IRS Looks at Investment Loss Claim on Real Property

All of the following quotes are directly out of

IRS Publication 544 “Sale and Other Dispositions of Assets”

The first step is to determine what you have. Based on IRS definitions, a timeshare
is an asset and its disposition is subject to IRS regulations. NOTE: When it says
ordinary gain or loss remember it is referring to adding to or subtracting from your
gross taxable income.

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Capital Assets
Almost everything you own or use for personal purposes or investment is a capital asset.

Personal-use property. Property held for personal use is a capital asset. Gain from a sale or exchange of that property is a capital gain. Loss from the sale or exchange of that property is not deductible. You can deduct a loss relating to personal-use property only if it results from a casualty or theft.

Investment property. Investment property (such as stocks and bonds) is a capital asset, and a gain or loss from it’s sale or exchange is a capital gain or loss. This treatment does not apply to property used to produce rental income.

Noncapital Assets
A noncapital asset is property that is not a capital asset. The following kinds of property are not capital assets.
4. Real property used in your trade or business or as rental property, even if the property is fully depreciated.

Business assets. Real property and depreciable property used in your trade or business or as rental property. . . are not capital assets. The sale or disposition of business property is discussed in chapter 3.
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The first determination is whether the timeshare or property is held for personal
or business rental use. Before you claim it as business rental use, you better have
all the bills and receipts associated with the process and clearly showing your intent
to rent the property, whether you were successful or not. It must be clear that
rental was your intent for a reasonable period of time (consider going back at least
one year).

If you can establish a proven track record of attempting to rent it, you can deduct
any loss associated with it. If not, it is considered personal-use property and you
can not deduct any loss.

Chapter 3 referred to above deals with determining if the gain or loss is to be
reported as a capital gain or loss. Essentially, as a non-capital asset, any gain or loss
is reported as regular income and not subject to the reduced capital gain tax
percentage. A capital loss can be taken as a limited $3,000 loss but a gain is taxed
at a lower tax bracket.

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PROPERTY CHANGED TO BUSINESS OR RENTAL USE
You cannot deduct a loss on the sale of property you acquired for use as your home and uses as your home until the time of sale.

You can deduct a loss on the sale of property you acquired for use as your home but changed to business or rental property and used as business or rental property at the time of sale. However, if the adjusted basis of the property at the time of the change was more than its fair market value, the loss you can deduct is limited.
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The word ‘home’ includes your timeshare or vacation property. If you bought the
timeshare or property to use personally, or did use it personally at any time, you
can change that use to business use, but you must divide any gain or loss by the
amount of time it was used in each category. If your timeshare was used by you for
8 of the 12 years and you have proof of your attempt to rent it the other 6 years (no
proof = personal use), 2/3 of everything is considered personal-use and only 1/3 is
considered business use.

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Property Used Partly for Business or Rental
If you sell or exchange property you used partly for business or rental purposes and partly for personal purposes, you must figure the gain or loss on the sale or exchange as though you had sold two separate pieces of property.

Gain or loss on the business or rental part of the property may be a capital gain or loss or an ordinary gain or loss. Any gain on the personal part of the property is a capital gain. You cannot deduct a loss on the personal part.
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An example is in the Publication 544 that shows this computation. The final element
was to show that even though a $15,000 net loss was taken on the property, only
$2,380 was considered the actual loss because of the difference in personal (2/3)
versus business (1/3) use. The personal portion of the loss is not deductible while
the business portion has some limitations to its loss.

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Abandonments
The abandonment of property is a disposition of property. You abandon property when you voluntarily and permanently give up possession and use of the property with the intention of ending your ownership but without passing it on to anyone else.
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This is a tricky question. According to the IRS any transfer is considered disposition
of ownership. Abandonment is literally, walking away and allowing the property to
undergo foreclosure (which brings other questions and concerns into focus) or
reclamation by the governing government (usually the county) for non-payment of
taxes and assessments.

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Loss from abandonment of business or investment property is deductible as an ordinary loss. Even if the property is a capital asset. The loss is the property’s adjusted basis when abandoned. This rule also applies to leasehold improvement the lessor made for the lessee that was abandoned.

