New Law Allows Co-Ops to Increase Commercial Rent

Client Advisory

January 18, 2008

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:

  1. the old 80% of revenue test,
  2. a square footage test: at least 80% of the total square footage of the property owned by the corporation is used or available for use by the shareholders for residential purposes (or purposes closely related to residential purposes), or
  3. an expense test: at least 90% of the co-op’s expenses are for the acquisition, construction, management, maintenance or care of the co-op’s property for the benefits of its shareholders.

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. 

Questions regarding this client advisory may be directed to Howard Barnet at (212-238-8608, or Dan Pittman (212-238-8854, of our New York office.

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2020 Carter Ledyard & Milburn LLP.
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