IRS rules for coops

 
what does happen if a “coop” has too much income?
I did a post in early December about pricing at 55 Greene St that got picked up on Curbed.com (On the Proper Pricing of Manhattan Apartments) along with a similar posting by Urban Digs about 70 E 96 St. I noted in passing that 55 Greene has zero “maintenance” as the “coop” has a very high-paying commercial tenant.
 
I was intrigued by the fact that several Curbed commentators fastened on the low (no) maintenance in commenting on the post and I resolved to offer a post about that issue. 2007 is here, so I can cross one resolution off the list.
 
IRS rules permit “pass through” benefits to coop shareholders
In brief (and in a non-lawyerly way), coop shareholders get certain benefits that shareholders in other kinds of entities don’t get. Microsoft shareholders don’t get to deduct from their own income taxes the real estate taxes that Microsoft pays, but coop shareholders do. Coop shareholders get to take a pro rata share of the coop’s expenses for real estate taxes and on an underlying mortgage, as if they were making the expenditures directly. But they only get the benefits if the coop is correctly organized and if certain rules are met.
 
The pertinent IRS rules require that at least 80% of the income of the coop be from shareholders as opposed to being from outsiders, such as commercial tenants or garage licensees. If that test is not met in any year, the shareholders are not entitled to the pass-through deductions they would otherwise be entitled to.
 
As a result of this test, some coops charge below market rents to their tenants because the 80/20 benefits to shareholders are deemed to be more valuable than the additional rent that could be charged. Other coops spend a fortune on lawyers and accountants to figure out ways to deal with the “problem” of having “too much income”.
 
put condops out of our mind for today
(Some day I will talk about true “condops”, which are not really “coops with condo rules”, as many people say. True “condops” are two-unit condominiums, where one condo unit is the ground floor commercial tenant paying a huge portion of common charges and the second condo unit is a full multi-unit residential coop. But that complicated story is for another day.)
 
Since the “maintenance” at 55 Greene Street is zero, that “coop” is probably not a qualifying cooperative housing corporation for IRS purposes since the shareholder income (zero) cannot be 80% of the total income of the building. (Even if there is no underlying mortgage, they pay something in real estate taxes, and something to keep the lights on and the building clean.) So unless there is something specific and technical about 55 Greene St that I am missing, the shareholders there should not be entitled to pass-through deductions under the IRS rules.
 
why should AMT burdened shareholders care?
It may not matter much to shareholders if they can’t deduct building mortgage and real estate taxes on their personal tax returns, especially if their income puts them into the Alternative Minimum Tax level – at which all deductions are heavily discounted in value. For these folks, the balance between high rental income and not-so-meaningful pass-through deductions may fall overwhelmingly on the side of the high rental income. But there is more to consider.
 
without 80/20, no home mortgage deduction (and maybe no home mortgage)
When I contributed to the Curbed commentary I suggested that the 80/20 issue would not impact a shareholder’s ability to deduct interest on their own individual mortgage or to benefit from the $250k / $500k non-recognition of gain enjoyed by American “home” owners.
 
on further review … oops
I am pretty sure I was wrong about that. (Consult your tax adviser.)
 
After thinking about it some more, talking to some bright lawyers, and reading a NY Times Q+A column that touched on this, I can see that all the IRS benefits to coop shareholders (the analogy of coop shareholders to homeowners) depend on the 80/20 rule.
 
So the mortgage deduction will not be available. And when the “coop” shares are sold, all the gain should be recognized and taxed at normal rates, without the seller being able to get the benefit of “non-recognition” of $250,000 or $500,000 of the gain.
 
And I have been told by one mortgage broker that banks won’t offer “coop mortgages” to shareholders that cannot meet the 80/20 test. If they can be financed at all, the shares would get a commercial loan (usually at higher rates and with higher down payments). If they can be financed at all.
 
more a problem than a quirk
I have not yet had a buyer interested in one of these “coops”, so I have not had to think about this issue until noting (in passing) 55 Greene (and a few other buildings) as low-or-no maintenance “coops”.
 
I have not noticed in the marketing of “coops” in these buildings any special caution about this topic, but maybe I haven’t been paying attention, or maybe I have not been close enough to get the “special” disclosures.
 
I like to think that I am as sophisticated about lofts as any Manhattan agent. I wonder if I have been alone in my ignorance up to now, or if I still have the company of many agents who work with buyers and sellers of lofts.
 
I think I have a lot of company on this.
 
a loft problem
Curiously, this issue is not likely to be relevant to “apartments” as opposed to lofts, and then only to a specific and narrow sub-set of loft buildings.
 
Coops in traditionally residential neighborhoods were likely to have addressed these issues when they were formed, even with the coops on commercial streets such as on the avenues with enough foot traffic to attract high-paying tenants. (Or the original sponsors sold the commercial space separately from the residential coop portion.)
 
But smaller coops (like 12-unit loft buildings) don’t have a lot of flexibility financially, like 200 unit coops may have.
 
more a SoHo loft problem
And the coops with the greatest likelihood of attracting AAA commercial tenants these days are in and near SoHo, where it is not only conceivable but do-able to have a commercial tenant pay so much rent as to carry the entire building’s expenses (as at 55 Greene St) or nearly so, as in other buildings nearby.
 
Newer conversions or constructions were probably done as condos (no 80/20 issue with condos), but lofts that were legitimized as residential spaces in the early waves of the late 1970s and early 1980s were probably formed as coops. ‘Back in the day’ the last thing those coops worried about was “too much income”, but times have changed.
 
I don’t know enough specifics about the finances to say that any of these buildings *has* this problem, but I have seen listings lately for lofts with low-or-no maintenance at several buildings in or near SoHo.
 
Unit 2 at 652 Broadway is for sale for $2.75mm for 3,300 sq ft with maintenance of $548/mo. I don’t see anything in the listing that specifies that none of the maintenance is deductible, or that there may be an 80/20 issue.
 
Unit 11F at 476 Broadway is for sale for $2.995mm for 2,250 sq ft; not only is there no maintenance, “even Cable T.V. is paid for”.
 
did smart lawyers find a way at 458 Broadway?
Maybe there is a clever way around this, as the 7th floor at 458 Broadway sold two months ago (the listing is still available on the web) off an asking price of $2.65mm for 2,500 sq ft with a maintenance of $3,000 per month but there is “quarterly income from the retail ground floor store”. (Our building notes say the monthly maintenance is “almost completely offset” by the rental income.) Maybe they pay monthly maintenance out of one pocket and receive quarterly rental income in another pocket in some way that washes (do not say “launders”) this money.
 
there is nothing wrong with this, of course, if…
… everyone who is supposed to know about this knows about it when they are supposed to know about it. Maybe they do.
 
But maybe not. Did I mention you should consult your own tax adviser?
 
© Sandy Mattingly 2007
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