You cannot deduct any loss from abandonment of your home or other property held for personal use.
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Again, if any loss is to be claimed, it must be a business property, not a personal-use
property.

There are other references in Publication 544 to Fair Market Value at the time of
disposition but that is treated in another whole article. Essentially, one thing implied
in Publication 544, again, is that a FMV can be determined by the sale price
received by the entity that receives the timeshare or property, but that has to go
back to other publications to find that the time limit is considered 36 months.

Without a sale price, FMV is determined by purchase price and/or replacement
price in most cases. So, if your purchase price for the property was $20,000 and
you did try to rent it but can only show records for 1/4 of the time you owned it,
you can only consider $5,000 as the business portion which can be taken as a loss
against other income.

Another option is to donate to a federally authorized charity (nonprofit
organization). Doing this falls under other guidelines and can end up with a much
greater income deduction than a claim as a loss.

Timeshare Donation and IRS Regulations

• It is up to you, the timeshare owner, to understand the IRS regulations concerning your decision to donate your timeshare. Don’t just accept the word of a nonprofit organization (NPO), your CPA or attorney. No one wants to read a stack of IRS books and publications so we have filtered the critical points out for you here. We won’t discuss the reasoning, only quote and try to explain the law. All direct quotes from IRS regulations and publications are in bold print. (The publication, form of regulation follows the quote and is in parenthesis). Comments are indented. All references to donation deduction, credit, etc. specifically mean a reduction in your adjusted gross income equal to the amount of the donation credit you are taking. It is NOT a tax credit.

• You can donate anything to a federally qualified NPO. Understand that there are different kinds of NPOs. Some are the familiar 501(c)3, others fall under 501(c)(8), 170(c)(1), or 7871(d), and other sections may apply. All can accept donations and give credit but the main difference is how you can apply those income deductions to your return. The only real differences apply to what percentage of your adjusted gross income you can deduct for the contribution – from 20% (limit applies to all gifts of capital gain property) of your adjusted gross income depending on several factors too complicated to go into here. If you’re not donating at least ½ of your adjusted gross income you generally don’t need to worry about this. If you do, find out which section the NPO is classified under and ask the IRS how it applies to you. If your income is $30,000 and you donate a $50,000 timeshare and claim the full deduction, you may be limited to taking part this year and the remaining as a carryover for the next 5 years.

“Carryovers
You can carry over your contributions that you are not able to deduct in the current year because they exceed your adjusted-gross-income limits. You can deduct the excess in each of the next 5 years until it is used up, but not beyond that time. Your total contributions deduction for the year to which you carry your contributions cannot exceed 50% of your adjusted gross income for that year. “ (Publication 526)

• The IRS has established criteria for different types of donation. We’ll deal with timeshares only.

• Who must file? Any taxpayer who claims a noncash donation of more than $500 must file form 8283 which must be signed by the NPO as having received the item(s) on a particular date. The valuation on the form is up to you, the taxpayer. The NPO is supposed to give you a separate thank you letter/receipt stating what they think the donation may be worth but that only comes into question if the timeshare is sold within 36 months after receipt (explained later). All they do on Form 8283 is sign as having received the timeshare on a specific date.

“Part IV Donee Acknowledgment – To be completed by the charitable organization.
This charitable organization acknowledges that it is a qualified organization under section 170(c) and that it received the donated property as described in Section B, Part I, above on the following date ________ Furthermore, this organization affirms that in the event it sells, exchanges, or otherwise disposes of the property described in Section B, Part I (or any portion thereof) within 3 years after the date of receipt, it will file Form 8282, Donee Information Return, with the IRS and give the donor a copy of that form. This acknowledgment does not represent agreement with the claimed fair market value.” (Form 8283)

“You must file Form 8283 if the amount of your deduction for all noncash gifts is more than $500.”
“Form 8283 is filed by individuals, partnerships, and corporations.”
“File Form 8283 with your tax return for the year you first claim a deduction.”
(Instructions for Form 8283 – Noncash Charitable Contributions)

• If the taxpayer is going to claim more than $500 in donation credit and file form 8283, they can actually take up to $5,000 in such credit without having to get an appraisal. This is still subject to the Fair Market Value (FMV) determined by other means, but it is a limit that the IRS generally grants without further proof of value. Anything above that amount requires a licensed appraisal.

“Section A. Donated Property of $5,000 or Less and Certain Publicly Traded Securities – List in this section only items (or groups of similar items) for which you claimed a deduction of $5,000 or less. Also, list certain publicly traded securities even if the deduction is more than $5,000 (see instructions).”
“Section B. Donated Property Over $5,000 (Except Certain Publicly Traded Securities) – List in this section only items (or groups of similar items) for which you claimed a deduction of more than $5,000 per item or group (except contributions of certain publicly traded securities reported in Section A). An appraisal is generally required for property listed in Section B (see instructions).” (Form 8283)

• It is up to the taxpayer to state what the FMV is. The only absolute criteria is that it can’t exceed the purchase price of the timeshare otherwise it falls into a different category as a capital gain donation. However, FMV is important to determine because of potential penalties if you overstate its value and the IRS asks you to prove it.

“FMV is the price a willing, knowledgeable buyer would pay a willing, knowledgeable seller when neither has to buy or sell.”
“Reductions to FMV. The amount of the reduction (if any) depends on whether the property is ordinary income property or capital gain property.”
“An acceptable measure of the FMV of a donated vehicle is an amount not in excess of the price listed in a used vehicle pricing guide for a private party sale of a similar vehicle.”
(Instructions for Form 8283 – Noncash Charitable Contributions)

• (This says vehicle but can be construed to cover other items with similar information readily available to the public such as coins, other collectibles, and even timeshares if there is enough information available.)

• According to the above, a willing and knowledgeable buyer and seller. Does that describe you and most other timeshare buyers? The IRS does NOT factor in information available and known to a relative few people that have long term experience with timeshares and the “secondary market”. The majority of people, like yourself maybe, don’t know about disposing of a timeshare at the time they purchase so that is not a relevant issue. The only issue the IRS considers is whether the property was considered an income producing property or was purchased for investment (capital gain) purposes. Pricing guides may be used, but that is only a guideline and may include unusual seller market conditions.

• When you fill in Column D on Form 8283 AND the amount you are claiming is $5,000 or less you must enter how you, as a layman, arrived at that value.

Column (h). Enter the method(s) you used to determine the FMV.
Examples of entries to make include “Appraisal,” “Thrift shop value” (for clothing or household items), “Catalog” (for stamp or coin collections), or “Comparable sales” (for real estate and other kinds of assets). See Pub. 561. (Form 8283 – Noncash Charitable Contributions)

• In determining the FMV, the IRS gives these guidelines:

“Factors.
In making and supporting the valuation of property, all factors affecting value are relevant and must be considered. These include:
• The cost or selling price of the item,
• Sales of comparable properties,
• Replacement cost, and
• Opinions of experts.”
(Publication 561 – Determining the Value of Donated Property)

“Cost or Selling Price of the Donated Property
The cost of the property to you or the actual selling price received by the qualified organization may be the best indication of its FMV. . .
The cost or selling price is a good indication of the property’s value if:
• The purchase or sale took place close to the valuation date in an open market,
• The purchase or sale was at ‘arm’s length’,
• The buyer and seller knew all relevant facts,
• The buyer and seller did not have to act, and
• The market did not change between the date of purchase or sale and the valuation date.”
(Publication 561 – Determining the Value of Donated Property)

• Take Note! The valuation is best made based on either your purchase price or what the timeshare actually sold for if it was sold within 36 months of your donation date to the NPO (covered later). As for the “close to the valuation date” the IRS generally considers 36 months adequate. Did you buy your timeshare within the last 36 months? In other words, if you claim $5,000 and the NPO sells it for $500, all you can claim is $500 because that is how the IRS will look at it’s best FMV representation. Notice, also, that both parties knew the facts (not just the buyer knowing he could get a steal) and you did not have to act (were you pressured to sell due to finances, time or change in your life that would cause a depressed sale?)

• Here is a factor the IRS will consider. This applies to many of the sales at greatly reduced prices in the secondary market for timeshares.

