END OF THE OLD 80/20

For the last 65 years, a property could qualify for cooperative status — and its shareholders could deduct real-estate taxes and mortgage-interest payments from their taxable income — only if the co-op received 80 percent or more of its income from residential shareholders and no more than 20 percent of its income from other sources, such as commercial tenants and rental apartments.

This Internal Revenue Service (IRS) rule — "80/20" for short — meant co-ops often could not charge market-rate rents for commercial spaces or residential tenants, since the extra income would put the co-op over the 20 percent threshold. But in late 2007, the Mortgage Forgiveness Debt Relief Act (HR 3648), was put into law, reconfiguring one of the most infuriating regulations in the New York co-op world.

Aside from immediate tax benefits and increased property values, Covas, for instance, expects to get more rent from her co-op's commercial space when the current lease expires in August 2008. "We've warned [the DVD shop] that we're going to ask for market rent," she notes. "It's kind of sad because we like the tenant, but I have a fiduciary responsibility."

How It Works

The old 80/20 rule survives under HR 3648, which goes into effect for the 2007 tax year. But now there are two additional ways for a property to qualify for co-op status.

The first is if 80 percent or more of the total square footage of the property is used or is available for use by tenant-shareholders for residential purposes. The second is if 90 percent or more of expenditures are for the benefit of tenant-shareholders.

Anthony Wolff, board president of the 55-unit co-op at 223-231 West 21st Street, welcomes the new law. "We used to sort of skirt [the 80/20 rule] because we had a fair amount of what we call 'bad income' — two rental apartments we bought from the sponsor and a doctor's office in the basement. 'Good income' meant maintenance income [and] any money the co-op took in from shareholders: laundries, late fees, storage fees, the one percent flip tax," Wolf says. "This new law is going to get rid of that exercise in sophistry."

"So much human capital and time went into complying with 80/20 that could be much better spent," agrees Stephen Vernon, board treasurer at Nagle Apartments, a 111-unit co-op in upper Manhattan. "Under the idea of keeping maintenance affordable, sometimes our good income was not sufficient to cover our capital needs. That put pressure on how much bad income [i.e., rent] we could take in," adds Vernon, whose cooperative has 12 rental apartments and a commercial garage. "There were a couple of years when we had to forgive a month's rent for our renters and commercial tenant."

Part of the penalty was a series of maintenance increases — 11 percent in 2004 and four percent in both 2006 and 2008. To buttress this "good" income, the co-op submetered electricity and charged shareholders for parking, use of the laundry and other services. Even so, more than $1 million in maintenance had to be deferred.

"Now that's all gone," Vernon says, "and we can work on things that better the life of the building." Apartment rents will probably be raised, he says, and the garage lease will be renegotiated when it expires in 2013. Meanwhile, long-range plans are in place for repairing the roofs of the residential buildings and garage, and possibly installing solar roof panels and greening the heating plant.

Rent Hike

The change is potentially bad news for many commercial and apartment renters in co-op buildings. "Many co-ops will have no trouble meeting the new square-footage or expenditure tests," says veteran attorney Joel E. Miller. "And now co-ops can charge any rent they want to because there's no limit on outside income…."

This doesn't mean the demand for co-op attorneys or accountants is likely to evaporate. "Right now, most New York co-ops are not paying taxes on their outside income," Miller says. "Now that it's unlimited, the IRS might start taking a closer look at that income. It could be considered as dividends by the IRS."

Elsie Stark, for one, is eager to generate such dividends. "We've been exploring using some of our excess common space and converting it into rentable space for doctors' offices," says Stark, board president at the 485-unit Howard condop in Rego Park, Queens. "We also have quite a bit of outdoor space that we might be able to convert into parking spaces that we can rent out," she adds.

Overall, she says, "It will be a challenge to find creative ways of making the most of the rule change. But regardless, the change seems to be positive."

Adapted from Habitat April 2008. For the complete article and more, join our Archive >>