Biggest impact of 80-20 rule change yet to be felt

After literally decades of campaigning by the Council of New York Cooperatives and Condominiums, as well as others, a limitation on the amount of money that a co-op building can collect in rent from commercial (technically, patronage) operations was changed in December 2007 starting that tax year.

The impact of what was an expanded definition of “cooperative” has yet to be fully realized, though there are isolated instances of occasionally enormous benefits.

Until it was changed, the so-called 80-20 rule prevented cooperatives from enjoying a tax deduction for their expenditures on property taxes and mortgage interest if their income from retail stores, garages and such exceeded their operating budgets by 20 percent.

As a result, many commercial tenants were paying a pittance in rent, including nothing in the case of a few nonprofits such as, say, thrift shops.

With a new, more comprehensive definition of “cooperative” in the revised IRS rule, buildings now can permit the budgetary contribution of commercial rent to go over 20 percent.  The new rule enables buildings that had to charge below market rates for renting out their space to derive substantially more income than previously.

A shareholder’s maintenance in a building with commercial space can thereby stop rising, stay flat or even go down.

“It did have a significant effect,” Gary Ziprin, chief financial officer of Midboro Management, which numbers some 150 buildings as its clients, said of the rule change. Of that number, more than 10 percent of the cooperatives have benefited by reducing maintenance increases by perhaps 2-3 percent.

When a commercial tenant’s lease was renewed in one building that the company manages, the CFO told me, the store’s rent went from $45,000 a month to $175,000.  The Board of Directors was able to cut maintenance by 8 percent at a time when other cooperatives were raising it in the neighborhood of 8 percent.

“They knew they had a sweetheart deal in prior years,” Ziprin said of the retailer.

Yet the impact of the rule change has been rather limited, and that is for two reasons: 1. Commercial rents remain pretty much in the dumps; and 2. Until a lease expires, rent cannot be raised.

Instances of buildings that have been affected are “few and far between,” Abe Kleiman, whose accounting firm Kleiman and Weinshank works with approximately 200 buildings, half of them cooperatives, said in a telephone interview.

Still, property manager Eric Greenberg of Tudor Realty, is aware of a downtown Manhattan building in which the lease renewals of a supermarket and a garage permitted a reduction in that cooperative’s maintenance fees by 10 percent.

Several of the individuals interviewed also acknowledged that there could be twofold tax consequences from the change.  For one thing, any profits from rent might be taxable.  Second, while the possibility is normally acknowledged in an accountant’s footnote, the potential liability is rarely, if ever, listed as such on the cooperatives’ financial statements.

“They are theoretically vulnerable,” said a busy accountant who is not quoted elsewhere in this post and who asked to remain unidentified.  “They hope the IRS won’t audit any buildings.”

There is no question that commercial tenants will be forking over more and more money as the economy improves and as their leases run out.  The question that will go unanswered for now is whether the cooperatives will face some serious tax consequences for any profits they record.

The IRS is said to be studying the issue.

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Malcolm Carter
Licensed Associate Real Estate Broker
Senior Vice President
Charles Rutenberg Realty
127 E. 56th Street
New York, NY 10022

M: 347-886-0248
F: 347-438-3201

Malcolm@ServiceYouCanTrust.com
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