The 80/20 Dilemma How to Keep the Balance

Picture this: the mom-and-pop dry cleaner that has inhabited your building's ground floor retail space for years is moving out and a broker tells you that an upscale clothier wants the space for triple the rent. Or perhaps one of the many cellular companies in town wants to rent your roof for antennae placement. Maybe your adjacent parking garage is changing hands and the new contract will yield twice the income of the old one.

Any co-op board would be salivating at this point, visions of new elevators and lobby upgrades dancing in their heads. Then along comes the perennial bearer of bad news, the Internal Revenue Service, to tell you that these lucrative commercial deals violate the 80/20 rule. Before you throw out the paint chips and carpet samples, there are ways to welcome the increased income without penalties.

The Golden Rule

Section 216 of the Internal Revenue Code, which contains provisions related to the 80/20 rule, grants co-op owners certain tax deductions, provided that at least 80 percent of a housing cooperative's income comes from shareholders. Section 528 of the IRC grants similar rights, and demands the same responsibilities, from condo owners. When Congress passed the original form of the law in 1942, they wanted to give urban dwellers the same rights as suburban homeowners.

"The problem," says Gerald Marsden, CPA, a partner at the Manhattan accounting firm of Eisner & Lubin, LLP, "comes largely from the rental of commercial tenants such as garages or stores. The 80 percent appears to have been an arbitrary number. [Congress] didn't want commercial income hiding."

"The government is concerned," says Carl Cesarano, founder of Manhattan accounting firm Cesarano & Khan, CPAs PC. "Are you running a real estate company, or a true cooperative?" In general, any income from shareholders, including maintenance and things like move-in and sublet fees, are "good" income; the more there is, the better. Anything from an outside source is "bad" income - and must therefore be offset by a larger proportion of "good" income.

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