Fractional interest, also known as fractional ownership, is a way of expressing percentage-based ownership of a piece of real property, such as a residential building. Fractional interest shares in the asset are sold to stakeholders. These individual stakeholders both pay their percentage of property costs, such as maintenance and taxes, and also partake in the asset's usage benefits, such as dividend distribution, priority access, and usage rights.
Fractional interest is different from the timeshare model. In a typical timeshare, the owner only has usage rights for specific periods of time, and does not actually have an ownership share in the title. In contrast, a fractional owner usually possesses shares of the property's title, expressed as a percentage; thus, when the value of the asset increases, so too does the value of the owner's shares in the asset.
Fractional interest models have certain common characteristics, such as:
- No management or direct responsibilities related to maintenance and upkeep. A property manager handles such duties, and also engages in marketing activities for the fractional interests of the asset.
- A choice between using the property as a personal residence or using it to bring in rental income.
- Regular payment of a set percentage of costs associated with the property, as well as a percentage of all relevant taxes.
- Ownership of real property without the risks associated with sole ownership.
What Realtors Should Know
Realtors that have a firm grasp of shared ownership concepts, including fractional interest/ownership, can often make sales that their competitors are unable to broker. Certain properties that are well-suited for the fractional interest model will often sell at a higher price, and sometimes sell more quickly, than other listings.
Real estate agents can often leverage the fractional ownership concept into new avenues of marketing and revenue. Of course, they must first have a detailed understanding of relevant national, state, and local laws that regulate fractional ownership.
When drafting a contract for fractional ownership of a property, generally the first major consideration that must be taken into account is usage rights. Most fractional owners agree to an "assignment approach," in which each stakeholder can use the property for a specified amount of time, or a specific timeframe, throughout the year. A less prevalent model is the "pay to use" method, in which each owner must pay a predetermined fee for each day or week of usage.
What Accountants Should Know
With regards to tax treatments of fractionally owned properties, accountants should know that there are typically 3 categories of taxation into which a fractionally owned vacation home will fall:
- Pure Second Home
- Pure Rental Property
- Second Home/Hobby Rental
The "Pure Second Home" tax bracket is for situations when the home is only rented out for 14 days or less during a particular tax year. In this classification, the mortgage and property taxes would generally be tax deductible, and any rental income would be tax free.
The "Pure Rental Property" category applies when the following 2 conditions are true:
- The property is a "rental" for more than 14 days in the tax year
- The total number of days for personal usage is either 14 or less, or no more than 10% of the total number of "rental" days (whichever number is greater)
When neither of these categories apply, the property will be taxed under the "Second Home/Hobby Rental" classification, which divides the tax year into "personal days" and "rental days" and assigns tax rates accordingly.
Fractional interest is a shared ownership model that can offer unique tax benefits and investment advantages. If you'd like to further your education with regards to fractional interest or other financial subjects, reach out to us today at Lorman Education Services.