New Options for Co-ops Financial and Legal Changes to the 80/20 Rule

As many readers are by now aware, a rule that proved a hindrance to the operations of many co-ops in New York was drastically altered in December of last year--and the changes are having far-reaching effects on the city's co-op communities.

The rule was the so-called “80/20 rule,” and according to Charles H. Baller, a co-op tax specialist with Manhattan-based law firm Wolf Haldenstein Adler Freeman & Herz LLP, it separated a co-op’s income streams into “good” and “bad.” “Good” income was anything that was “‘derived from tenant-shareholders’”—like maintenance fees, flip taxes, assessments—and “bad” income was everything else: rent from commercial tenants, and says Baller, “taxable interest income received by the co-op corporation, income from the sale of property owned by the co-op corporation, etc.”

“The concept of good or bad income was applied for purposes of determining compliance with the old 80/20 test under Section 216 of the Internal Revenue Code (IRC),” says Baller. Under the law, if bad income represented more than 20 percent of a building’s total annual income, the building forfeited its status as a cooperative corporation under Section 216 for that year, and lost valuable tax benefits. “Of course, from a marketing point of view for the building, it would also be a complete disaster,” says Baller.

The Burden of 80/20

According to Manhattan-based real estate attorney Michelle Freudenberger, the origin of the 80/20 rule, part of Section 216 of the Internal Revenue Code, was passed in 1942. It was part of an overall law that was actually advantageous, since it allowed co-op shareholders to take advantage of the same deductions for real estate taxes and mortgage interest as other homeowners. However, almost everyone involved agrees that as things evolved over the years, the 80/20 rule became an albatross around the neck of the co-op community. Many co-ops had to rent their very valuable retail space at a discount in order to stay on the right side of the rule, a state of affairs that Manhattan-based attorney Andrew P. Brucker of Schechter & Brucker PC describes as “extremely inequitable.”

Changes Sought for Years

Changes to 80/20 were sought for years by organizations such as the Council of New York Cooperatives and Condominiums (CNYC) and the Federation of New York Housing Cooperatives and Condominiums (FNYHC). However, since this was a federal rule, it would have to be changed in Washington.

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4 Comments

  • I would like to ask Mr. Baller if interest income from a reserve account derived from the sale of commercial space into stock is deemed to be Patronage Income. Further , the income subsidizes maintenance in lieu of the past rental income foregone. Thanks
  • I would like to ask mr. baller if income from a commercial tenant is patronage, or non-patronage, for purposes of form 1120-C
  • Mr Baller I have a basic question which I am finding difficulty in answering. I would appreciate your input. I am preparing Form 1120-C for Section 216 cooperative association. It has patronage income in excess of its patronage expenses. Is this income subject to tax ? The Association has no nonpatronage income or expenses.
  • co-op's converting to condo must recognize taxable gain to the extent there are non-resident shareholders (shareholders who do not qualify for IRC 216-e treatment). Is the taxable gain patronage income?