Q&A: Commercial into Residential

Q We have a two-building, 146-unit cooperative that has a five-hundred-square-foot ground floor of commercial rental space. It has been vacant for about a month now. We, the board of directors, would like to know: Can this space be converted into another cooperative apartment unit? Who would we have to contact to make [sure] it is done legally?

—Board Member in Manhattan

A “Commercial space in a cooperative building may be converted to residential space legally and without jeopardizing the cooperative’s favorable tax status, if it’s accomplished in accordance with the provision of Section 216 of the Internal Revenue Code, the attorney general’s regulations and applicable zoning codes,” says Jeffrey S. Reich, Esq., co-chair of the real estate department of Wolf Haldenstein Adler Freeman & Herz LLP.

“In order to ensure that the conversion of commercial space to residential use is done in compliance with law, the cooperative’s board of directors should contact an attorney familiar with cooperative law, an architect who is well versed in zoning and conversion issues and a real estate broker or appraiser.

“As a threshold matter, the board should retain an architect to review the building’s certificate of occupancy and the New York City zoning resolution to determine whether the building’s certificate of occupancy may be amended to provide for residential use of the commercial space.

“Once the feasibility of the conversion has been determined, the board should seek counsel from an attorney familiar with cooperative law to help guide it through the conversion process. An analysis of the apartment corporation’s certificate of incorporation and bylaws must be conducted by the cooperative’s attorney to ensure that the cooperative has a sufficient number of authorized shares and the authority to allocate some of those shares to the commercial space. If the cooperative does not have a sufficient number of authorized shares, a vote of the shareholders (usually a majority vote of the shareholders is required, but a greater number may be required by the cooperative’s certificate of incorporation) will be necessary to authorize the issuance of additional shares. The cooperative’s governing documents and the New York State Business Corporation Law often provide a board with the authority to issue and allocate new shares.

“The next step is to determine the appropriate allocation of shares for the commercial space. This calculation is often made by an appraiser or a real estate broker after an evaluation is made of the size and value of the space. In order to comply with the requirements of Section 216 (which among other things, allows tenant-shareholders to deduct their proportionate share of the cooperative’s interest expenses and real estate taxes) the allocation of the new shares must be reasonably related to that portion of the cooperative’s equity in the building. It would also be prudent for the cooperative to obtain a private letter ruling from the IRS to confirm that the cooperative has met the requirements of Section 216 in structuring the transaction.

“Finally, the apartment corporation will need to apply to the office of the New York State Attorney General for a “No-Action” letter. The issuance of a “No-Action” letter allows the cooperative to sell the shares allocated to the commercial space without the need for an offering plan to be filed.

“To fulfill its fiduciary responsibilities to the shareholders of the cooperative, the board may wish to consult with an appraiser or real estate broker to determine how to best maximize the value to be received for the commercial space. The board should also consider whether it will undertake to convert the commercial space for residential use or whether it will leave the task of conversion to the purchaser. In either case, the conversion of the space must meet the requirements of the Multiple Dwelling Law, the New York City Building Code and other relevant codes, rules and regulations.

“While the conversion process requires planning and effort on the board’s part, it can prove to be financially rewarding for a cooperative.”

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