The 80/20 Rule: How Will Selling Air Rights Affect UT's Taxes

This issue came up rececently on the UT Yahoo Message Board, and one of the members kindly posted the below article, which states, among other things, that a co-op will still qualify for cooperative status "if 80 percent or more of the total square footage of the property is used or available for use by tenant-shareholders
for residential purposes."

Please read the article for full details:

BREAKING NEWS

Late-Breaking News Exclusive
The End of 80/20?

by Bill Morris

For New York City's co-ops, the year-end holidays brought a golden
gift from a most unlikely source: the subprime mortgage crisis.

On December 20, President George W. Bush signed the Mortgage
Forgiveness Debt Relief Act of 2007 (also known as HR 3648) into law,
praising its mechanisms for offering relief to strapped homeowners who
are being squeezed by taxes and fluctuating mortgage rates.

But during the signing ceremony in the Roosevelt Room at the White
House, Bush neglected to mention a sidelight of the law that will
reconfigure one of the most durable building blocks in the New York
co-op world, the so-called 80/20 rule.

Since the enactment of Section 216 of the Internal Revenue Code in
1942, a property could qualify for cooperative status – and
shareholders could deduct real estate taxes and mortgage interest
payments from their taxable income – if the property received 80
percent or more of its income from residential shareholders and no
more than 20 percent of its income from other sources, including
commercial tenants.

The old 80/20 rule remains in place under HR 3648, which goes into
effect for the 2007 tax year. But there are now two additional ways
for a property to qualify for co-op status and the attendant tax
breaks. The first is if 80 percent or more of the total square footage
of the property is used or 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.

"This is a major change," says Joel E. Miller, a veteran co-op and
condo attorney from Queens who kept a close eye on HR 3648 as it
sailed through Congress. In the House of Representatives, where New
York's Rep. Charles Rangel was a co-sponsor, the measure passed by a
vote of 386-27; in the Senate, where Sen. Charles Schumer was a
sponsor, it passed by unanimous consent, an indication of Washington's
sensitivity to the political aftershocks of the subprime mortgage crisis.

"Many co-ops will have no trouble meeting the new square-footage or
expenditure tests," Miller says. "And now the co-op could charge any
rent they wanted to because there's no limit on outside income. Which
is a big change."

While many co-ops could see a windfall from rising commercial rents,
potential losers in this brave new world are the small army of co-op
lawyers who have worked hard, and sometimes creatively, to protect
their clients' tax-exempt status under the 80/20 rule. In fact, Miller
says, one distraught colleague phoned him the day Bush signed the bill
into law, lamenting that it would drive him out of business.

"Personally I'm relieved," Miller says, "because what we were doing to
qualify co-ops under 80/20 were things that might be challenged by the
I.R.S. Now, if co-ops can pass one of the other two tests, they're not
going to need a lawyer to help them comply with 80/20."

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

Another person who's pleased with the new law is Mary Ann Rothman,
executive director of the Council of New York Co-operatives &
Condominiums, which actively lobbied for passage of the bill. "I'm
elated," says Rothman. "Many low-income co-ops were put together with
commercial tenants as a way of providing services and keeping
shareholder costs down. This new law will allow co-ops to realize
additional commercial rent. It's probably not a happy moment for
commercial tenants, but it's a happy moment for co-ops."

While it's too early to know how many co-ops will experience a
financial windfall from the new law, it's safe to say that life will
be simpler for just about everyone. Anthony Wolff, who has been board
president of the 55-unit co-op at 223-231 West 21st Street for the
past quarter century, welcomes the prospect of not having to jump
through the old 80/20 hoops.

"We used to sort of skirt it [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," Wolff says.
"'Good income' meant maintenance income. We always added to that any
money the co-op took in from shareholders – laundries, late fees,
storage fees, the one percent flip tax – to bolster our 'good income'
and make sure we complied with 80-20. Now we don't have to do that.
This new law is going to get rid of that exercise in sophistry."

It's an exercise Wolff says he will not miss. It's safe to say he's
not alone.