Whether it be in the sunny south or in Canada, time-sharing and fractional ownership are common alternatives to traditional cottage ownership. However, to avoid buyer’s remorse, research is important before signing on the dotted line.
Time-sharing or fractional ownership?
Although the terms time-sharing and fractional ownership are often used interchangeably, the two are distinct.
In time-sharing, a user enters a lease arrangement — usually for an extended period, such as 50 years. The user doesn’t receive an ownership interest but has the right to occupy the property at designated times.
In addition to the fee associated with being granted the lease, the user pays a fee to the management company for overseeing the operations of the property.
Fractional ownership, on the other hand, creates an ownership interest. In most cases, the property is divided into several shares, and the purchaser buys one or more shares. They pay a one-time purchase price and receive a fractional ownership in both the building and land. As with time-sharing, the user is contractually obliged to pay an ongoing maintenance fee.
Since the owner has title, they’re free to sell their shares on the open market or pass them down to future generations.
Considerations before signing an agreement
Regardless of whether entering a time-sharing or fractional ownership arrangement, several factors must be considered.
Some costs may not be obvious when first reading the agreement. For instance, some agreements stipulate an additional fee to swap properties, if swapping is allowed. Also, the ongoing maintenance fee is subject to HST/GST if the property is in Canada.
Since fractional ownership creates a legal ownership interest, the purchaser will be required to calculate and submit land transfer tax in provinces such as Ontario.
Consumer protection legislation
The agreement is governed by the law in the jurisdiction where the property is located. Before purchasing, it’s advisable to seek legal counsel to determine what the law says.
Some jurisdictions have cooling-off periods during which a purchaser can cancel the agreement without reason. For instance, Ontario’s Consumer Protection Act provides a 10-day cooling-off period. The act also provides for the purchaser to cancel the agreement within one year if they don’t receive a copy of the agreement.
Florida has a similar 10-day cooling-off period; Arizona provides only a seven-day period; and Mexico, a five-day period.
Buying as an investment
If an important factor in fractional ownership is investment growth, it’s prudent to research the local real estate market to ensure that the property is in an appreciating market.
An advisor should also discuss with the purchaser how the investment compares with the potential return of investing in the stock market.
Read the purchase agreement carefully and discuss the terms with legal counsel. Watch for these contract terms:
- Management fee calculation: Does the user of the property have any control over the fee, or can it be increased unilaterally by the management company?
- Renting the property to third parties: Can the user or purchaser rent out their assigned weeks either on their own or through the management company?
- Reselling or bequeathing: What are the terms associated with reselling or bequeathing? Often in time-sharing, the user doesn’t have the right to bequeath their interest and is restricted in reselling it.
- Termination rights: In time-sharing, what steps are required should the user decide to terminate the agreement?
In Canada, fractional ownership purchases are normally considered transactions on account of capital, and, upon sale, any increase in value will be taxed as a capital gain. A time-share arrangement may also be capital property depending on the holders’ right to sell their interests.
In many cases, a fractional ownership likely wouldn’t qualify as a principal residence, as it wouldn’t satisfy the rule that it must ordinarily be inhabited. However, should it qualify, using the principal residence exemption isn’t ideal if the gain on the fractional ownership is small relative to the potential gain on an owner’s other residence.
The income earned from renting to a third party, in either a time-share or fractional ownership, is taxable and subject to the same rules as in a sub-lease agreement. In a time-share, the ability to rent the property is governed by the terms of agreement. Since many time-shares are located outside Canada, a tax advisor specializing in the jurisdiction where the property is located must be consulted, as local rules may add complexity.
For instance, a property located in the U.S. is defined as U.S. situs property. It would be subject to U.S. taxation upon sale and may trigger U.S. estate taxes upon death. If a U.S. time-share is rented to a third party, rental income may be subject to withholding tax to the Internal Revenue Service.
A time-share can provide a great destination for your client and their family. To ensure that the destination is enjoyed without unanticipated stress, proper planning and advice is imperative.