If you have clients who are thinking of selling their homes to purchase a condo or co-op, make sure you know how the IRS will apply certain tax rules. Here, tax guru Julian Block explains the differences between condos and co-ops so you can better serve your home-owning clients.
I recently received several queries from individuals living in single-family homes in the New York City metropolitan area who plan to sell their dwellings and purchase a condominium or cooperative apartment. Some potential sellers want to know how ownership of a single-family home differs from ownership of a condo or co-op, while others are curious about how the IRS will apply tax rules when owners of co-ops use a portion of their monthly maintenance charges to increase the adjusted bases for their apartments. The next few articles will be devoted to answering these questions to help potential sellers as well as tax and accounting professionals who want to improve their practices and better serve their clients.
Co-ops, which are found mainly in the northeast United States, particularly in and close to New York City, and condos come in all shapes, sizes and configurations. They can range from three-unit wood-frame houses to high-rise apartment buildings containing hundreds of units to sprawling townhouse communities in park-like settings.
Individuals who buy single-family homes and condo units become owners of real property and receive deeds that evince their ownership. Whereas owners of single-family homes own all of their dwellings, different rules govern ownership of condos. These folks own their apartments outright but do not acquire any direct ownership interest in those portions of the building or development that are referred to as the common areas. These can include lobbies, yards, garages, central heating, landscaping, laundry and storage rooms and athletic facilities. Indirect ownership is exercised through a membership in a condo association that owns and is responsible for maintaining the common areas.
Meanwhile, the condo owner is responsible for separate payment of her own real estate taxes, amounts that she can claim, within limits, as itemized deductions on Schedule A of the 1040 form. She’s also responsible for her share of monthly charges, usually referred to as common charges. Her payments help cover expenses incurred by the condo to maintain and operate the common areas and the building systems.
When someone buys a co-op apartment, they don’t become an owner of real property, and they don’t receive a deed. However, they do become an owner of personal property; that is, they own shares in the building as a whole. In legal lingo, the building is a cooperative housing corporation. These shares allow owners, pursuant to what are known as proprietary leases, to occupy particular apartments or units.
Owners must pay monthly charges, known as maintenance charges. These maintenance expenditures help cover what the building spends on salaries, utilities and other operating costs, local property taxes and payments of principal and interest on any underlying mortgage on the building.
The typical co-op corporation has such a mortgage and assumes responsibility for principal and interest payments. It passes them along to shareholders as part of the maintenance charges.
What’s next. Parts two and three will explain how the law allows a co-op owner to increase her apartment’s basis beyond what she spends for capital improvements, as opposed to repairs, within her apartment and how an owner can increase her basis to reflect her share of maintenance charges or special assessments that are spent on improvements for the benefit of all apartments.
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...