The Tax Court has held that a married couple could not deduct losses from their timeshare rental activity because: (1) they did not engage in the activity with the bona fide profit objective as required under the Code Sec. 183 hobby loss rules, (2) they failed to meet the ordinary and necessary requirements of Code Sec 162 for their travel expenses, and (3) they did not meet the strict expense substantiation rules of Code Sec 274.
(a) General rule – In the case of an activity engaged in by an individual or an S corporation, if such activity is not engaged in for profit, no deduction attributable to such activity shall be allowed under this chapter except as provided in this section.
Tax regulations (Reg. § 1.183-2(b)) also provide nine factors that must be considered in the determination of whether a taxpayer has a profit objective:
(1) The manner in which the taxpayer carried on the activity;
(2) The expertise of the taxpayer or his advisors;
(3) The time and effort expended by the taxpayer in carrying on the activity;
(4) The expectation that assets used in the activity may appreciate in value;
(5) The success of the taxpayer in carrying on other similar or dissimilar activities;
(6) The taxpayer’s history of income or losses with respect to the activity;
(7) The amount of occasional profits, if any, which are earned;
(8) The financial status of the taxpayer; and
(9) The presence of personal pleasure or recreation.
Both taxpayers worked full-time in other occupations. They purchased four timeshares in 2005 and seven in 2006. The taxpayers traveled frequently, attending timeshare previews and meeting with representatives who discussed the details of the resorts and gave them tours. The timeshare presentations normally took only four or five hours. The taxpayers’ family accompanied them, and they generally stayed overnight at lavish resorts and then went to the beach the next day.
Looking at the amount of profit from the activity, the Court found that the timeshare activity had yet to earn any profits. In the four years in the record, the activity had lost $217,705 and earned only $40,995.
Although the taxpayers submitted their credit card bills and some receipts, they had difficulty identifying which of the charges were incurred in connection with the timeshare activity and which were personal; thus, they failed to meet the required substitution requirements. In addition, the Court determined the expenses were not ordinary and necessary because the taxpayers mixed business with pleasure, staying at lavish resorts with their family and only spending minimal time viewing timeshares.
As result, the court only allowed the taxpayers to deduct their expenses to the extent of the income from the timeshare losses.
If you have question related to timeshares or the hobby loss rules, please give this office a call.