Playing the Percentages How 80/20 Affects Co-ops and Their Shareholders

It may sound like an oxymoron, but in the world of co-ops there is such a thing as “bad income.” The federal tax code requires that cooperative buildings receive at least 80 percent of their income from their shareholders—usually in the form of monthly maintenance charges and periodic special assessments. Failure to meet this requirement (commonly known as the 80/20 rule) results in a building’s shareholders being unable to declare certain tax benefits, such as declaring the interest on mortgages and an exemption on taxable income when selling a home.

“The 80/20 rule is a tax concept that a cooperative must meet in order to qualify as a cooperative,” says Ed Taub of the Manhattan-based accounting firm ERE LLP.

Problems can arise when buildings rent out their valuable first-floor retail space to make money from adjacent parking garages, or lease exterior space to large-scale advertisers. While these strategies can be great moneymakers, they can be problematic within the confines of 80/20 regulations. To avoid losing valuable tax abatements—the penalty for breaking the 80/20 rule—co-ops either have to come up with ways to increase their good income, or offer the space at less than market value.

What’s 80/20?

The 80/20 provision is contained in Section 216 of the Internal Revenue Code. In essence, its purpose is to make sure that a residential co-op is indeed a residence and not a business.

“The original concept was that if more than 20 percent of the income came from other sources, then not enough is coming from residents—and therefore they shouldn’t get a special tax treatment of taking their deductions a second time,” says Stephen Beer of the Manhattan-based accounting firm Czarnowski & Beer.

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