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Eliminating the 80/20 Rule Offers Tax Relief to New York City Co-ops

We all want to enjoy tax benefits and increase the value of our homes.  Well, New York City co-ops were formally restricted in that respect pursuant to Section 216 of the Internal Revenue Service (“IRS”) code.   This federal tax rule (also known as the “80/20 Rule”) required residential co-ops to get at least 80 percent of their gross income from their tenant-shareholders and no more than 20 percent form other sources like commercial rents.  The rule was created in the early 1940's when Congress sought to give co-op shareholders tax deductions yet wanted to keep commercial corporations from taking advantage of tax benefits (these benefits include deductions for property taxes and mortgage interest, and the shielding of up to $500,000 from capital-gains taxes when the co-op is sold).  Under the 80/20 rule, New York City co-ops routinely rented commercial space at bargain rents and charged the shareholders higher maintenance charges in order to fall within the proper percentage to receive tax benefits.  If a building did not qualify under the 80/20 rule it would lose its legal status as a co-op and shareholders would lose the tax benefits granted to homeowners. 

The Mortgage Forgiveness Debt Relief Act of 2007, signed by President Bush in December 2007, relieved co-ops from having to give up money in rental income or risk losing their status as a housing cooperative under federal tax laws.  The new law requires a co-op to pass one of three tests to enable the shareholders to qualify for tax benefits.  The first test is the original 80/20 rule.  The second test requires 80 percent or more of the total square footage of the corporation’s property is used or available for use by the tenant for residential purposes.  The third test requires at least 90 percent of the income be for the benefit of the shareholders (including but not limited to maintenance, management or care of the property).   This new law makes it easier for co-ops to qualify for the tax benefits.  It increases the co-ops’ ability to charge market-rate rents for commercial space, keep maintenance charges lower for shareholders and still receive the same tax benefits of an owner of a condominium or single family residence.  This new law will ultimately increase the value of the co-ops and will make many shareholders of co-ops very happy.

Full post as published by New Jersey Law Blog on March 04, 2008 (boomark / email).