient heir receives a stepped-up of stepped-down basis in the timeshare interest equal to the value of the interest included in the decedent’s estate under IRC section 1014. Thus, any unlikely appreciation in the timeshare while owned by the decedent escapes income taxation. Similarly, in the unlikely event the timeshare was classified as rental use, the potential loss deductions available based on the decline in value and excess rental losses incurred during the decedent’s ownership would be permanently lost.
C. Tax Consequences from other Terminations of a Timeshare Interest
The most unfortunate effect of the unscrupulous practices of timeshare developers is the eventual financial ruin of many timeshare owners, many of whom incur upwards of hundreds of thousands of dollars in debt in timeshare interests with no possibility of ever being able to pay off the high interest debt. Although some of these timeshare owners face the possibility of foreclosure or bankruptcy, many are unaware of the possibility of eliminating their timeshare debt by giving the deed back to the developer through a deed in lieu of foreclosure.
The IRS takes the position that a timeshare interest that is included in a bankruptcy estate does not result in any tax consequences to the timeshare owner because the transfer is not a deemed disposition but rather a non-event for tax purposes. Timeshare owners who file under Chapter 7 of the Bankruptcy Code will be required to liquidate their assets to pay off outstanding debts, and a trustee assigned by the court to manage the bankruptcy estate will be required to attempt to sell the timeshare before the court will eliminate the balance of debt and maintenance fees owed. In a Chapter 13 filing, the court restructures debts into an affordable payment plan payable in installments, and the court may ask a timeshare owner to surrender the timeshare back to the developer in order to free up cash to repay other creditors. Although bankruptcy can eliminate the debt incurred and outstanding maintenance fees, under section 523(a)(16) of the Bankruptcy Code, the post-petition maintenance fees will likely continue to accrue to the timeshare owner in the event that the title of the timeshare does not transfer despite the interest being listed for surrender in the bankruptcy petition.
In a foreclosure of a timeshare interest, if the timeshare interest secures the debt on which the timeshare owner is personally liable, the debt is considered a recourse debt, and under IRC sections 61(a)(12) and 108 the timeshare owner must report as ordinary income the amount by which the canceled debt is more than the fair market value of the property. The fair market value will be reported by the lender on a Form 1099-C. If the lender reports the fair market value for purposes of the Form 1099-C as higher than the canceled debt, or if the debt is a non-recourse debt, the timeshare owner will not have any ordinary income upon the foreclosure of their timeshare interest. Moreover, under the Crane doctrine, for purposes of determining the gain or loss on the deemed disposition, the amount realized includes any cash received plus the liability forgiveness that is not deemed discharge of indebtedness income. Thus, the gain or loss is equal to the cash received plus the discharged debt minus the timeshare owner’s adjusted basis. In most situations, a timeshare owner’s debt will be less than the original purchase price, assuming the debt is not subject to reverse amortization, so the gain realized will likely be equal to the cash received that combined with the canceled debt exceeds the adjusted basis. The best outcome for the timeshare owner facing a foreclosure from a tax consequence is to recognize an ordinary loss deduction if the timeshare owner elevated their rental activity to a trade or business. In the event that the timeshare was classified as a rental use property but the activity did not rise to the level of a trade or business, a timeshare owner will likely recognize a capital loss. If the timeshare was classified as personal use property, however, the loss would not be deductible. Of course, bankruptcies and foreclosures also have significant and long-lasting impact on a timeshare owner’s credit rating.