“Unusual Market Conditions
For example, liquidation sale prices usually do not indicate the FMV. Also, sales of stock under unusual circumstances, such as sales of small lots, forced sales, and sales in a restricted market, may not represent the FMV.” (Publication 561 – Determining the Value of Donated Property)

• In other words, those sales made when an owner simply says, “Get me out at anything you can get. FAST!” don’t have to be considered indicative of FMV.

• Without the above Unusual Market Conditions or without a sale price within 36 months of your donation date, the IRS gives clear guidelines as to how to determine FMV. There are three methods they consider:
• 1. Comparable Sales,
• 2. Capitalization of Income, and
• 3. Replacement Cost.
• Notice that what an experienced “used” timeshare buyer is willing to pay is NOT considered.

“1. Comparable Sales
For each comparable sale, the appraisal must include the names of the buyer and seller, the deed book and page number, the date of sale and selling price, a property description, the amount and terms of mortgages, property surveys, the assessed value, the tax rate, and the assessor’s appraised FMV. . . . Only comparable sales having the least adjustments in terms of items and/or total dollar adjustments should be considered as comparable to the donated property.” (Publication 561 – Determining the Value of Donated Property)

“Selection of Comparable Sales
. . . the amount of weight given to a sale depends on the degree of similarity between the comparable and the donated properties. The degree of similarity must be close enough so that this selling price would have been given consideration by reasonably well-informed buyers or sellers of the property.” (Publication 561 – Determining the Value of Donated Property)

• Here you read that the comparable sale must be backed up with actual individual information, not assumptions or offered prices, but actual sales. And that any difference from such researchable comparable prices must be given greater weight the closer they are to the donated property in description, location, and other essentials like use week, etc. A question arises, where can a person get that information? If not from the normal sales conducted at the resort, a person must try to delve through county records on all sales to find those that match and have all the information required. Unfortunately, such records on the secondary market are not usually available or complete. Therefore, they are not usable.

“2. Capitalization of Income
This method capitalizes the net income from the property at a rate that represents a fair return on the particular investment at the particular time, considering the risks involved.” (Publication 561 – Determining the Value of Donated Property)

• Unless the timeshare was bought specifically for investment purposes, this doesn’t apply. Even if an individual tries to rent it out each year, it doesn’t qualify unless the term of the rental is MORE than 7 days.

• “3. Replacement Cost New or Reproduction Cost Minus Observed Depreciation
• This method . . . generally tends to set the upper limit of value.” (Publication 561 – Determining the Value of Donated Property)

• Where would you find a replacement? Can you always know you’ll find a comparable timeshare on the secondary market in the Internet or through a broker or dealer? No. The best place to find a replacement is at the resort at resort prices.

• All of the above has been dealing with a claim of $5,000 or less. Before looking at a higher deduction let’s consider the ramifications of error. According to the IRS, if the timeshare is sold within 36 months of the donation date, they must send the IRS (and a copy to you) of Form 8282 – Donee Information Sheet to state what the difference was between what they stated in their thank you/receipt letter and what they actually received for it. They gave you $5,000 in credit but only received $500.

• Form 8282 is what many NPOs fail to understand or file. This can get both them and you in trouble. It is specific in it’s intent. If the timeshare is sold for cash or equivalent value (stock, bonds, etc.) within 36 months of your donation date, the actual value must be reported to the IRS if it differs from the thank you/ receipt they gave you. After the 36 months has elapsed, there is no longer such a requirement. Once you are given your thank you/receipt letter, you better ask how much or when the timeshare will be sold by the NPO so you don’t get stuck on this issue.

“Purpose of Form
Donee organizations use Form 8282 to report information to the IRS and donors about dispositions of certain charitable deduction property made within 3 years after the donor contributed the property.”
(Form 8282 – Donee Information Return (Sale, Exchange, or Other Disposition of Donated Property)

“Penalties
Failure to file penalty. The organization may be subject to a penalty if it fails to file this form by the due date, fails to include all of the information required to be shown on this form, or fails to include correct information on this form. The penalty is generally $50.”
(Form 8282 – Donee Information Return (Sale, Exchange, or Other Disposition of Donated Property)

• What are the consequences if you claimed an incorrect amount? According to the IRS there is a 20% or 40% penalty (on the tax you should have paid) if the following conditions arise. Notice the “and” to include both criteria in each section. In a 20% tax bracket, that would require an income deduction of $25,000 or more to be penalized.

“Penalty
20% penalty. The penalty is 20% of the underpayment of tax related to the overstatement if:
• The value or adjusted basis claimed on the return is 200% (150% for returns filed after August 17, 2006) or more of the correct amount, and
• You underpaid your tax by more than $5,000 because of the overstatement.
40% penalty. The penalty is 40%, rather than 20%, if:
• The value or adjusted basis claimed on the return is 400% (200% for returns filed after August 17, 2006) or more of the correct amount, and
• You underpaid your tax by more than $5,000 because of the overstatement.”
(Publication 561 – Determining the Value of Donated Property)

Appraisals
Appraisals are not necessary for items of property for which you claim a deduction of $5,000 or less.
(Publication 561 – Determining the Value of Donated Property)

• Anything above the $5,000 claimed deduction requires a licensed appraisal. For one thing, this essentially gets you off the hook if it’s later determined untrue. You relied on a licensed professional.

“Appraisal Requirements
The appraisal must be made by a qualified appraiser (as defined on page 6) in accordance with generally accepted appraisal standards.”
“If you had to get an appraisal, you must get it from a qualified appraiser.”
“In addition, the appraiser must complete Part III of Form 8283.”
(Publication 561 – Determining the Value of Donated Property)

• Let’s take a look at that appraisal. According to the IRS it can only include comparable sales and must include the following information on all those comps.

“For each comparable sale, the appraisal must include the names of the buyer and seller, the deed book and page number, the date of sale and selling price, a property description, the amount and terms of mortgages, property surveys, the assessed value, the tax rate, and the assessor’s appraised FMV. . . . Only comparable sales having the least adjustments in terms of items and/or total dollar adjustments should be considered as comparable to the donated property.” (Publication 561 – Determining the Value of Donated Property)

• In addition, there must be reasonable valuation based on actual sales without weighing heavily on depressed or unusual markets. Notice it says, “ Only comparable sales having the least adjustments in terms of items and/or total dollar adjustments should be considered. . .”

“Unusual Market Conditions
For example, liquidation sale prices usually do not indicate the FMV. Also, sales of stock under unusual circumstances, such as sales of small lots, forced sales, and sales in a restricted market, may not represent the FMV.” (Publication 561 – Determining the Value of Donated Property)

• It is not our intent to advise you to claim more than FMV for your timeshare donation. Just make sure you DO claim a reasonable FMV and not some depressed figure because you wanted to bail out at any cost. It is reasonable to use resort data since that is where the majority of sales are coming from and where the best comparable information can be found. It is reasonable to discount that amount by some factor to consider the costs of sale. Must you only accept 20% to 50% of what you paid for it? I don’t believe so.

• If you are going to claim the $5,000 deduction, make sure the NPO doesn’t cut that out from under you by selling it for less. If you are going to claim more than $5,000, talk it over with a few different appraisers in the area of your timeshare. Tell them the law as you’ve found it here and ask them how they would do their appraisal and what a general estimate might be before you pay them for the appraisal. Doing these simple things can make a big difference in how much you actually get back from Uncle Sam for donating your timeshare to a nonprofit organization.

• If you are going to donate and want to find an NPO that accepts timeshares, doesn’t sell them during the 36 months window, and lets you take a bigger donation credit as a result you can go to http://www.communityhealthtraining.org/Timeshares/ Understand that there will be a cost for their service since they don’t get anything by selling your timeshare. That cost is $500 plus all closing costs (about $300). Do a personal comparison of your tax bracket, what you will get with different donation credits and consider the benefits one way or the other to you. Plug in your own numbers in this formula. ($500 credit) x (20% tax bracket) = ($100 tax refund). Without a sale or an appraisal, you can effectively take the $5,000 donation credit versus what another NPO will actually sell your timeshare for. Use this article to talk to an appraiser. If you believe you can get a higher appraisal plug that number into the formula.

If you have any questions, feel free to contact me.
Dr. Ken Rich
SeniorDirector@CommunityHealthTraining.org