Temptation, Taxation When Buyers Want Your Co-op Building for a Family Home
Nov. 5, 2013 — Lately, a number of longstanding Manhattan co-ops have been approached by brokers on behalf of wealthy persons who would like to buy the building and turn it into a single-family residence. Think of a four-unit building for which a buyer would be willing to pay $12 million. Three million dollars for each shareholder sounds pretty good. Or actually, maybe not.
First of all, there would be sizable transaction costs. The transfer taxes alone would be more than $360,000. For the sake of simplicity, let's assume a total of $500,000, thus leaving $11.5 million for shareholders to walk away from the table with. And then what else?
The income taxes. The first step in computing the co-op's income-tax liability would be to subtract the building's "adjusted basis" from the $11.5 million "amount realized." If we assume an "adjusted basis" of $1.5 million, the co-op's taxable gain would be $10 million.
Deep in the Heart of Taxes
Here is where the first shock comes in, at least for the many who are not conversant with such matters: There is no special capital-gains rate for corporations, and the effective combined federal-state-city rate for Manhattan corporations is approximately 46 percent. Thus, the amount available for distribution to each shareholder would be — not $3 million — but only about $1,725,000. Then comes the second shock, the phenomenon known as "double taxation." Notwithstanding the enormous tax already paid at the corporate level, the distribution would generate another tax — of a considerable amount — at the shareholder level.
It is not surprising, then, that many such potential sales have been abandoned when the income-tax cost became known. We do know of one instance in which a building sale by a co-op did go through, but that was only because the co-op board had signed a contract of sale without consulting its tax advisor and the court had refused to excuse it from performance.
That is not to say that there can never be a solution. Sometimes a deal can be structured in which the co-op is converted to a condominium and the buyer purchases all of the units. Of course, such an approach requires not only a favorable set of facts, but also a knowledgeable team of professionals to make it work.
Joel E. Miller is a partner at Miller & Miller.
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