Clients who are thinking of selling their co-op apartments should scrutinize financial statements and tax forms if they want to trim their taxes. In this article, tax guru Julian Block explains how reading these documents will pay your clients in the long run.
If you’re just joining us, the first two parts in this series explained how ownership of conventional single-family dwellings differs from ownership of condominiums or co-op apartments and how an owner of a co-op can build up the adjusted basis for her apartment.
This article, part three, will explain why co-op owners should closely read year-end financial statements and IRS 1098 forms (Mortgage Interest Statements) that co-op boards provide owners.
For starters, I would caution a co-op owner that she’ll lose more money to the IRS if she skims those documents, focusing solely on what they disclose about her share of the co-op’s payments for mortgage interest and real estate taxes. These documents tell the owner what she’s entitled to claim as itemized deductions on Schedule A of the 1040 form, assuming it’s inadvisable for her to become a nonitemizer and avail herself of one of the standard deduction amounts. But she might needlessly overpay taxes on her profit from an eventual sale should she fail to familiarize herself with special tax breaks for co-op sellers.
Special assessments and mortgage amortization payments.
A co-op owner should routinely scrutinize these documents to determine whether they disclose increases in her adjusted basis for her share of co-op expenditures that benefit all apartments. Those expenditures are the portion of special assessments or monthly maintenance charges that are applicable to capital improvements.
The possibilities include replacing roofs or elevators, renovating lobbies, installing permanent storm windows or putting in new heating systems that the co-op board has categorized as capital improvements. They also include mortgage amortization payments, that is, payments of principal on the underlying mortgage for her building.
While a co-op owner can’t claim current deductions for improvements and amortization payments, both represent additional investments in her apartment. They’re routinely overlooked outlays that can considerably build up her adjusted basis over an extended period.
Keep in mind, however, that there’s no increase to the adjusted basis for board-approved assessments used to cover shortfalls in monthly maintenance charges, perhaps due to owners who are delinquent in paying those charges.
Co-op boards could impose other kinds of assessments. Sometimes, they aggregate six figures and counting for pricy places. For instance, some boards impose what are commonly called flip taxes. Actually, they’re not taxes; they’re apartment transfer fees that sellers pay to co-ops when they sell their apartments. Sellers can use those fees to reduce their profits from sales.
There are several ways for boards to determine what amounts to assess for flip taxes or transfer fees. They can select figures that are set amounts based on, say, the number of shares assigned to an owner’s apartment, a percentage of her profit or a percentage of the sale price.
How co-op board members rationalize flip taxes.
Board members are aware of soaring prices for apartments and a noticeable increase in the frequency of sales. In particular, they’re on the prowl for additional revenue sources that help to moderate steady increases in monthly maintenance charges or lessen the need to impose unpopular special assessments for necessary improvements.
Several years ago, the New York Times reported that one seller of a Manhattan co-op incurred a flip tax north of $100,000. The Times also reported a trend among condo buildings to impose transfer fees. Today, that six-figure fee might even be a seven-figure fee.
My client roster includes a co-op owner whose determination of the gain from the sale of her apartment was disputed by the IRS. The agency sought additional taxes, interest and penalties because my client, so it seemed, lacked the records needed to establish that she’d shelled out a six-figure amount over a 40-year period for basis-increasing special assessments and mortgage amortizations.
As a long-time co-op dweller, I knew that the easiest way for my client to prevail was to see if her board could verify the amount in issue. Fortunately, the board did just that in less than a day; she emerged unscathed from the audit.
What’s next. Part four will discuss how co-op owners are supposed to calculate their gain when they sell their co-op.
Attorney and author Julian Block is frequently quoted in the New York Times, Wall Street Journal, and the Washington Post. He has been cited as “a leading tax professional” (New York Times), an “accomplished writer on taxes...