New York cooperatives: Do they qualify for Section 1031 tax deferral?

In a city where residential properties were originally almost all created as cooperatives, investors frequently find themselves asking whether the coop they own or would like to buy is real or personal property for the purposes of §1031. The answer is critical to performing a tax deferred exchange as the regulations provide that personal property is not "like kind" to real property and thus, the exchange of one for the other will not qualify under §1031. However, there is good news for the investor. When buying into a cooperative (co-op), the taxpayer acquires stock in the cooperative corporation that owns or leases an entire building. As a stockholder of the cooperative corporation, the taxpayer receives a long-term "proprietary" lease and the right to exclusive possession of an apartment. With this in mind, can a co-op be exchanged under §1031? Yes. The IRS has consistently ruled that a New York co-op is like kind to real estate, even though ownership is held in the form of stock in a corporation. Most recently, in PLR 200631012, the IRS approved a proposed exchange of co-op stock for real property and improvements to be acquired by family members and family owned entities as tenants in common. In so ruling, the drafter notes that: "Whether stock in a cooperative apartment located in New York State constitutes real or personal property under section 1031 is determined under New York law. Although New York case law might suggest that there are conflicts concerning whether a cooperative interest in real property is real property, various New York statutes treat an interest in a cooperative as equivalent to an interest in real property." N.Y. Civ. Prac. L.& R. §5206(a) (McKinney 1997) (homestead exemption); N.Y. Real Prop. Law § 279(5) (McKinney 1989) and N.Y. Pub. Auth. Law § 2402(5) (McKinney Supp. 2006) (mortgage for cooperative interest); N.Y. Real Prop. Tax Law § 467(3-a) (McKinney Supp. 2006) (real property tax for senior citizens); N.Y. Tax Law § 1402-a(a) (McKinney 2004) ("mansion tax"); and N.Y. Real Prop. Law § 254-b(1) (McKinney 1989) (limit on mortgage late charges)...Accordingly, we rule that the interests in cooperative apartments in New York owned by Partnership and Company will be considered like kind, for purposes of section 1031, to the improved and unimproved real property that Partnership and Company intend to acquire as replacement properties. For other rulings involving the characterization of New York co-ops as real property interests under Section 1031, see IRS Letter Rulings 8810034, 8445010 and 8443054. One final, but critical, note. Even though NY cooperatives are considered real property for purposes of §1031, the property must still be deemed to have been held for "investment or productive use in a trade or business." Thus, if one has used a co-op exclusively for personal enjoyment or family use, the co-op will not likely qualify. Thus, if the co-op has restrictions on rentals as many do, this may affect the ability of an investor to actually "hold for investment" as defined by the IRS. In certain circumstances, renting to a family member who may also be a partial shareholder may qualify as well as use of the cooperative for business purposes. The latter may be the case where an investor only uses the cooperative when in New York for business and is able to substantiate this fact. As this issue is very fact specific, it is essential to consult with a legal or tax advisor before proceeding. Pamela Michaels is an attorney and vice president of Asset Preservation, Inc., Manhattan, N.Y.