holy coop Batman! 80/20 hurdle falls down

[I have had a draft of this post since Friday, without getting around to polishing and posting it. Reader Tariq gave me a nudge on Sunday, pointing put that Jay Romano did a piece on it in the Sunday Real Estate Section of the NY Times, Coops Get a Break on Revenue Rules (thx for that nudge, Tariq).]

I doubt very much that Bush is responsible for this (take a bow Charlie Rangel??) and I am amazed not to have seen something big about this in the Times before Sunday], Post or Sun, or from REBNY for that matter (take a bow REBNY??).

My take on this is that the number of Manhattan coops with continuing problems from potentially having too much rental income will shrink from a few hundred to just a handful. And many of the coops that are on the border of compliance with the new tests may be able to jigger their space or their books to reach compliance.

remember what is at stake
As I have highlighted before (in the January 16, 2007 IRS rules for coops / beware the 80/20 rule), coop compliance with the rules gives shareholders personal income tax benefits, described by Romano as “deductions for property taxes and mortgage interest, and the shielding of up to $500,000 from capital-gains taxes when the co-op is sold”. Indeed, careful banks should not be providing residential mortgages into buildings that don’t qualify as “cooperative housing corporations”.

Curiously enough, I think the coops that will benefit first (and probably most) are those that have not been in compliance with the 80/20 rule, while those that will have to wait to benefit have been straining to comply with that test. (Life is … unfair, no?)

new text adds 2 tests
I get the text of the bill as reported out of the House and Senate conference from the official US government website, nicknamed Thomas. As you see, the old 80/20 test (the Income test) is now one of three tests that a coop can meet; the second test (the Square Footage test) should bail out any 5-story coop with only ground floor retail, or any 10-story coop with ground floor and basement retail; the third test (the Expenditures test) should bail out everybody else if they pay out 90% of their expenditures for the residential part of the building.

I wonder if a roof deck qualifies within “total square footage”, so that a 3-story coop with ground floor retail can creep over the 80% test by adding a roof deck “available” to shareholders, even if no one uses it.

… some need to count beans
The Expenditures test should provide a safe harbor for all but the smallest coops that cannot meet the Square Footage test, though the smart CPAs may be required to find the margins. The typical Big Ticket expenditures for a coop include some that are allocated evenly over the entire building (including commercial space), such as real estate taxes and insurance, but others should be allocable only to the residential portion, such as utilities and payroll. Maybe some small buildings will take this opportunity to hire some (or more) staff to soak up some ‘excess’ income.

I wonder if creating (or increasing) a coop’s reserve fund will qualify as an “expenditure” for the “management” or “care” of the building for the benefit of shareholders. If so, that is an account into which ‘excess’ income can be stashed, at least until the scale of a reserve fund gets ridiculous.

effective immediately, but benefits delayed for most
Since the bill was signed on December 20 and is effective in the current tax year, the only coops that will benefit immediately are those that have not been in compliance with the 80/20 Income test. All of a sudden, they get the benefits of pass-through deductions and non-recognition of gains (to $250k or $500k) if they meet the Square Footage or Expenditures tests.

Funny thing is, the coops that have been straining successfully to meet the Income test by capping their rental income below market will have to wait to get the full benefit of this change. For most of these coops, the additional income available from market rate rents will have to wait until the current leases expire.

some need those pesky lawyers to parse magic clauses
Some ofthe coops that have been straining to meet the Income test by capping their rental income may have magic clauses in their commercial leases that can provide immediate benefits. I know some coops have clauses that essentially escalate rental payments to the 80/20 cap. If those clauses are specific to the Income test, then they will likely not provide a way to raise rents to market rates until the leases expire, but if the clauses are written more broadly to measure against Section 216 standards, these coops may be able to go right to market rents (without passing Go but collecting the metaphoric $200).

Check the fine print.

Charlie, not REBNY
The Times article identifies Charlie Rangel as a prime sponsor of the bill, so Charlie gets the credit. One, two, three … THANKS CHARLIE.

© Sandy Mattingly 2007