On December 20, 2007 the President signed into law the Mortgage Forgiveness Debt Relief Act of 2007 (the “Act”). The law contains a provision that expands the definition of the term “housing cooperative” in a manner that will allow many co-ops with commercial tenants to charge them market-rate rents without adverse tax consequences to the co-op shareholders.
The Internal Revenue Code (the “Code”) provides many tax incentives to homeowners, including the right to deduct property taxes and mortgage interest, and to exclude up to $500,000 of gain on the sale of a principal residence. Technically, however, members of housing cooperatives do not own homes; instead, they are shareholders in and tenants of a corporation which owns residential property. Code Section 216 provides that for purposes of the tax benefits described above, co-op shareholders are treated the same as owners of homes or condominium units. However, prior to the passage of the recent Act, Section 216 provided that 80 percent or more of a corporation’s gross income had to come from its shareholders for it to qualify as a cooperative. This has meant that many cooperatives with commercial space have been forced to charge their commercial tenants below-market rent or employ other methods of satisfying the 80%/20% test.
Under the provisions of the Act, shareholders in a co-op will generally be eligible for the tax benefits if the co-op meets any of the following tests:
It will now be possible for co-ops to charge market-rate rent to commercial tenants, even if by so doing the 80% of revenue test is violated, as long as one of the other tests is met.