The High Hurdle of Co-op to Condo Conversions

The Kadampa Meditation Center occupies the entire ground floor of a seven-story commercial co-op building in Manhattan’s Chelsea district. The nonprofit that bought the 7,500 square foot space in 2012 has been trying for the past two years to convince the co-op board to convert the building to a condominium association. Such a conversion would enable the nonprofit to take advantage of a tax exemption that is not available to nonprofit shareholders in a co-op.

“Many not-for-profits are so hungry for ownership that they give up the tax benefits so they can own in a co-op,” says Michael Rudder of Rudder Property Group, which represented the nonprofit in its Chelsea co-op purchase. The long-term benefits of ownership include not being displaced at end of their lease, and being able to finance or lease the space and earn a profit.

The Chelsea nonprofit’s push to convert the commercial co-op into a condominium is a desire shared by shareholders and boards in numerous residential co-ops. To be sure, New York City condo units have been fetching 10- to 20-percent higher prices on average than co-op units for several years – numbers that are skewed by the escalation of luxury condominium construction. But the hurdles that cooperative housing corporations have to jump to do a conversion make very few co-ops willing to take it on.

The process referred to as a conversion is actually a collapsing of a cooperative corporation, says attorney Shaun Pappas, a senior associate at Starr Associates, which is known for its work on co-op conversions. “That is not done that often because there are substantial tax consequences, because you’re basically dissolving a corporation.”

To be able to convert from a co-op to a condominium association, a co-op board first needs approval from a supermajority – generally 80 percent – of its shareholders. If a supermajority approves, all shareholders must pay off any existing share-backed loans for their units, or convert to a regular mortgage loan. The co-op itself also must pay off any outstanding loans, or convert.

The co-op then goes to the state Attorney General’s office with a letter stating the shareholders’ desire to convert to a condominium, and that there is no public offering involved. Once the Attorney General approves the letter, the co-op hires an architect to draft tax lot drawings and floor plans of the condo units and common elements, and then uses those drawings to purchase individual tax lots from the city’s Department of Finance (DOF). The co-op’s attorney drafts a condominium declaration, which becomes the governing document for the condo association, and that is also submitted to the DOF for review and approval. If approved, the co-op is free to create the condo association based on its tax map drawings and condo declaration. This is recorded in the City Register’s Office.

Under the law, the conversion of co-op units to condo units is treated as a sale, subject to capital gains tax. But residential owners who use their unit as their primary residence are not required to pay a capital gains tax on their condo unit. Owners who either use their units as a secondary residence or rent them out do have to pay taxes on any value gain, as does the condo association itself, says attorney Warren Gleicher, a partner at Olshan Frome Wolosky, who advises clients on the tax impact of conversions.

On the other hand, says Gleicher, the IRS has ruled that commercial owners who convert from co-op to condo are treated as a “like kind exchange” – that is, when the size and the use of the space remain the same.

Attorney Pappas says Starr Associates receives about five to 10 inquiries each year about the co-op-to-condo conversion process, from either individual shareholders or board presidents of small residential co-ops. Although very few go forward, Pappas says conversions could become more common if condo prices continue to rise and the value gap between condos and co-ops continues to widen.