Cooperative and Condominium Apartments (Portfolio 596)

Tax Management Portfolio, Cooperative and Condominium Apartments, No. 596-3rd, treats the federal income tax consequences of the two principal forms of individual equity ownership in a residential unit in a larger development — the cooperative unit and the condominium unit.

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Tax Management Portfolio, Cooperative and Condominium Apartments, No. 596-3rd, treats the federal income tax consequences of the two principal forms of individual equity ownership in a residential unit in a larger development — the cooperative unit and the condominium unit. Although the more common situation is that of an apartment in a multi-unit structure, the same rules apply where the individual units are one-family dwellings, townhouses, garden apartments, or any combination.
This Portfolio deals with the federal income tax consequences of each of these two very different forms of ownership — cooperatives and condominiums — from three different points of view: (1) that of the owner of an individual unit; (2) that of the entity (i.e., the cooperative housing corporation or the condominium management association); and (3) that of the owner of real estate who wishes to establish a regime of either type. In those instances where there is a scarcity of authority on an important point, an analytical discussion is provided so as to provide the reader with at least some guidance. In some cases, the legislative history provides the only clues and accordingly is examined in some detail.


Joel E. Miller

Joel E. Miller, A.B., Columbia College (1954); J.D., Columbia University School of Law (1956); LL.M. in Taxation, New York University Graduate School of Law (1964); Law Secretary to Honorable Harold R. Medina, Judge, U.S. Court of Appeals for the Second Circuit, 1956–1957; associated with Paul, Weiss, Rifkind, Wharton & Garrison, New York, N.Y., 1957–1960; associated with and member of Demov, Morris, Levin & Shein, New York, N.Y., 1961–1969; member of adjunct and full-time faculty, St. John's University School of Law between 1976 and 1989; Chair, Subcommittee on Condominiums and Cooperatives, Committee on Real Estate Tax Problems, Section of Taxation, American Bar Association; Chair, Subcommittee on Liens, Cooperatives and Condominiums Committee, Real Property Law Section. New York State Bar Association, Tax Section; co-author, Modern Trust Forms and Checklists (Warren, Gorham & Lamont, Inc. 1980); author, Federal Taxation of Trusts (Prentice-Hall, Inc., 1968); contributor to Tax Law Review, Journal of Real Estate Taxation, Journal of Taxation and other legal publications on matters involving federal taxation and property law; editor, Real Estate Tax Ideas 1979–1983; member, several advisory boards; and lecturer at various tax institutes. Note: Portions of this portfolio are taken from articles written by Mr. Miller and originally published in the Journal of Real Estate Taxation (Warren, Gorham & Lamont, Inc.).

Table of Contents

Detailed Analysis

I. Introduction

A. Income Tax Incentive

B. Terminology Used in Portfolio

C. Legal Concepts in General

1. Condominiums

2. Cooperative Realty Corporations

a. Name-Only Housing Cooperatives

b. True Housing Cooperatives

(1) Full-Ownership Housing Cooperatives

(2) Limited-Equity Housing Cooperatives

D. Applicability of Code Provisions in General

1. The Supreme Court's Rule

2. The IRS's Approach

E. Nominees

F. Limiting Rules

G. Outline of Portfolio

II. Taxation of Condominium Unit-Owner

Introductory Material

A. As Owner of Realty

B. As Association Member

C. Credits

III. Taxation of Cooperative Apartment Owner

A. Underlying Issues

1. Realty or Personalty?

a. If State Label Controls

b. If There Is a Federal Meaning

2. Is it “Stock”?

B. Acquisition and Disposition of Apartment

1. In General

2. Amount of Gain or Loss

3. Character of Gain or Loss

4. Deferral of Gain or Loss Recognition

a. Section 1031(a)(1)

(1) Ineligibility of “Stock”

(2) What Property is “Of Like Kind”

b. Section 1036(a)

c. Section 109

d. Section 1038

5. Gain Exclusion under § 121

6. Possible Effect of § 216(e)

7. Charitable Donation

8. IRS Lien

9. Redemption Rights

10. Deductible Loss

11. Sale or Exercise of Purchase Rights

12. Applicability of § 2702

C. Income While Owner

1. In General

2. Actual Distributions

3. Constructive Dividends

D. Deductions and Credits While Owner

1. Taxes Imposed Directly on Apartment Owner's Property

2. Interest on Apartment Owner's Direct Debt

a. In General

b. Section 163(h)

