As House and Senate conferees began negotiations on the final shape of the Tax Reform Act of 1986 last week, they spotlighted a problem affecting potentially thousands of real-estate buyers around the country this summer.
The pieces of real estate those buyers are ogling may not measure up well under some of the fine-print sections of the new legislation. Consumers may be signing up for a tax pig in a poke, with or without the property seller's active knowledge of the fact.
Take, for example, the multibillion-dollar-a-year vacation condominium industry. Reports from would-be buyers at several East Coast resorts the past three weeks suggest widespread confusion about the future tax status of condo second-home investments.
As one purchaser put it in a telephone interview, "All the developer emphasized in the sales presentation was that second homes are golden under the tax-reform bill. Period." What the developer didn't mention, the buyer said, were any of the technical snares and traps in the legislation -- some of which have direct bearing on the future resale values of the condo units being offered.
The most glaring omission concerns tax deductions. The buyer had no idea, he said, that the "rent pooling" feature of the condo project could disqualify him from taking traditional, sizable deductions at tax time. The Senate bill's provisions on this subject, now virtually certain to be included in the final tax-revision law, work like this:
Vacation-home buyers who rent out their property for all or part of the year will not be able to write off all the traditional year-to-year deductions (except mortgage interest) unless they qualify for the special $25,000 "relief" exemption. Owners who do qualify will be able to deduct each year as much as $25,000 of their costs, including depreciation and maintenance.
How will you qualify? That's the key question for anyone looking at second-home or vacation property. To pass the tax test, you will need to "actively participate" in your real estate and meet an income standard.
"Active participation," as defined by Senate tax draftsmen, could snag large numbers of current and future resort-condo buyers. You'll need to own 10 percent or more of the unit as an individual, not as a partnership or corporation, and participate in management decisions, such as the "approving of new tenants, deciding on rental terms," repairs and capital expenditures and "other similar decisions." The degree of "active participation," in short, is significantly beyond what many owners of ski-resort and oceanfront units traditionally encounter.
Condo-apartment owners who rent via a common "pool" arrangement -- sharing revenue with all other owners in a professionally managed rental operation -- probably would be restricted under the Senate bill's language. Such owners rarely or never approve tenants, for instance. They have no idea who is in their unit at any moment, or in fact whether it's even occupied.
They signed up for a vacation property that they could visit now and then, and have no worries about or involvement in it otherwise. They bought what is in essence a passive piece of deduction-producing real estate -- precisely what the tax-bill writers are determined to restrict.
The income standard to qualify for the $25,000 annual write-off relief should be less onerous for the majority of condo owners. If your adjusted gross income is $150,000 or above, you are disqualified automatically from using the write-off on your vacation home. If your income is between $100,000 and $150,000 a year, you get to write off progressively less of the full $25,000 maximum. If you make less than $100,000 a year, you pass the income test automatically.
The problem with pending legal changes such as these during the summer of 1986 is that, for certain would-be buyers, any of them can vitally affect the economics of a vacation real-estate investment. If you can't write off actual expenses but instead have to defer them indefinitely, as the Senate bill would require of many taxpayers, you may not want to plunk down all that money for a new condo unit.
If developers and sales personnel aren't divulging such potential tax problems to the buyers of 1986, they may be setting themselves up for future lawsuits.