Tenant-stockholders of a cooperative housing corporation (CHC) may be entitled to a tax deduction for the portion of maintenance payments that represent taxes and interest. In order for the deduction to be valid, the CHC must meet stringent IRC requirements and the tenant-stockholders must meet certain qualifications.

Qualifying as a CHC

The CHC determination is made annually on the basis of a four-part test as follows: 1) no more than one class of stock outstanding; 2) each stockholder must be entitled through stock ownership to occupy the residential unit; 3) distributions to stockholders must be from earnings and profits of the corporation unless they are liquidating distributions; and 4) 80% or more of the gross income for the taxable year must be derived from tenant-stockholders. There is no requirement, however, that the corporation own all of the apartments in a residential unit to satisfy the CHC status.

The corporation must have a single class of stock outstanding. However, a specific exception is made in IRC Sec. 216(b)(4) for stock issued to a governmental unit (federal, state, or local) empowered to acquire shares for the purpose of providing housing facilities. Indeed, Reg. Sec. 1.216-1(d)(1) allows a special class of stock for a nominal amount, $100, to be issued to governmental entities solely for the purpose of creating a security interest in the mortgage indebtedness of the corporation.

Rev. Rul. 87-130 provides guidance on how the "one class of stock" requirement may be satisfied when the stock carries the right to use one or more specific parking spaces. According to the ruling, as long as shares are acquired by persons who have proprietary leases entitling them to occupy living units, all such stock of the cooperative is owned by persons having the right of occupancy. In addition, valuation, voting, and distribution rights must be the same for each share to preclude a disproportionate allocation of the CHC expenses. Provided it is the stock that provides the right to enter into a lease with the cooperative, leasehold agreements that provide different occupancy or garage space rights do not create a separate class of stock.

Stockholders are precluded from receiving distributions from the CHC that are not out of earnings and profits. The only exception is for distributions in complete or partial liquidation of the corporation. The issuance of combined units of ownership in the form of stock and non- interest-bearing notes will disqualify CHC status because of the possibility of receiving distribution from sources other than earnings and profits. The rationale is that the debt will not likely be repaid from earnings and profits.

The corporation must derive at least 80% of its gross income in the taxable year from tenant-stockholders. For taxable years beginning after December 31, 1969, the gross income attributable to residential units that a governmental unit is entitled to occupy, pursuant to a lease or stock ownership, shall be disregarded. The year in which a corporation converts to cooperative ownership, the 80% rule applies to the total gross income for the entire taxable year, not just that portion of the income realized after the date of change.

Amounts received by the CHC from its tenant-stockholders to cover expenses attributable to maid and secretarial services, garage or parking space, recreation facilities, and related services qualify as payments from tenant-stockholders. However, for the purpose of the 80% test, amounts received from customers or tenants of commercial space cannot be included as amounts received from tenant stockholders.

The CHC may receive income from commercial leases without threatening its status, as long as the income does not exceed 20% of the total gross income of the corporation. Likewise, income generated from a real estate brokerage service provided solely to tenant-stockholders and used to cover recurring expenses, such as Treas. Reg. Sec. 1.216-1(d)(4) repairs and maintenance of the corporation's property, is considered as income derived from tenant-stockholders. But, amounts paid by tenants that are earmarked solely for capital expenditures qualify as contributions to capital and are, therefore, excluded from gross income. In some years, excess contributions may be collected from tenant-stockholders as a result of imprecise estimates. If the excess is returned to the stockholder or is applied to the following year's assessment, the amount is not included in gross income of the corporation.

The ownership of the stock must allow stockholders to occupy the residential units owned by the corporation. Reg. Sec. 1.216-1(d)(2) notes that it is immaterial that the right of occupancy depends on the payment of periodic charges and fees in the nature of rentals or assessments. But, the issuance of debt can cause CHC disqualification. In a 1967 court case, the Ninth Circuit denied tenant-stockholder status to a taxpayer because the interest in the apartment was evidenced by a debt instrument.

The intent of IRC Sec. 216 is to allow tenant-stockholders the same benefits as other home owners. The key linkage is the ownership of the unit by the tenant-stockholder. This ownership is established by 1) the ownership of stock in the CHC or 2) the ownership of some type of perpetual interest. In the 1967 case, because only debt was issued by the corporation, the interest in the apartment was that of a creditor, not an owner.

Some additional restrictions apply to CHCs. First, sole ownership of the corporation by a single stockholder prevents its classification as a CHC. Second, single-family units whose stockholders are entitled to a private room for perpetual use do not qualify as CHCs. IRC Sec. 216(b) refers to a "house or an apartment in a building" in its definitions. The IRS's interpretation is that each unit must have facilities for cooking, sleeping, and sanitation. Therefore, a CHC that provides mobile homes for occupancy can meet the requirements of a CHC.

Qualified Tenant-Stockholders

To obtain tax benefits, a tenant-stockholder of a CHC must satisfy three conditions: 1. The tenant-stockholder must own fully paid-up stock in a CHC; 2. The value of the stock and the residential unit(s) must be commensurate with the value of the corporate equity in the land and building; and 3. The tenant-stockholder must have the right of occupancy.

Prior to 1987, only individual taxpayers were allowed tenant- stockholder status. TRA 86, however, made it possible for other taxable entities such as corporations, trusts, estates, partnerships to be qualified tenant-stockholders.

The tenant-stockholder must own fully paid-up stock in the CHC to obtain tax benefits accorded tenant-stockholders. The IRC and regulations provide little amplification of the term "fully paid-up." In an early ruling, Rev. Rul. 70-9214, the IRS issued a narrow interpretation of the term. Under the facts of the ruling, subscriptions for membership were accepted by the corporation, and the funds were used to acquire land and to finance construction costs beyond those paid for by mortgage proceeds. The ruling held that the subscription payments represents the initial equity interest of the tenant-stockholder and not payment for a share of interest or taxes during the construction period.

However, in Rev. Rul. 73-15, the IRS modified Rev. Rul. 70-92 in allowing the allocation of subscription payments between an equity interest in the corporation and a share of the permanent financing expense incurred and deducted by the CHC. In addition a 1978 letter ruling reaffirmed the more flexible paid-up requirement of Rev. Rul. 73- 15.

The consideration paid for the stock must be reasonably related to the fair market value of the stock, which must be commensurate with the equity in the land and building on the date of issuance of the stock. The determination of reasonableness is left to the discretion of the District Director of the IRS.

Tenant-stockholders must have the right of occupancy in the premises solely by reason of the ownership of stock in the CHC. For this purpose, tenant-stockholders need not occupy the premises to realize tax benefits; rather, they simply must have the right of occupancy. The fact that a taxpayer has the right to occupy more than one apartment by reason of stock ownership does not preclude eligibility for tax benefits.

In determining whether or not a taxpayer is eligible for tax benefits as a qualified tenant-stockholder, such person may not be able to occupy the premises without prior approval of the CHC. This right of prior approval does not prevent tenant-stockholder status if: 1) the person acquires the stock by operation of law; 2) a taxpayer other than an individual acquires stock of a CHC; or 3) the original seller from whom the corporation acquired the apartments receives any stock of the CHC from the corporation no later than one year after the date on which the residential unit is transferred by the original seller to the corporation. This provision allows a corporate stockholder in a CHC to qualify for tenant-stockholder tax benefits even though the CHC retains the right of approval over the actual tenant appointed as the nominee of the corporation.

Although the definitions and qualifications in IRC Sec. 216 and the regulations make constant reference to stock ownership, the actual issuance of stock by the CHC is not mandatory.