REVENUE RULE 90-35

1990-1 C.B. 48, 1990-17 I.R.B. 5.

Internal Revenue Service
Revenue Ruling

COOPERATIVE HOUSING CORPORATION; NONRESIDENTIAL UNITS; DEDUCTION OF TAXES, INTEREST AND BUSINESS DEPRECIATION

Published: April 23, 1990

Section 216. - Deduction of Taxes, Interest, and Business Depreciation by Cooperative Housing Corporation Tenant-Stockholder, 26 CFR 1.216-1: Amounts representing taxes and interest paid to cooperative housing corporation.
Cooperative housing corporation; nonresidential units; deduction of taxes, interest and business depreciation. Conditions under which allocating shares of stock to non-residential apartments will not prevent a cooperative housing corporation from meeting the requirements of section 216(b)(1)(B) of the Code. Rev. Rul. 58-421 modified and superseded; Rev. Rul. 74-241 amplified.

ISSUE

Under what circumstances will the allocation of shares of a cooperative housing corporation to nonresidential units permit the corporation to remain qualified as a cooperative housing corporation under section 216 of the Internal Revenue Code?

FACTS

Situation 1. X Corporation is a cooperative housing corporation, as defined in section 216(b)(1) of the Code, that owns land and a building thereon containing apartments. All units in the multistory building are residential apartments, except for three units on the ground floor that are leased for use as professional offices. All of X's issued and outstanding shares are allocated to the residential apartments in the building.

X proposes also to allocate authorized but unissued shares to the professional office units and sell them to the corporate or individual occupants of those offices. The professional units are structurally similar to residential units in the building. Although the offices do not contain sleeping or cooking facilities, they do contain one or more rooms that contain sanitation facilities normally found in a dwelling unit. Moreover, it would be reasonable to add sleeping and cooking facilities normally found in a dwelling unit to the office units under all the facts and circumstances. The cost of adding sleeping and cooking facilities is equal to approximately 20 percent of the fair market value the professional units would have if they were sold as residential units. Ownership of the shares attributable to the office units would entitle the tenant- stockholders to install sleeping and cooking facilities and occupy the units for dwelling purposes upon approval of the board of directors of the corporation. X has agreed that such approval would not be unreasonably withheld and that it would cooperate in effecting the conversion.

The entire building, including the professional office units, is located in an area that is zoned for residential use, except that the ground floor may have certain enumerated nonresidential uses that include use as professional offices. The ground floor units could be converted from office use to residential apartment use as a matter of right under the applicable local zoning, building, and fire codes.

SITUATION 2. The facts are the same as in Situation 1, except that shares allocated to one of the professional offices will be sold to a third party and not the current occupant. The existing commercial lease has one year to run until it terminates. If shares are allocated to the unit and sold to a third party, the third party will succeed to the lessor's rights and obligations under the existing commercial lease.

SITUATION 3. The facts are the same as in Situation 1, except that the building already has the maximum number of residential units permitted under the local zoning code. A zoning variance would have to be obtained from the local zoning authority in order to obtain permission to convert the office units to residential units.

LAW AND ANALYSIS

Section 216(a) of the Code allows a tenant-stockholder to deduct amounts paid or accrued to a cooperative housing corporation within the taxable year to the extent that the amounts represent the tenant- stockholder's proportionate share of certain real estate taxes allowable as a deduction to the corporation under section 164, and certain interest allowable as a deduction to the corporation under section 163.

Section 216(b)(2) of the Code, in part, defines the term 'tenant-stockholder' to mean a person who is a stockholder in a cooperative housing corporation.

The term 'cooperative housing corporation' is defined in section 216(b)(1) of the Code to mean a corporation (A) that has only one class of stock outstanding; (B) each stockholder of which is entitled, solely by reason of stock ownership in the corporation, to occupy for dwelling purposes a house or an apartment in a building leased or owned by the corporation: (C) no stockholder of which is entitled to receive any distribution not out of earnings and profits except on a complete or partial liquidation of the corporation; and (D) that derives 80 percent or more of its gross income from tenant- stockholders.