(1) Introduction

(2) Application to Cooperative Apartment

3. Casualty Losses

4. Depreciation

a. Background

b. Requirements of § 216(c)(1)

c. Amount of Deduction

d. Computing the Corporation's Hypothetical Deduction

(1) The Method

(2) The Base

(3) Later Determinations

5. Maintenance in General

a. Income-Seeking-Use Holding

b. Personal-Use Holding

6. Maintenance Attributable to Corporation's Taxes or Interest

a. “Countable Corporate Interest”

(1) “Points”

(2) Taken-Over Debt

(3) Refinanced Debt

(4) Possible § 163(h) Limitation

b. “Countable Corporate Realty Tax”

(1) Taxes on Realty Not Owned by Cooperative

(2) Fee Ownership Not Required

(3) “Tax Equivalency Payments”

(4) Applicability of AMT Limitation on Deduction of “Taxes”

c. Necessity of § 163 or § 164(a)(1) Deductibility by Corporation

d. Deductibility by Corporation Not Sufficient

e. Duplication Rather Than Passthrough

f. The Regulations’ Attempted Delinquency Limitation

g. Timing Problems

h. Rental Surcharges

i. Life or Term Tenant

j. Payments on Behalf of “Tenant-Stockholders”

k. Effect of Refund to Corporation

l. Is a § 216(a) Deduction for “Interest” and “Taxes”?

(1) The Code's Distinguishing References

(2) The Interest Reporting Rule

(3) Deductibility by Decedent's Successor

(4) The Regulations’ Language

(5) Other Interest-and-Taxes Descriptions

7. Energy Credits

8. Certain Mortgage Insurance Premiums

E. Meaning of “Proportionate Share”

1. The Per-Share Method

a. The Statutory Rule

b. Where There Are Governmental Units

c. The Regulations’ Attempted Other-Income Limitation

d. Where the Corporation Holds its Own Shares

e. Weaknesses of the Per-Share Method

(1) The Missing Income-Outgo Link

(2) The Even-Slice Assumption

2. The Trace-Through Method

a. Background

b. The Statutory Language

c. Pre-Conditions to Election

d. The Election

F. Qualification as “Cooperative Housing Corporation”

1. Origin of § 216

2. The Statute's Definition

3. Summary of Requirements

4. A Corporation Having Shareholders

a. Eligible Entities

b. Eligible Interests

c. Who Is the Shareholder

5. The One-Class-of-Stock Requirement

a. Permissible Differences

b. Sources to Be Considered

c. Meaning of “Outstanding”

d. Stock Pledged by the Corporation

e. Exceptions

6. The Link-to-Defined-Space Requirement

a. Every Shareholder

b. Time Sharing

c. Summary of Necessary Elements

d. The Stock-as-Source Element

(1) Allocation of Shares

(2) Effect of Requiring Proprietary Lease

(3) Other Sources

e. The Owned-by-Corporation Element

f. The Necessary-Rights Element

(1) As Against the Corporation

(2) Exclusion Right

(3) Live-In Right in General

(4) Cases Where No Live-In Right Required

g. The Actual-House-or-Apartment Element

(1) Existence of House or Apartment

(2) Facilities Required

(3) Legality of Dwelling Use

(4) Inclusion of Other Space

7. The No-Entitlement-to-Distribution Requirement

a. Meaning of “Entitled”

b. “Good” and “Bad” Distributions

c. No Requirement of “Good” Distributions

d. Constructive Distributions

8. The One-of-Three Percentages Requirement

a. The 80% Gross Income Test

(1) Meaning of “Gross Income” in § 216

(2) Contributions to Capital

(3) Meaning of “Derived from Tenant-Stockholders”

(4) Receipts from Apartment Owners

(5) Receipts from Third Parties

(a) Concession Income

(b) Rent Insurance Proceeds

(c) Refunds

(d) Rents from Taken-Over Apartments

(e) Debt Forgiveness

(6) Possible Ways of Dealing with Test

(a) Increasing Good 80/20 Income

(b) Avoiding Bad 80/20 Income

(c) Use of Short Year

(d) Use of Related Entity

b. The 80% Square Footage Test

c. The 90% Qualifying Expenditures Test

9. More Than One Shareholder

10. Maintenance Related to Shareholdings

a. Source of the Problem

b. Examples Showing Potential Abuse

c. The Price-Per-Share Proposition

d. The Maintenance-by-the-Share Proposition

e. Possible Implied Requirement

11. Governmental Units

12. Period of Qualification

G. Qualification as a “Tenant-Stockholder”

1. The Paid-in-Full Requirement

2. The High-Enough-Price Requirement

a. The Statutory Language

b. Applying the Requirement

c. Valuing the Apartment

d. When the Requirement Is to Be Applied

e. Re-Allocations

f. The “Not Less Than” Problem

g. The Discount Problem

IV. Taxation of Housing Cooperative

Introductory Material

A. Income Problems

1. “Artificial” Income

a. On Distribution to Shareholders

b. Effect of Proprietary Lease

c. Relief Under § 216(e)

