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By Leonard J. Candela, CPA

IRC section 280A limits deductions otherwise allowable for a dwelling unit that is used as a residence. A district court had ruled in Holmes that co-op shares are not subject to this restriction. The Court of Appeals for the Second Circuit, however, has reversed the district court and ruled that co-op shares are subject to section 280A.

The case involved a partnership of a son and his parents which was formed to purchase the son's apartment when it converted to a co-op. The son continued to live in the apartment and paid rent to the partnership. The partnership incurred losses which were passed through and deducted by the son and his parents. Upon audit, the IRS disallowed the losses and the dispute wound up in district court.

The district court reviewed the history of the tax treatment of co-op shares and ruled in favor of the taxpayers, stating that there is a fundamental difference in owning real estate and in owning shares of a corporation. The taxpayer had argued that a co-op is not specifically listed in the extensive code definition of dwelling unit and does not qualify as "similar property" because a person cannot inhabit shares as he or she does real estate. Upon appeal, the Second Circuit believed this argument to be "too formalistic" and reversed the district court. The Second Circuit reasoned as follows:

The shares in the corporation confer the right to occupy an apartment. And, under the code, they also grant the shareholder many other rights that are typically available only to owners of real property. Thus, the code specifically provides that stock in a cooperative housing corporation can be defined as a principal residence for the purpose of rolling over capital gains on its sale, section 1034(f), as well as for the purpose of obtaining nonrecognition of $125,000 in capital gains on the sale of a principal residence by a taxpayer over age 55, section 121(d)(3).

IRC section 216, moreover, permits a tenant-shareholder in a "cooperative housing corporation" to deduct amounts paid to the corporation to the extent that such amounts represent the proportionate share of real estate taxed and mortgage interest allowable as a deduction to the corporation.

The Second Circuit agreed with the government's argument that many code provisions had open-ended terms that the courts must interpret. "Dwelling unit" and "similar property," found in section 280A, are two such terms and "are intended to cover co-ops." The court noted that "a co-op appears to be quite comparable to the properties specifically covered in section 280A(f)(1)(A) ('house, apartment, condominium, mobile home, boat,...and all structures or other property appurtenant to such dwelling unit')."

Accordingly, the Second Circuit concluded that it could not distinguish between co-op shares and other types of dwelling units and reversed the district court's decision. Section 280A does indeed limit losses from co-op shares.

The Circuit Court remanded the case to the district court on the question of whether the "fair rental" exception for rentals to family members would apply in this case where the family member was also a partner. (The fair rental exception does not apply for rentals to partners.) *

Source: Holmes, __ F.3d __, Nos. 95-6009, 95- 6103 (2d Cir. 6/4/96)

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