Section 1.216-1(d)(2) of the Income Tax Regulations provides that, in order for the corporation to qualify as a cooperative housing corporation, each stockholder of the corporation must be entitled to occupy for a dwelling purposes an apartment in a building or a unit in a housing development owned or leased by the corporation. The stockholder is not required to occupy the premises. The right as against the corporation to occupy the premises is sufficient if conferred on each stockholder solely by reason of ownership of stock in the corporation. That is, ownership of the stock must entitle the owner either to occupy the premises or to lease the premises.

Rev. Rul. 80-299, 1980-2 C.B. 82, holds that actual occupancy of certain apartment units by stockholders of a corporation is not required for purposes of satisfying section 216(b)(1)(B) of the Code when those units are occupied by non-stockholder tenants protected under rent control laws.

Rev. Rul. 74-241, 1974-1 C.B. 68, provides that, for purposes of section 216(b)(1)(B) of the Code, the term 'apartment in a building' means an independent housekeeping unit consisting of one or more rooms that contain facilities for cooking, sleeping, and sanitation normally found in a principal residence.

Rev. Rul. 74-241 does not require, however, that a unit presently contain all the facilities normally found in a principal residence in order to constitute an apartment in a building for purposes of section 216(b)(1)(B) of the Code. Accordingly, a unit will be treated as meeting that definition if (1) the stockholder is entitled to convert the unit to an apartment, as defined in Rev. Rul. 74-241, solely by reason of ownership of stock in the cooperative housing corporation; (2) the conversion of the unit would be reasonable under all the facts and circumstances, including structural feasibility and cost; and (3) the applicable local zoning, building, and fire codes permit both the conversion referred to in (1) and residential use of the unit as a matter of right.

Whether conversion of a unit to residential use is reasonable will depend on all the facts and circumstances. Generally, conversion will be reasonable where the unit is structurally similar to existing residential units in the building, has ready access to plumbing and utility sources, and the cost of converting the unit to residential use is not disproportionate to the fair market value the unit would have if the unit were sold as a residence.

Under the facts in Situation 1, (1) the stockholders are entitled to add sleeping and cooking facilities to convert the office units to dwelling units solely by reason of their ownership of stock in the corporation, (2) the addition of those facilities to the office units would be reasonable under all the facts and circumstances, including structural feasibility and cost, and (3) the applicable local zoning, building, and fire codes permit addition of those facilities and residential apartment use as a matter of right.

In Situation 2, the purchaser of shares attributable to the one unit is temporarily barred from occupancy by the existing commercial lease. Nevertheless, ownership of stock confers occupancy rights upon the stockholder as against the corporation and the fact that a current occupant has the right to remain in possession of the unit under a pre-existing lease is immaterial for purposes of section 216(b)(1)(B). See Rev. Rul. 80-299.

In Situation 3, the zoning restriction precludes the conversion of the units to residential use without obtaining a zoning variance, which may or may not be granted. The zoning restriction is a substantial legal impediment to the conversion of the office units to residential use.

HOLDINGS

In Situation 1, the allocation of shares to nonresidential units will not disqualify the corporation from treatment as a cooperative housing corporation under section 216 of the Code because those units meet the definition of an apartment for purposes of section 216(b)(1)(B).

In Situation 2, the existence of a long term commercial lease on the nonresidential unit will not disqualify the corporation from treatment as a cooperative housing corporation under section 216 of the Code provided that the unit is capable of conversion as provided in Situation 1 and the purchaser of the shares has the right to occupy the unit as provided in section 1.216-1(d)(2) of the regulations.

In Situation 3, the allocation of shares to nonresidential units will disqualify the corporation from treatment as a cooperative housing corporation under section 216 of the Code because there is a substantial legal impediment to occupying the units for residential purposes as required in section 216(b)(1)(B).

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 58-421, 1958-2 C.B. 112, which holds that the sale of commercial space in a cooperative apartment building will not prevent the corporation from being classified as a cooperative housing corporation under section 216(b)(1)(B), is modified to include the conditions set forth in this revenue ruling. In addition, as a result of the Tax Reform Act of 1986, the holding of the revenue ruling that income derived from stockholders who are not individuals cannot be included as income from tenant-stockholders is obsoleted. As modified, Rev. Rul. 58-421 is superseded.

Rev. Rul. 74-241 is amplified.

DRAFTING INFORMATION

The principal author of this revenue ruling is David L. Click of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact David Click on (202) 566- 4821 (not a toll-free call).

Rev. Rul. 90-35, 1990-1 C.B. 48, 1990-17 I.R.B. 5.