(1) Potential Regulatory Limitations

(2) The Corporate-Qualification Issue

(3) The Dwelling-Unit Issue

(4) The In-Exchange-For Issue

(5) The Used-as-Principal-Residence Issue

d. On Allowing Bargain Use of Commercial Space

e. On Allowing Bargain Use of Apartments

2. Refunded Amounts

a. Actual Return in the Same Year

b. Credit Against Later Charges

3. Amounts Held as Agent

4. Payments Received for Stock

5. Capital Contributions

a. The IRS Position

b. Need Not Be Voluntary

c. Enforcement Mechanism Irrelevant

d. The Purpose Test

e. The Tracing Problem

f. Voluntary Characterization as Rent

6. No Exclusion Under Subchapter T

B. Deduction Problems

1. Patronage Dividends

a. Background of Subchapter T

b. Applicability to Housing Cooperatives

c. Requirements of a Patronage Dividend

(1) Business with the Individual Patron

(2) Business with All Patrons

(3) Pre-Existing Obligation

(4) Time of Payment

(5) Manner of Payment

2. Limitations on Deductions

a. Nature of the Problem

b. The Theoretical Answer

c. The Approach Actually Used

d. The § 277(a) Deduction Limit

(1) In General

(2) Applicability to Housing Cooperatives

(3) Revenue Ruling 90-36

(4) Investment Income

(5) Credits

(6) Other Effects of § 277(a)

e. The Subchapter T Deduction Limit

f. Pre-1974 Depreciation

V. Taxation of Condominium Association

Introductory Material

A. Two Sets of Rules

B. Rules Under § 528

1. Reason for § 528

2. Basic Operation of § 528

3. “Exempt Function Income”

a. The Source Test

b. The Nature-of-the-Obligation Test

c. The Purpose Test

d. The Includibility-in-Gross-Income Test

e. Tenants of Unit-Owners

4. Qualification as “Homeowners Association”

a. The Substantially-Residential Test

b. The Purpose Test

c. The 60% Income Test

d. The 90% Expenditure Test

e. The Lack-of-Private-Benefit Test

5. Meaning of “Association Property”

a. Held by Association or Unit-Owners in Common

b. Owned by Governmental Unit

c. Held Privately

6. Reasons Not to Elect § 528 Treatment

VI. Taxation of Condominium Creator

Introductory Material

A. Gain Deferral

1. The Overall Project

2. Individual Sales

B. Capital Gain

1. The General Rule

2. Use of Pre-Condominiumization Sale

3. Possible Exceptions

a. Section 1237

b. The Counting-of-Factors Approach

c. The Any-Liquidation-of-Investment Approach

d. The Only-Feasible-Disposition Approach

e. The Necessary-to-Prevent-a-Loss Approach

f. The Unable-to-Give-Away Approach

g. The Forced-Liquidation Approach

4. Initial Retention of Land

VII. Taxation of Transferor to Cooperative

Introductory Material

A. Capital Gain Treatment

1. The Multiple-Sales Approach

2. The Single-Sale Approach

B. Section 351

1. Reason for Existence

2. Effects of Applicability

a. Covered Property Exchangers

(1) Loss

(2) Gain

(3) Basis

b. The Corporation

3. Not Optional

4. Basic Requirements

5. Possible Issues

a. Lack of Prior Affiliation

b. Different Kinds of Property

c. Shares Not to Be Taken into Account

d. Transferors Not to Be Taken into Account

VIII. Timeshare Associations

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Example of Contrasting Per-Share and Trace-Through Allocations under § 216(b)(3)(A) and (B)

Worksheet 2 Paragraph to be Included in Lease if Two or More Leases Contain Safetycaps

Worksheet 3 Paragraph to be Included in Lease if No Other Lease Contains a Safetycap

Worksheet 4 Checklists

Worksheet 5 Key Revenue Rulings




Treasury Regulations:

Legislative History:

Treasury Rulings: