William D. McCracken in Board Operations on June 21, 2022
They say once is an anomaly, twice is a coincidence and three times is a trend. So when half a dozen of my co-op board clients called me recently looking to amend their flip tax policies, I considered it a definite trend.
Flip taxes, also known as transfer fees, are sums charged by a cooperative to a selling shareholder as a condition of the board consenting to the sale. Those fees typically are then used to offset the building’s capital improvement costs.
A cooperative’s annual revenue from flip taxes can be unpredictable, as it depends on how many shareholders decide to sell their apartments in a given year, as well as the sales prices in the current market. Ideally, a building’s flip tax will raise enough money from departing shareholders to meet the building’s capital needs without the board having to impose unpopular monthly assessments. However, several factors are putting pressure on that equilibrium.
The first issue is that capital improvement costs are going up. Buildings are having to deal with outdated infrastructure and numerous laws addressing carbon emissions, aging gas pipes, crumbling facades and other problems — all while interest rates, inflation and construction costs are increasing.
The other factor is that co-op boards are seeing an increasing number of proposed intergenerational transfers, that is, from parent to child. This is happening for two reasons: because co-op shareholders, as a group, are getting older and giving more thought to estate planning; and because New York City real estate is getting so expensive that the children of co-op shareholders are having difficulty buying apartments on their own. No matter what’s driving them, intergenerational transfers are typically exempt from the payment of flip taxes because they do not involve the payment of cash at market rates, and often do not even require board approval, depending on the terms of a given proprietary lease.
So this is creating a bind for boards. While capital improvement costs and obligations are going up, boards are seeing an increasing number of non-cash transfers that do not contribute to the building’s bottom line.
This is especially concerning for those shareholders who would have trouble paying for assessments or who don’t have heirs to pass their apartments to. Some boards are troubled by the perceived inequity of shareholders passing down intergenerational wealth without paying their fair share of the building’s maintenance needs.
All of this explains why I have been getting so many calls seeking to amend flip tax provisions.
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The most obvious fix available to boards is to charge a flip tax for non-cash transfers. To do that, however, requires figuring out a way to peg an apartment’s value when there is no market-based transaction involved. Who does the appraisal? Who pays for it? How does the board ensure that the appraisal does not come in too low?
Moreover, when you charge a flip tax for a non-cash transfer, you’re asking someone to pay a substantial fee when he may not have access to liquid assets, such as proceeds from a sale. For many shareholders, their apartment is their most valuable asset, and imposing a flip tax could actually prevent them from passing it down to their children.
Even if a board decides to support a flip tax amendment, there is no guarantee it will be adopted. These sorts of amendments generally require supermajority approval from shareholders, typically two-thirds, and they could face heated opposition. Indeed, many long-serving board members will recall how difficult it was to get their shareholders to adopt a flip tax in the first place. Amending it isn’t likely to be any easier.
No matter what boards decide to do with their flip taxes now, the conditions that have led to the issue — old buildings, aging shareholders, expensive regulations and overheated real estate values — are not going away any time soon. It looks like this trend is here to stay.
William D. McCracken is a partner at the law firm Ganfer Shore Leeds & Zauderer. He can be reached at email@example.com.
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