If timeshare owners are falling behind on paying for their debt and maintenance fee obligations and having trouble selling their timeshare interest for a reasonable price, one option that is not widely known or utilized is a deed in lieu of foreclosure, in which the timeshare developer takes back the deed to the timeshare interest in exchange for a complete termination and satisfaction of the associated debt. The deed in lieu of foreclosure solution offers significant benefits to both the timeshare owner and the timeshare developer. Timeshare owners can eliminate the debt that is secured by the timeshare interest without the significant damage to their credit because the loan is marked as satisfied or paid as agreed on their credit report, in contrast to the devastating impact of a foreclosure or bankruptcy. Timeshare owners are also likely to not have any discharge of indebtedness income or taxable gain. For purposes of calculating the discharge of indebtedness income, the timeshare developer should report to the IRS the fair market value of the timeshare interest on a Form 1099-A. Because there is no sale that takes place upon executing the deed in lieu of foreclosure, the timeshare developer typically lists the fair market value of the timeshare interest as the amount for which the developer will list the interest for resale in its inventory. This estimate of fair market value is of course different from the traditional definition of fair market value, which would reflect the value of the timeshare to the owner on the secondary market. However, the timeshare developer’s sales price typically rises every year despite market conditions, so the fair market value is typically listed by the developer on the Form 1099-A as an amount that is significantly higher than the debt that is canceled. In other words, the timeshare is worth much more as an asset to the developer than it is to the owner. In addition, the timeshare owner is likely not to recognize any gain on the deemed disposition. The amount realized under Crane is simply the canceled debt because no cash is typically exchanged. As a result, the timeshare owner does not recognize any discharge of indebtedness income and is likely to realize a non-deductible loss on the deemed disposition. There is, of course, a reciprocal benefit to the developer, which gets the interest back in its inventory right away without having to deal with the expense or delay caused by judicial foreclosure proceedings, and the developer can sell the timeshare interest at a significant profit to the next unwary customer. Despite this reciprocal benefit, many timeshare developers will not offer a timeshare owner a deed in lieu of foreclosure right away. In order for a timeshare owner to be offered a deed in lieu from these unscrupulous developers, the owner will have to survive deceptive and harassing collections efforts for a set period of time before the owner’s account is forwarded out of collections. The deed in lieu of foreclosure option has created a market for companies like VO Financial Corporation to educate timeshare owners regarding various options that are available and to guide timeshare owners through the daunting task of surviving the developer’s continuing deceptive practices.
The timeshare industry is fraught with unscrupulous developers that use deceptive and sometimes fraudulent tactics to lure prospective purchasers into financial nightmares. In order to ensure a more pleasant timeshare ownership experience, consumers should learn the benefits and disadvantages of timeshare ownership, including the many complexities of timeshare tax consequences, prior to making any purchase.
BY: Joshua L. Gayl Esq
 Benson, David A., “Timeshare Ownership: Regulation and Common Sense,” 18 Loy. Consumer L. Rev. 459, 461 (2006).
 Id. at 462.
 Cameron, Elizabeth A. and Maxwell, Salina, “Protecting Consumers: The Contractual and Real Estate Issues Involving Timeshares, Quartershares, and Fractional Ownerships,” 37 Real Est. L. J. 278, 297 (Spring 2009); Benson, 18 Loy. Consumer L. Rev. at 462.
 9C Am. Jur. 2d Bankruptcy § 2199 (2005); 11 U.S.C. § 101(53D); Fla. Stat. §§ 721.01-721.32 (the Florida Vacation Plan and Timesharing Act).
 Benson, 18 Loy. Consumer L. Rev. at 464.
 Cameron and Maxwell, 37 Real Est. L. J. at 279; Craig, Caroline K., and Luttman, Suzanne M., “Taxation of Timeshares – Acquisition, Use, and Disposition Issues,” 27 J. Real Est. Tax’n 301, 302 (Summer 2000).
 Craig and Luttman, 27 J. Real Est. Tax’n at 302.
 Benson, 18 Loy. Consumer L. Rev. at 465.
 The use of the term owner will be used throughout this article even for purchasers of right to use and points systems who, technically speaking, do not own property per se.
 Benson, 18 Loy. Consumer L. Rev. at 465-67.
 Id. at 467-68.
 Timeshare owners seeking greater flexibility can register for an annual fee and a per use fee with exchange programs such as Resort Condominiums International (RCI) or Interval International (II), which assist owners in trading their timeshare stay for a stay at a different resort location or at a different time. Cameron and Maxwell, 37 Real Est. L. J. at 287.
 Cameron and Maxwell, 37 Real Est. L. J. at 290; Benson, 18 Loy. Consumer L. Rev. at 469.
 Cameron and Maxwell, 37 Real Est. L. J. at 281; Benson, 18 Loy. Consumer L. Rev. at 469.
 Cameron and Maxwell, 37 Real Est. L. J. at 281.
 Id. at 284.
 Long, Travis H., “Timeshare Tax Issues,” Cedar Street Times (September 7, 2012); Cameron and Maxwell, 37 Real Est. L. J. at 281.
 Long; Cameron and Maxwell, 37 Real Est. L. J. at 291.
 Id. at 293-94; Benson, 18 Loy. Consumer L. Rev. at 469.
 Struck, Heather, “Got a Penny? Buy a Timeshare,” Reuters (May 25, 2012).
 Cameron and Maxwell, 37 Real Est. L. J. at 284.
 Craig and Luttman, 27 J. Real Est. Tax’n at 303-05.
 Id. at 304.
 Cameron and Maxwell, 37 Real Est. L. J. at 288.
 Craig and Luttman, 27 J. Real Est. Tax’n at 305.
 Fla. Stat. §§ 721.01-721.32
 Cameron and Maxwell, 37 Real Est. L. J. at 296; Benson, 18 Loy. Consumer L. Rev. at 469-475.
 Craig and Luttman, 27 J. Real Est. Tax’n at 307.
 Id. at 306.
 If a timeshare owner purchases multiple fee simple interests at different resorts, only one of the timeshares is eligible for the qualified interest deduction. However, a timeshare owner who purchases multiple weeks at one resort is likely able to consider the multiple weeks as one residence for purposes of the qualified interest deduction. McClintock, David H. and Czerwonka, John R., “Timeshares and Tax Deductions,” TimeSharing Today, p. 18 (July/Aug. 2001).
 IRS Publication 936 (2012).
 Craig and Luttman, 27 J. Real Est. Tax’n at 308.
 Even timeshare owners who only occasionally rent out their timeshare interest for just a few days are unlikely to receive the tax-free rental treatment because the rental limitation of 15 days under IRC § 280A(g) takes into account the number of rental days for the entire dwelling unit, and thus all owners of a given unit must rent out the unit for less than 15 days. Thus, a timeshare owner that only occasionally rents out their unit is more likely subject to the much more complicated mixed use classification for tax purposes rather than the personal use rules. Craig and Luttman, 27 J. Real Est. Tax’n at 309.
 Saibeni, August A., “How About a Vacation from the Complexity of Vacation Home Rules,” The CPA Journal (April 2007); Craig and Luttman, 27 J. Real Est. Tax’n at 310, n. 18.
 Id.; Craig and Luttman, 27 J. Real Est. Tax’n at 310.
 Craig and Luttman, 27 J. Real Est. Tax’n at 310.
 Id. at 309.
 Personal use is defined by IRC § 1.280A(d)(2) and Prop. Reg. 1.280A-1(e)(1) to include use by the owners, lineal family members of the owners, anyone with whom the owner exchanges use of the timeshare, and anyone who rents the property for less than fair market value. Saibeni; Craig and Luttman, 27 J. Real Est. Tax’n at 309, n. 17. Days that a timeshare owner donates are also included as personal use. Saibeni, citing Rev. Rul. 89-51, 1989-1 C.B. 89.
 Craig and Luttman, 27 J. Real Est. Tax’n at 310-11.
 Craig and Luttman, 27 J. Real Est. Tax’n at 311.
 Id. at 313.
 Craig and Luttman, 27 J. Real Est. Tax’n at 313.
 Under § 469(i), if a timeshare owner actively participates in the rental activity of their timeshare by making bona fide and significant management decisions and the timeshare is not eligible for personal use or mixed use treatment, the timeshare owner may qualify for the rental real estate exception to the passive loss rules, which would enable the timeshare owner to deduct up to $25,000 per year in rental activity losses in the current year even in the absence of offsetting rental income. The deduction is limited to the extent the timeshare owner’s adjusted gross income is in excess of $100,000. To the extent that the timeshare owner’s material participation rental activity losses exceed $25,000 in a given year, the timeshare owner can carry over the excess to offset ordinary income in subsequent years subject to § 469(i)(1) and Treasury Regulation (Reg.) 1.469(h)(3)(j). If, however, the timeshare owner rents out their timeshare for seven days or less, or 30 days or less with significant personal services provided, the timeshare owner is not considered under Temp. Reg. 1.469-1T(e)(3)(ii) to be engaged in rental activity for the purposes of the rental real estate exception to the passive loss rules. Such timeshare owners are unlikely to meet the more stringent test for material participation in a non-rental real estate activity as defined and required by Temp. Reg. 1.469-5T to deduct the losses in the event the rental real estate loss exception is not available. McClintock, David H., “Tax Aspects of Renting Your Timeshare,” TimeSharing Today (publication date unknown), <www.redweek.com/resources/articles/tax-aspects-renting-timeshare> (last visited February 27, 2013); Saibeni; Craig and Luttman, 27 J. Real Est. Tax’n at 314, and n. 24.
 Craig and Luttman, 27 J. Real Est. Tax’n at 314.
 A timeshare owner is presumed to be engaged in activity for profit if the rental activity results in profit in three of five consecutive years. Craig and Luttman, 27 J. Real Est. Tax’n at 314, citing IRC § 183(d); Lukens v. Commissioner, 945 F.2d 92 (5th Cir. 1991); Ames v. Commissioner, TCM 1990-87.
 Craig and Luttman, 27 J. Real Est. Tax’n at 314-15.
 Id. at 315.
 Id. at 316.
 Benson, 18 Loy. Consumer L. Rev. at 475-78 (e.g., “…a timeshare purchase should be viewed as an investment in future vacations rather than a financial investment.”); Ziobrowski and Ziobrowski, “Resort Timeshares as an Investment,” The Appraisal Journal (October 1997), pp. 371-80.
 Long; Craig and Luttman, 27 J. Real Est. Tax’n at 317.
 Cameron and Maxwell, 37 Real Est. L. J. at 293-94.
 Craig and Luttman, 27 J. Real Est. Tax’n at 317.
 McClintock, David H., “Tax Aspects of Selling Your Timeshare,” TimeSharing Today (publication date unknown) <www.redweek.com/resources/articles/tax-aspects-selling-timeshare> (last visited February 28, 2013).
 Most timeshare owners will receive a Form 1099 upon the sale of their timeshare, in which the gross proceeds of the sale are reported to the IRS. Therefore, even if a timeshare owner realizes a non-deductible loss on the disposition of their timeshare, they should report the sale on their tax return in order to avoid the increased likelihood of being selected for an audit. McClintock, “Tax Aspects of Selling Your Timeshare.”
 IRS Publication 544 (2012).
 Under IRC section 1231, a timeshare owner must net out (1) gains and losses from long-term business use casualties and (2) gains and losses from sales, exchanges and involuntary conversions of section 1231 assets. If a net section 1231 loss results, the loss will be treated as an ordinary loss. If a section 1231 gain results, the gain will be treated as long-term capital gain subject to the “lookback” provision of IRC section 1231(c).
 Craig and Luttman, 27 J. Real Est. Tax’n at 318-19.
 McClintock, “Tax Aspects of Selling Your Timeshare”; Craig and Luttman, 27 J. Real Est. Tax’n at 319.
 Fair market is what a willing buyer would pay the timeshare owner for the timeshare interest in an open market, as opposed to the timeshare owner’s purchase price or the timeshare developer’s current selling price for similar timeshares. The resale market, dubious at best, is the best evidence of the fair market value of timeshare interests. McClintock, David H., “Donating Your Timeshare to Charity,” TimeSharing Today (publication date unknown) <www.redweek.com/resources/articles/donating-timeshare-to-charity> (last visited on March 1, 2013).
 www.irs.gov/Charities-&-Non-Profits/Substantiating-Charitable-Contributions (last updated Aug. 2, 2012); McClintock, “Donating Your Timeshare to Charity.”
 Towell v. Commissioner, T.C. Summ. Op. 2010-141; No. 8002-09S (9/21/10); Teitell, Conrad, “Charitable Giving Tax Pitfalls: Avoiding, Climbing Out; Cyanide Capsule?,” ST050 ALI-ABA 651 at section II, subsection X (“Timeshare Gift – No Appraisal, No Deduction”).
 Craig and Luttman, 27 J. Real Est. Tax’n at 320.
 McClintock, “Donating Your Timeshare to Charity.”
 Craig and Luttman, 27 J. Real Est. Tax’n at 321.
 IRS Publication 544 (2012).
 Westbrook, Allison, “Bankruptcy & Timeshares,” (original publication unknown) <www.ehow.com/info_8014281_bankruptcy-timeshares.html> (last viewed on March 1, 2013).
 Kelly, Jeffrey, “Bankruptcy – Wipe Out Debt Owed on Timeshares,” <www.kellycanhelp.com/bankruptcy-wipe-out-debt-owed-on-timeshare> (last visited on March 1, 2013).
 If a lender cancels or forgives a debt of $600 or more, the lender is required to issue a Form 1099-C stating the amount of debt canceled and the date of the cancellation. If the Form 1099-C is being used for the purpose of reporting a foreclosure, execution, or similar sale, the fair market value is also to be entered in the Form 1099-C. Under Temp. Reg. §1.6050J-1T, question/answer #32, for purposes of calculating fair market value in the case of a foreclosure, execution, or similar sale, the fair market value for purposes of the Form 1099-C reporting requirement is “in general, in the absence of clear and convincing evidence to the contrary, the proceeds of the foreclosure, execution, or similar sale will be considered the fair market value of the property for purposes of this reporting requirement.”
 Crane v. Commissioner, 331 U.S. 1 (1947).
 Craig and Luttman, 27 J. Real Est. Tax’n at 321.
 Westbrook, Allison, “Bankruptcy & Timeshares”; Craig and Luttman, 27 J. Real Est. Tax’n at 322.
 The Form 1099-A requires the developer to state the date of the lender’s acquisition or knowledge of the abandonment, the balance of the principal outstanding on the loan, the fair market value of the timeshare acquired, whether the borrower is personally liable for the payment of the debt (recourse or non-recourse), and a description of the timeshare interest.
Disclaimer: This is for information purposed only, and should not be used as legal advise