RETAIL SPACE AND 80/20, P.2

There have been concerns that the interests of the LLCs may eventually differ from those of the co-ops (the use by the subtenant being one of the primary disagreements, for example), and there has been concern that if the LLCs simply become a mirror of the co-ops, the IRS could describe the entire arrangement as a sham.

Qualifying a commercial space as a co-op apartment requires strict adherence to IRS rules that relate to a different requirement of the code: that each shareholder must "be entitled … to occupy [the unit] for dwelling purposes …." If local zoning laws at a building's location do not permit ground floor space or basement space to be used for residential purposes, it is difficult to properly issue shares to a first-floor or basement store in that building.

However, if the zoning permits both commercial and residential use, and existing commercial space can, in the opinion of a licensed architect, be converted to meet building department requirements for residential occupancy at a cost of not more than 25 percent of the value of the unit, shares may be issued for the unit, sold to an owner, and the income from the sale and the maintenance received from those shares would be counted as good under 80/20.

Other co-ops have solved 80/20 problems by increasing their good and minimizing their bad income. Some have met the test creatively: through bulk purchases of electricity, Internet, cable TV or homeowners' insurance for all apartments, and by leases that requiring commercial tenants to pay many operating costs applicable to their units.

Finally, some buildings carefully time the receipt of a substantial amount of money to coincide with the creation of a short accounting year, during which the corporation is not, for that brief period, a qualified co-op under Section 216. For example, the corporation could require its commercial tenant to pay what would be, essentially, a prepayment of rent: a one-shot payment on a specific date, with rental payments for the remaining lease term to be ay a level of less than 20 percent of the co-op's total income. The co-op could file tax returns in which it elects a one-time short tax year. In that period, the co-op would record the receipt of the large rental income, and not qualify as a co-op for federal tax purposes – meaning shareholders would be ineligible to deduct interest or real estate payments from their income taxes, or shelter any profits from sales, during that brief period.

Such an election must be made after careful consultation with the building's accountants and attorneys, as well as with all shareholders to enable them to schedule projected sales of units around the short tax year.

That said, I expect that the new legislation will make the 80/20 problems easier to deal with for the majority of co-ops that have had to face these issues.

Arthur I. Weinstein is an attorney in private practice.

Adapted from Habitat February 2008. For the complete article and more, join our Archive >>

Art by Danny Hellman