Owners of a special breed of condominium located primarily in resort areas can tip their beach umbrellas this summer in thanks to federal tax writers.
A key congressional tax committee has helped safeguard what many of these owners feared they had lost: favorable tax treatment of "condominium hotel" units, rented out by the day, week or month.
A condominium hotel is American real estate's most celebrated hybrid. It is simultaneously a condominium and a fully functioning hotel, motel or country inn. Every unit or suite in a condo hotel is owned separately by a family, individual or group, just as in any conventional residential condominium development. But every unit is also a hotel room, with daily maid service, linen changes, telephones wired to a central switchboard and other conveniences of a conventional hotel.
Condo hotels exist in nearly every state, but are rarely advertised as such. In Oregon, for example, all but two of the major destination resort hotels are condo hotels, but few of their guests would know it without asking. Manhattan's Essex House on Central Park is partially a condo hotel. Well-known ski resorts and New England inns are condo hotels. So, too, are high-profile beach front resorts on the Atlantic, Gulf and Pacific coasts, mountain spas in Colorado and Utah, and dozens of other fun-to-visit locations.
The tax problems that thousands of condo hotel unit owners worried about extend back to last summer's Tax Reform Act. The legislation never specifically addressed the tax status of real estate that's part hotel, part condo. A dialogue on the Senate floor between two powerful Oregonians, however, sought to clear up any confusion.
Sen. Bob Packwood (R-Ore.), chairman of the tax-writing Finance Committee at the time, joined with Sen. Mark Hatfield (R-Ore.) to differentiate condo hotels from other forms of real estate. Whereas rental second homes and all other rental real estate should be subjected to tax revision's tough new "passive loss" restrictions, the senators said, qualified condo hotels should be treated for federal tax purposes as active businesses.
That treatment, in turn, would be of great financial significance to condo-hotel owners. Purchasers of most "rental" real estate are now prohibited from writing off all losses generated by their properties against their regular incomes. Exceptions exist for certain rental residential units owned and actively managed by taxpayers with incomes up to $150,000. But in general, the passive-loss rules cut the bottom-line attractions of most forms of investment real estate, from rental second homes on the beach to ski chalets in the mountains.
Active business owners, by contrast, can write off legitimate expenses -- and net losses -- against their regular active business incomes. Although the condo-hotel colloquy on the Senate floor by the Oregon Republicans was considered part of the legislative record relating to the tax bill, some tax experts questioned whether it was solid enough ground for condo-hotel unit buyers to bank on.
The testimony may have sought to clarify the tax bill, they warned, but it was never actually part of the law itself. Taxpayers who used it might find themselves thumbing through congressional debates, trying to convince an Internal Revenue Service auditor that their deductions were legitimate under federal law.
The congressional Joint Committee on Taxation removed that worry with the recent release of its so-called "Blue Book," the most detailed federal explanation yet of what the Tax Reform Act means. The committee's report said condominium hotels qualify for the passive-loss exemption, provided they meet a series of "material participation" tests. Among them are requirements that condo-unit owners regularly participate in such integral functions of the hotel as establishing room-rental rates, hiring practices, review and approval of operating budgets, and frequent on-site meetings at the hotel.
The tests should help "separate out the real hotel-condos from the tax-dodge condos," said one Capitol Hill tax authority. If you happen to own a real condo-hotel unit -- or you're thinking of buying one -- the Blue Book could be your best tax news of the year.