While owning a second home is a luxury that few can afford, 10% of a vacation home might be more in your price range. Through fractional ownership, you can share a home with a larger group of people without actually sharing the space when you go on vacation. Instead, each owner uses the home for a portion of the year.
Fractionals v. timeshares: Check the fine print. Fractional ownership isn't the same as a timeshare. While timeshares come in many forms, they are typically owned and run by for-profit companies. Rather than having your name on a deed, you sign a contract giving you the right to use vacation property for a certain amount of time. In contrast, if you own part of a fractional vacation property, your name is usually on the deed, and owners exercise more control over the property. Not everyone uses these terms the same way, however. Check the details of any arrangement you're considering very carefully to make sure it offers the rights and protections you want for your shared vacation property.
There are a variety of ways to get into fractional home ownership:
- You could manage the whole process yourself by forming a group of friends, acquaintances, or people you find on the Internet, and buying property together. You can use a website such as www.yours2share.com or even Craigslist to find potential co-owners.
- You could buy a property (or use a property you already own) and sell fractional shares to others. It often helps to have a vacation fractional broker or consultant handle the marketing and sale of the shares. An example of such as service is www.fractionalrealestateconsulting.com.
- You could buy into a vacation fractional or timeshare that has been organized by a private developer or broker. These services are typically based in a particular region of the world. If you do an Internet search for "Fractionals" or "Timeshares" and "Costa Rica," for example, you will likely find a local company that sells fractional vacation homes and timeshares. Also take a look at fractional service websites such as www.dreamslice.com and www.grandshare.com.
Vacation all over the country. Many timeshare and fractional home ownership programs give you points or credits that you can redeem to use other vacation properties. For example, a timeshare ownership might entitle you to 14 nights per year in vacation properties across the country. With a fractional ownership program, you may own a deeded portion of a property, but that ownership sometimes comes with points you can redeem at other properties in a fractional vacation home network.
Fractional vacation homes are typically owned as tenants in common. Every owner's name appears on the deed, along with their respective ownership percentage. Some fractional owners form an intermediate entity, such as an LLC, nonprofit, or for-profit corporation. Rather than owning the property directly, the owners hold shares in the company or a membership in the nonprofit. This limits the group's liability and makes it easier to bring in new owners, but also creates administrative burdens and prevents owners from claiming property tax and mortgage interest deductions. (You'll find more about forming an intermediate ownership entity in Chapter 3.)
Typically, co-owners take out a group mortgage and divide the down payment and monthly payments. However, fractional financing may be available, particularly if your group is relatively small.
It's a good idea to ask every owner to chip in a set amount each month to cover expenses. This is preferable to trying to reckon costs as needed or reconcile bills every month. You can also overestimate costs, which allows the group to build up a reserve fund for major repairs or remodeling. Vacation fractional owners often hire outside management companies to handle scheduling, pay expenses, and do regular cleaning, maintenance, and repairs.
Scheduling and House Rules
Because only one owner uses the home at a time, scheduling is an important issue for a fractional home, particularly if the home is likely to be most popular during one season or time of year (as might be true of a ski cabin or beach house).
Your group can use any system that works for you. A typical scheduling method is to assign certain weeks or months to each owner every year. You can use the same schedule every year—some groups even include these dates in the deed or other recorded real estate document—or you can rotate or otherwise change the dates each year. If you want less formality and more spontaneity, you can simply sign up when you want to use the house, and pay the group based on the number of days you use it. At the end of the year, if the payments exceed the annual costs, then owners divide the surplus. If the amount falls short of the annual costs, each owner chips in extra money to cover the deficit. Of course, this method risks disputes when owners want to use the home at the same time. You could require owners to sign up well in advance, or perhaps rotate the most popular months or weeks, to solve this problem.
Your group should come up with rules about what kinds of alterations can be made on the property, whether there is a fixed decorative scheme, whether pets are allowed, whether there's a limit on the number of guests, and so on.
Make sure that you can resell your share of a shared vacation home without too many hassles. Some co-owners might want a right of first refusal or even a right to reject a proposed buyer if they can articulate a good reason why.
If you have a shared mortgage on the property, the group may have to refinance if one person sells a share. In some states, selling a share may also mean the property is reassessed for property tax purposes—something your group no doubt wants to avoid.
It can be hard to sell a share of a fractional, which means some owners may eventually feel stuck with a share of a home they no longer use (for example, once their children move out or they hang up their downhill skis for good). To avoid this problem, the group may want to set a future date, in their sharing agreement, when owners who want out can either force a sale of the whole property or require other owners to buy them out at the then-current market price.
Renting the House
One thing to consider before buying into a fractional vacation home is whether you or other owners will be able to rent out the house during the time when it's yours to use. One benefit of fractional ownership, versus individual ownership, is that there is less need to rent out your property. Traditionally, vacation homeowners rent out their property to cover the costs of owning a second home. By dividing the cost of ownership, you can avoid having to rent.
If, however, you want to be able to rent out your fractional share, make sure your agreement allows for it. There will be a number of issues to work out, including how often the house may be rented, how renters will be chosen, how much rent you can charge, what happens if a renter damages the property, and so on. And depending on how many days you rent out the property, there may be some tax implications to consider. (See IRS Publication 527, Residential Rental Property, for more information; you can find it at www.irs.gov.)
In many states, timeshares and fractionals are subject to approval by a state real estate agency. For example, in California, a vacation home with more than ten owners must be approved by the state Department of Real Estate, to ensure that the property, financing, and agreements between owners are properly arranged. Before buying, your group should talk to an attorney or consultant who can advise you about any regulatory issues that apply in your state.
Also, if your fractional home is primarily an investment vehicle and all owners will share in the rent, the arrangement may be subject to state and federal securities laws. Generally, these laws may apply when ownership shares earn passive income (income from someone else's activities). In this situation, you should consult with an attorney and find out whether you'll have to meet additional legal requirements.
Get legal help when purchasing foreign property. If you want to buy a share of vacation property in another country, you'll need an attorney in that country and one in the United States. Depending on the laws of that country, you may have a difficult time enforcing an ownership agreement and carrying out real estate transactions. One way to solve difficulties with vacation home ownership in other countries is to create an intermediate entity, such as an LLC, in the United States to hold the property. That way, all contracts relating to membership in the LLC are governed by American law, and buying and selling ownership does not involve a real estate transaction in the other country.
Your Fractional Ownership Agreement
It is especially important to have a written agreement to govern fractional ownership. There are likely to be a number of owners who will come and go over the course of the arrangement, and you'll want to ensure that all future owners know the terms of the deal. The documents your group creates will depend on whether you buy into a housing development, whether you create an intermediate entity, and so on.