Articles

Converting A Co-op Into a Condo

By JAY ROMANO

It is not unusual for co-op shareholders to wonder on occasion whether it would be worthwhile to convert their building into a condominium. After all, real estate lawyers say, condominium units often sell for more than comparable co-op apartments, because the former are generally easier to buy, sell or sublet than the latter.

It is also not unusual for co-op lawyers to gently discourage such a conversion. Converting from one form of ownership to the other, many lawyers say, generally involves complicated legal, practical and financial maneuvers, as well as the formidable initial hurdle of persuading anywhere from two-thirds to four-fifths of the shareholders, depending on the building's proprietary lease, to go along with the idea.

But the major impediment to converting a co-op to a condominium is usually financial, often centering around the tax implications of the transaction. "When you're doing a co-op to condominium conversion, there's usually going to be some negative impact on the co-op," said Alan Kazlow, a Manhattan co-op lawyer. "And, in most cases, the negative impact will be in the form of a tax bite."

Mr. Kazlow explained that in a conversion, the shareholders are basically exchanging their co-op shares for a condominium deed. And while it might appear that not much of anything is really going on - after all, the same people will own the same apartments - the tax and financial implications can be significant.

Dennis Greenstein, a partner of Mr. Kazlow, noted, for example, that since most co-ops have an underlying mortgage on the building, it is typically necessary for the co-op corporation to pay off that mortgage. And there is often a penalty involved for paying off the mortgage before it is due.

"Under the terms of some mortgages, the lender does not have to allow you to prepay the loan without paying a heavy prepayment penalty," Mr. Greenstein said. In such a case, a decision has to be made as to whether it is worth paying the penalty to go through with the conversion.

It is also necessary, Mr. Greenstein said, for individual shareholders to pay off their existing share loans and then obtain a mortgage on the condominium unit. While that might not be a problem for some people, he said, there might be cases in which a shareholder would not be able to get a mortgage loan or could get one only on less-than-favorable terms.

"And the new mortgage might have to be more than the old one to include the shareholder's proportionate share of the payoff of the undelying mortgage," he said.

Even if those obstacles can be negotiated, the most daunting impediment in co-op to condominium conversion is the tax impact on the co-op corporation and, in some cases, the shareholders themselves.

Joel E. Miller, a Queens tax lawyer, said that when a co-op shareholder exchanges his or her shares in the co-op corporation for a condominium apartment, a taxable event occurs.

On the shareholder side, Mr. Miller said, exchanging shares of stock in the co-op for the condominium unit is basically no different than selling the co-op apartment and using the proceeds to buy the condominium. And generally any time an individual sells a piece of real estate for more than its "tax basis" - often, the purchase price - a taxable event has occurred. This means that if an individual purchased a co-op apartment for, say, $100,000 and later exchanged the co-op shares for a condominium worth $300,000, the shareholder would have $200,000 in gains.

Under current tax law, Mr. Miller noted, up to $250,000 in gains on the sale of a principal residence can be excluded from income if an individual taxpayer has owned and lived in the residence for two out of the preceding five years. (Married taxpayers filing jointly who meet the same requirements may be able to exclude up to $500,000 in gains.)

So, the shareholder in the previous example might not have to pay a"But it's absolutely critical to think of the shareholder's point of view as separate from the corporate point of view," he said. "One might be subject to taxes and the other might not be."

For example, he said, the law specifically provides that if a co-op corporation conveys a condominium apartment to a shareholder in exchange for that holder's shares and the apartment is the person's principal residence, there is no taxable gain associated with the transaction for the co-op corporation.

At the same time, however, if a shareholder who is not residing in an apartment trades in his co-op shares for a condominium, it is possible that both the shareholder and the co-op corporation will be subject to income taxes.

In co-ops with a large amount of commercial space, Mr. Miller said, a significant tax may be due from the co-op corporation. (Shareholders who own rental apartments or commercial space may be able to avoid paying tax under another section of the tax code dealing with "like kind exchanges." Even if that is the case, however, the co-op corporation would still be responsible for income tax on any gain.)

This, Mr. Miller said, could amount to hundreds of thousands or even millions of dollars, money that would utlimately be paid by the shareholders.

Notwithstanding such concerns, some lawyers say that the benefits of converting from a co-op to a condominium may outweigh the costs. "Most people are much more familiar with condominiums than cooperatives," said Kenneth R. Jacobs, a co-op lawyer with offices in Manhattan and Yonkers. "And that enlarges the pool of potential buyers."

In addition, he said, lenders are generally willing to lend at a higher percentage of equity on a condominium apartment than in a co-op, and commercial space is more marketable as a condominium than a co-op.

Mr. Jacobs added that it might also be possible to minimize the taxes due from the co-op corporation. For example, he said, most co-ops have substantial "net operating loss carry-forwards" that can be used to offset gains.

"Depending on the circumstnaces of a particular building," Mr. Jacos said, "we may be able to minimize or even eliminate the taxes due from the corporation."

ny income taxes because the gain is less than $250,000. If, however, the tax basis of the co-op apartment was $100,000 and the value of the condominium for which it is being exchanged is $400,000, then the shareholder would be realizing a gain of $300,000, and $50,000 would be subject to taxation.

Thus, Mr. Miller explained, the conversion from co-op to condominium will affect different shareholders differently, depending on their tax situations. Those who purchased their apartments at the time of conversion, for example, would typically have a larger gain - and more exposure to paying taxes - than those who bought more recently or at an inflated price. And those who have not owned for at least two years - or who did not occupy the apartment as a principal residence for that period of time - typically have no proctection against being taxed on any gain realized from the exchange.

A different set of problems arises for the co-op corporation. Mr. Miller said that just as individual shareholders may realize a profit when they exchange their co-op shares for a condominium, so too many the co-op corporation realize a gain when it exchanges ownership of an apartment for the shares.