Co-ops in City
By BRADLEY HOPE,
Staff Reporter of the Sun January 17, 2008
A little-noticed provision in President Bush's plan to alleviate homeowners' mortgage debt will provide a windfall for cooperatives across the city.
The Mortgage Forgiveness Debt Relief Act of 2007 will allow co-ops to raise the rents for retail tenants — equaling hundreds of millions of dollars across the city — enabling the buildings to hire doormen, complete capital projects, and even stop charging apartment owners monthly maintenance fees, according to lawyers, managing agents, and co-op board members.
For years, co-ops in popular neighborhoods were forced to offer below-market rents to stores that leased space in their buildings to meet the requirements of the Internal Revenue Service's 80/20 law, which stipulated that no more than 20% of the co-op's gross income could come from non-shareholder sources. If the building crossed the 20% threshold, shareholders would forfeit their ability to deduct property taxes and the interest on mortgages.
More recently, as retail rents have soared across the city, co-ops have struggled to keep their non-shareholder income below 20%. Now, under new rules signed into law by Mr. Bush last month, shareholders are eligible for the tax deductions as long as they ensure that 80% of the building is used for residential purposes or that at least 90% of the total income is used for the benefit of shareholders.
"This is a very significant change," the president of the lobbying group Real Estate Board of New York, Steven Spinola, said. "This is exactly what government should have done years ago to deal with the changing retail rent."
One 100-unit co-op on Madison Avenue, whose board requested that the building's address not be disclosed, already is drawing up plans to increase the rents for six commercial tenants by 50%, translating into as much as $500,000 in additional annual revenue.
"This will give a tremendous increase in funding," a managing agent for the building, Neil Davidowitz, said. The co-op board is forming a subcommittee to prioritize new capital projects, which include a façade restoration, a new heating plant, and the addition of a gymnasium.
At another co-op in Chelsea, the board has calculated that increasing the rent it charges its retail tenants could reduce its monthly maintenance for shareholders by up to 40%, a lawyer who specializes in co-ops, Alan Fried, said.
Some of the cooperatives on major shopping corridors like Fifth Avenue and Madison Avenue, where retail rent is especially high, could realize enough income to end maintenance fees, he said.
"Any co-op on Madison from 57th Street to 86th Street could probably now earn enough income to eliminate or substantially reduce their maintenance fees," Mr. Fried said. Retail rents in the area often exceed $1,000 a square foot, according to data from Cushman & Wakefield.
While the change to the law will have the biggest impact on co-ops with commercial tenants, it will help in other ways, too.
In the past, if a co-op sold its air rights or received rental income on apartments owned by the co-op corporation, it was subject to the 80/20 law. Now, buildings will have more flexibility to pursue such transactions, the president of the Council of New York Cooperatives and Condominiums, Marc Luxemburg, said.
"You are talking about hundreds of thousands of dollars or more of income that was lost," he said. "It's a very big deal."
Mr. Fried cited as an example the co-op board at 125 W. 96th St., which will be able to save $10 million on taxes by reincorporating a holding company it created to shield some of its income.
The Upper West Side co-op received about two dozen apartments in the 1980s, when the sponsor defaulted on maintenance charges, but every time the co-op sold one of these apartments, the income would be added to the 20% mark. To avoid this, it formed a holding company. But while the holding company shielded the income from the 20% rule, the income was taxed as corporate at a rate of nearly 50%. Now the board is planning to merge the holding company back into the co-op.
"They are very excited," Mr. Fried said of the building's shareholders. "They could choose to retire their mortgage, which would reduce maintenance fees, or they could hire a doorman."
Besides forming holding companies, co-ops have tried all manner of legal loopholes to get past the 20% requirement, including artificially raising maintenance fees, taking a short fiscal year, and charging commercial tenants for capital improvements to the buildings, the executive director of the Council of New York Cooperatives and Condominiums, Mary Ann Rothman, said. "It was called the cliff. If you went past 20%, it was a very, very dire consequence."
While most co-ops are going to benefit from the change, some have missed the boat. At 220 E. 57th St., for example, the co-op board renewed its retail tenants' contracts for 15 years at below-market rates just before the new law was passed. It will have to wait for the benefits, but "we are looking forward to reducing maintenance increases," the president of the co-op board, George Kleiman, said.
The new rules, which were sponsored by Senator Schumer and Rep. Charles Rangel, both Democrats of New York, may take time to catch on, but they will be a boon for New York, experts say.
Co-op owners "should see significant economic benefits" from the new law, a real estate lawyer, Aaron Shmulewitz, wrote in a briefing on the change to his clients. "It is difficult to imagine how a residential co-op could fail to satisfy at least one of these three alternative tests."