As resorts continue to age and legacy resorts have increasing attrition in owners, the need for a resale mechanism and/or rentals has become paramount for sustainability. This is not news to anyone. Access to trustworthy, reliable resale markets is an ongoing problem. And rental competition adds a new dimension in the complexity of successful rental campaigns. It is always better to have an owner than a renter. Think of it as an annuity – owners pay an annual assessment but renters pay a one-time rental rate that is at the whim of the economy and market pressures, sometimes in amounts not adequate to cover the budgeted annual maintenance fee.
Association Income Tax Principles
Often resort operators will do whatever it takes to get money in the door without considering the income tax implications of the transactions. An assessment received is generally non-taxable to the Association as it is considered to be member income. This is a double win – a performing unit with an annuity payment stream and no income tax implications. Rentals of association owned units, however, are taxable transactions for income tax purposes. Delinquent owner rentals can be taxable or non-taxable depending on whether the association applies the rental proceeds to the delinquent assessment, in which case it is taxable to the owner rather than the Association. Many owner incentive-type programs are deemed to be rental in nature, such as upgrade fees, bonus weeks, etc. Therefore, the return on these revenue streams may be less than 100% once the tax effect is considered. That said, certain expenses are allocable against these types of income. However, these amounts are often not sufficient to completely offset the revenue which creates taxable income.
Most associations file a form 1120-H annually, which carries a flat federal tax rate of 32%. This form, reports limited information and takes significantly less time to prepare than Form 1120 which is filed by “regular” corporations and may be filed by associations as an alternative to Form 1120-H. The cost of the convenience of filing the less complex form is an increased tax rate. Form 1120 uses a graduated rate system starting at only 15%, but it is more difficult to prepare and is considered to carry significantly more exposure from an examination perspective. Regardless of which type of return is filed, the tax expense should be considered when budgeting for these revenue streams.
Income Tax Strategies
As mentioned above, certain expenses may be allocated to these taxable sources of income in calculating an association’s income tax liability. There are various methods of allocating these expenses and the association’s tax advisor should certainly be consulted about this. One popular approach is to allocate maintenance, housekeeping, insurance, utilities and other operational costs proportionality to rental revenue based on the percentage of rental nights to total occupied nights. Another approach is to allocate a portion of total expenses in the same proportion as rental revenue to total revenue. Most importantly, the allocations should be reasonable and consistently applied.
Sales of Association-Owned Inventory
Generally speaking, the sales of association-owned inventory are considered taxable in nature for income tax purposes. If the inventory was acquired by purchase, the cost of the inventory is a deduction against the unit sale revenue. Generally, the delinquent balance of an account related to a unit acquired by the association does not create basis in that unit. Typically, inventory costs included in the basis of an association owned unit are the cost of foreclosure or the purchase price. As more associations are acquiring units and have the opportunity for sales revenue, which will result in a performing unit owner who will pay future assessments, management and boards will need to seriously consider the tax consequences of these activities.
Consult a Qualified Professional
Often the income taxes of an association are very simple. However, if a resort is engaging in alternative methods of revenue generation, or significant rentals and/or sales, their tax returns are often more complex. The approaches described above are often useful when applied appropriately. Whether they are applicable to a particular situation or resort is a matter for careful examination. Management should consult with a qualified tax professional who has significant experience with association taxes in order to minimize exposure and make sure that the choices being made are reasonable and carry a business purpose.