Key Takeaways
- Co-operative housing corporations (co-ops) and condominiums (condos) can treat resident-funded capital improvements as equity contributions to increase cost basis.
- Allocating contributions to equity proportionally among residents raises each unit’s income-tax cost basis, reducing taxable gain upon sale.
- Capital projects and debt repayment funded through maintenance fees or assessments may qualify — but third-party debt or commercial rent funding does not.
Common Interest Realty Associations (CIRAs) — including co-ops and condos — fund most operating and capital needs through resident maintenance fees, common charges or special assessments. What many boards and managing agents may not realize is that portions of these charges can be treated differently for tax purposes. When amounts are used for capital improvements or repayment of related debt, a CIRA can implement a policy to treat those funds as non-taxable contributions to equity rather than taxable income.
Below, we break down how these rules work and how they can increase cost basis for CIRA unit owners.
Understanding the Tax Treatment
For financial-reporting purposes, all CIRA maintenance fees, common charges or assessments are treated as revenue. The following sources of revenue, however, can instead be treated as a contribution to equity, creating a permanent difference in the CIRA’s calculation of annual taxable income:
- Any portion of maintenance fees, common charges or special assessments that are used to:
- Fund expenditures for capital improvements.
- Repay debt utilized to fund capital improvements.
Within the context of this key tax benefit, board members and managing agents should consider the following when developing annual operating and capital budgets:
- Allocation of Contribution: The total contribution to equity should be divided among the residents based on their share of ownership, which will result in an increase in the cost basis of each resident’s co-op or condo unit.
- This increase in income-tax cost basis will result in a future benefit for residents upon the sale of their ownership in their unit.
- This increase in income-tax cost basis will result in a future benefit for residents upon the sale of their ownership in their unit.
- Capital Improvements / Expenditures: The following are common projects that fall under capital expenditures, designed to improve and add property value and, therefore, provide the potential to increase the cost basis of a co-op or condo:
- Roof replacement
- HVAC system replacement/installation
- Elevator modernization
- Certain exterior façade renovations
- Boiler replacement and/or installation
- Structural changes
- Certain lobby/hallway renovations
- Gym renovation and purchase of equipment
- Debt Repayments: If the CIRA has a mortgage or a loan that was drawn down to fund capital improvements, any portion of the outstanding principal that is repaid through maintenance, common charges or assessments is a factor in the contribution to equity.
Other Important Considerations
- Resident-Funded Required: In order to recognize contributions to equity, capital improvements must be funded from residents, not third-party debt.
- Benefit Taken Upon Sale: Residents can take the benefit for increase in cost basis upon sale of their shared interest.
- Mortgage Refinancings and LoC Drawdowns Don’t Qualify: If the proceeds of a mortgage refinancing or line-of-credit (LoC) drawdown were utilized to fund capital improvements, that expenditure does not qualify for increase in cost basis.
- No contribution to equity for income-tax reporting purposes would be reported as such in the annual income tax filings.
- No contribution to equity for income-tax reporting purposes would be reported as such in the annual income tax filings.
- Commercial Rent Caveat: If your CIRA collects a substantial amount of commercial rent to fund the capital improvements instead of maintenance/common charges or assessments, that also won’t qualify for the increase in cost basis.
Contact Us
Our team is happy to discuss these scenarios or any others regarding the potential increase in cost basis for CIRAs. Please contact your client service representative or reach out directly to any of our team members below:
Ginal Patel
Supervisor
gpatel@pkfod.com
James Molloy
Supervisor
jmolloy@pkfod.com
Samuel E. Botta, CPA
Partner
sbotta@pkfod.com
Paul Kruger, CPA
Partner
pkruger@pkfod.com
K. Joseph Lee, CPA
Partner
jlee@pkfod.com
Thomas Sorrentino, CPA
Partner
tsorrentino@pkfod.com