Fractional Property- the legal issues
Eric Gummers, Head of Leisure and Hospitality at international law firm Howard Kennedy talks us through some of the fractional property legal issues.
At the risk of the obvious, the first element from a legal and tax perspective is for the prospective fraction owner or member to understand the legal structure of the fraction.
Essentially, the fraction is likely to be configured in one of the following legal forms:
• Membership of a club
• Participation by way of a shareholding
• Becoming a limited partner
• Direct real estate holding with others, usually governed by a trust
There are pros and cons to each type of legal structure. However, a well-designed structure should fit the requirements and objectives of the individual fraction holders for the particular asset group, with security to enable usage over the long term and appropriate flexibility.
Because of the overlapping interests, the legal documentation is likely to be relatively lengthy and you will want a full explanation as to what it means in practice.
You should pay particular attention to the provisions for management and reservation so as to be satisfied that these are workable and robust.
One of the attractions of having a fractional interest is passing the burden of asset-management to a professional manager and sharing the costs with other fractional owners. Accordingly, the choice of manager, together with the inclusion of appropriate controls on costs and reporting requirements, will be very important.
Given the need to maintain the underlying assets, we recommend that you carefully consider how the annual fees and service charges work to ensure that the projections of these are soundly based and that there are sufficient protection clauses in place to avoid future unpleasant surprises.
Reservation and usage
Usage is at the heart of having a fraction. The arrangements for usage need to suit your desires, balanced with the desires of other fraction holders. In looking at the marketing materials for a fraction, are you comfortable that what is portrayed is deliverable in reality? If it sounds "too good to be true," then it may not be workable.
A carefully considered usage system is one of the hallmarks of a fractional system that is likely to work satisfactorily for all.
In looking at usage, review the reservation requirements to be sure that the advance notice requirements work with you and your family’s lifestyle.
The mechanisms for sale, transfer or exit at the point when you no longer want to use your fraction are important.
The ability to resell in the future and the timescale of reselling will be critical elements of value. As a fraction owner, you will wish to see that there is an orderly aftermarket and to understand any restrictions that may apply.
Some companies provide for buy-back provisions, such as repurchase after a certain number of other sales and, if these are being included, you will want to consider this option and how it might work in practice.
Whilst it is a relatively new product, finance is now being made available for the purchase of certain real-estate-based fractions. As with any finance option, you will need to be comfortable with the borrowing terms and the costs.
If you do require third-party finance for the purchase, the ability to exit and realise the fraction may be of higher importance.
Again, the prospective fraction holder should understand the tax implications of the purchase, holding and sale of the fraction.
Taxes on purchase
At the point of purchase, the price may be subject to a value added tax or equivalent sales tax. You should establish what the anticipated indirect taxes are and take account of this in the purchase decision. If the fraction involves a direct property interest, then stamp duty may be payable.
The fraction structure itself will be liable to certain taxes on the acquisition of assets, such as homes, and will have ongoing responsibilities for local taxes and employment taxes in respect of staff.
The 2007 Budget has helpfully removed a concern for UK taxpayers such that interests in overseas real estate held through corporate structures might involve liability to tax on usage as a "benefit in kind."
Rental income derived from your fraction will be liable to tax and is required to be included on your tax return.
For condo hotels or buy-to-use-and-let offerings, you may well need to separately register and account for value added tax in respect of the rental income generated. A responsible promoter will have taken steps to assist you with the necessary administration.
Taxation on sale
On the sale of your fraction, if a gain is made on the original price, then, subject to indexation and deduction of the costs of sale, the uplift will be subject to capital gains tax.
In some jurisdictions, there may be transfer taxes or stamp duty payable on the sale of interest and the responsibility for these between the buyer and the seller should be established.
Whilst fractions may have some complexity from a legal and tax perspective, the well-structured fractional offering will have taken these concerns into account so as to ensure an efficient structure for fractional owners, with the rights and obligations (including costs throughout the life of the fraction) being clearly presented at the outset.