Cooperative housing corporations are not exempt from income taxation. Like any other taxpayer, a housing
cooperative must pay tax on its taxable income, i.e., its gross income less allowable deductions. Not all amounts that would seem to qualify as deductions are necessarily allowable. There are various tax rules that limit the use of deductions, and two such rules are aimed particularly at organizations that both (a) have customers who for the most part are members of the organization and (b) receive income from sources other than members.
The basic concern of the IRS is that, because such an organization itself decides how much to charge its members, it could arrange matters so that the sum of all its income from members (its inside income) plus all its other income (its outside income) would be less than the aggregate of all its deductions, so that it would end up with no taxable income and therefore would have to pay no income tax. The net effect would be that the organization's outside income would be going to benefit its members (by allowing lower charges to them) without anyone ever having paid income tax on it.
Both of the aforementioned deduction-limiting rules work in basically the same wayeach provides that the organization's deductions attributable to its inside income can be used only to offset that kind of income. It follows that, even if such an organization had potential deductions that added up to more than all its gross income, one or both of those rules might nevertheless require it to pay some income tax.
Two Rules with Varied Results