Co-op to Condo Conversion Payoff? Not So Fast..or Maybe?

In Jay Romano’s piece for The New York Times, Your Home: Converting a Co-op to a Condominium, he addresses a question that has been asked of me and many of my colleagues hundreds of times by clients who own co-ops in this unique Manhattan real estate market.  Just Friday, I ran into a shareholder in a building in which I have sold about 40 units who insisted that the building should convert to condo.  When I suggested it was a difficult process, he stated that all shareholders would have to do is pay $50,000 each to pay off the buildings $13,000,000 mortgage.  Well, I have good news on that front.  Each shareholder would only have to pay about $9,000 to achieve a mortgage payoff for this particular building  But this is the least of the issues that a co-op faces when converting to condo according to this article.

In addition to 80% of the shareholders voting in favor of a conversion, paying off  the building mortgage, and every shareholder receiving permission to convert there share loan to a mortgage, the conversion has some large tax implications for shareholders:

There are also potential tax implications for both individual shareholders and the co-op corporation. Joel E. Miller, a Queens tax lawyer, said that converting an apartment from a co-op to a condo is considered a sale for tax purposes because shareholders exchange their co-op shares and proprietary leases for deeds to their apartments as condominium units. Since the transactions are considered sales, shareholders have to calculate their taxable gains based on the current market value of their apartments. So if shareholders originally paid, say, $100,000 for a co-op apartment, and that same apartment is now worth $700,000, they would have a $600,000 gain, even though they still remain the owners of the apartment.

And tax implications for the building as well:

There are also tax consequences for the co-op corporation. Marc Shernicoff, a certified public accountant in Manhattan, said that when the co-op corporation gives a shareholder a deed in exchange for shares and the proprietary lease, that also is considered a taxable event for the co-op. Since the deed is valued at the current market value of the apartment, any increase in value over the years, from the very inception of the co-op, is considered taxable.

And while the tax laws specifically exempt from taxation any gain associated with an apartment used as a principal residence by the shareholder, that exemption does not apply to apartments owned by investors and those not used as principal residences.

As a result, Mr. Shernicoff said, even if there are only a few apartments that are not exempt from taxes as far as the co-op corporation is concerned, those few can cost the co-op hundreds of thousands of dollars in taxes.

So it appears that the process is quite involved and could be quite costly for all involved…not so fast says an attorney who has successfully navigated buildings through this process.

Kenneth Jacobs, a co-op and condo lawyer in Yonkers who has done such conversions, says that it is easier to make the change from a co-op to a condo than most lawyers believe. And with regard to taxes at the corporate level, Mr. Jacobs said he believes that since the proprietary lease itself has value, the I.R.S. can be persuaded to treat the transfer in such a way that will substantially reduce the tax exposure of the corporation.

Obviously if a co-op board is considering a co-op to condo conversion, they should only consider using an attorney who is familiar with the process and I would add that using someone like Mr. Jacobs who doesn’t appear to be intimidated by this process, may not be a bad idea either.

Romano provides more advice for the co-op board considering such a proposition:

For those who want more information, The Cooperator, a monthly magazine about co-op and condo issues published by Yale Robbins, is conducting a panel discussion on converting from co-op to condo at its annual expo on April 25 at the New York Hilton. More information is available by calling (212) 683-5700 or online at www.coopexpo.com.

I can’t believe the process is that easy or more co-ops would take the plunge.  Or maybe more co-op shareholders are actually happy with the co-op experience…could it be?