PLR 200232031: Convertible commercial unit can carry cooperative housing shares

Plain-English summary

A cooperative housing corporation planned to issue shares for a ground floor unit currently used as commercial space. The proprietary lease would give the purchaser the right to convert the unit to a dwelling and live there, and the corporation represented that conversion was feasible, reasonable in cost, and permitted by zoning. The IRS ruled that issuing the shares and allowing commercial use would not by themselves end the corporation's cooperative housing status under IRC § 216. A purchaser using the unit commercially could still qualify as a tenant stockholder if the shares were fully paid and their price reasonably reflected the unit's share of the corporation's equity. The ruling assumes the corporation also meets § 216's other listed requirements.

Ruling snapshot

• Question: Can a convertible commercial unit have cooperative shares, and can its purchaser qualify as a tenant stockholder?
• Outcome: Approved, subject to the stated stock, equity, and other § 216 requirements
• Key authorities: IRC § 216(b)(1) and (2); Treas. Reg. § 1.216-1(e)(2); Rev. Rul. 74-241 and Rev. Rul. 90-35

Full text (IRS public release)

Internal Revenue Service
Department of the Treasury

Number: 200232031
Washington, DC 20224
Release Date: 8/9/2002
Index Number: 216.01-00, 216.02-00
Person to Contact:

Telephone Number:

Refer Reply To:
CC:PSI:7 / PLR-100191-02
Date:
May 08, 2002

Legend:

Corporation =

State =

a
=

b
=

c
=

d
=

e
=

f
=

g
=

h
=

Dear :

We received your letter requesting rulings under §216 of the Internal Revenue Code. This letter responds to your request.

The represented facts are as follows. Corporation is a cooperative housing corporation organized under the laws of State. Corporation owns a building, which consists of a residential units and a ground floor with b nonresidential units. Currently, c shares of common stock have been allocated to the residential units. No stock has been 2 PLR-100191-02

allocated to the nonresidential space on the ground floor.

Corporation proposes to create one commercial unit, attributable to the d square feet currently occupied by one of Corporation’s commercial tenants. Corporation intends to issue and sell e shares of common stock attributable to the commercial unit. The shares for the commercial unit will be fully paid up in an amount which bears a reasonable relationship to the portion of the value of Corporation’s equity in the building and land attributable to the commercial unit.

The proprietary lease will entitle the purchaser to use the commercial unit either for retail or as a residential apartment. The lease will also allow the purchaser to make whatever renovations and alterations necessary to convert the commercial space into a dwelling. The purchaser will at all times have the right, as against Corporation, to occupy the commercial unit for dwelling purposes.

Corporation has submitted the opinions of a real estate appraiser and an architectural firm on the reasonableness of converting the commercial unit to residential use. The zoning rules and regulations of State allow the commercial unit to be converted, as of right, to residential use. The commercial unit can be converted to a residential apartment similar to other apartments in the building for a total cost of $f. The fair market value of the commercial unit after conversion to a residential apartment is approximately $g. The cost of conversion is roughly h% of the fair market value of the commercial unit after conversion to a residential apartment. The conversion of the commercial units to residential use is reasonable under all the facts and circumstances.

You requested the following rulings:

1. Provided that Corporation satisfies the requirements of §216(b)(1)(A), (C), and (D) of the Code, neither the issuance of stock by Corporation to be allocated to the commercial unit, nor the possible nonresidential use of the commercial unit will prevent Corporation from qualifying as a cooperative housing corporation within the meaning of §216(b)(1) of the Code.

2. A person who purchases the stock of Corporation attributable to the commercial unit for the commercial use of such space will qualify as a “tenant- stockholder” for purpose of §216(b)(2), provided such stock is fully paid up and in an amount which bears a reasonable relationship to the portion of the value of Corporation’s equity in the building and land attributable to the unit which the purchaser is entitled to occupy.

Section 216(a) provides that in the case of a tenant-stockholder (as defined in
§216(b)(2)), there will be allowed as a deduction amounts (not otherwise deductible) paid or accrued to a cooperative housing corporation within the taxable year, but only to the extent that such amounts represent the tenant-stockholder’s proportionate share of 3 PLR-100191-02

--(1) the real estate taxes allowable as a deduction to the corporation under §164 which are paid or incurred by the corporation on the houses or apartment building and on the land on which such houses (or building) are situated, or (2) the interest allowable as a deduction to the corporation under §163 which is paid or incurred by the corporation on its indebtedness contracted -- (A) in the acquisition, construction, alteration, rehabilitation, or maintenance of the house or apartment building, or (B) in the acquisition of the land on which the houses (or apartment building) are situated.

Section 216(b)(1) provides that the term “cooperative housing corporation” means a corporation -- (A) having one and only one class of stock outstanding, (B) each of the stockholders of which is entitled, solely by reason of his ownership of stock in the corporation, to occupy for dwelling purposes a house, or and apartment in a building, owned or leased by such corporation, (C) no stockholder of which is entitled (either conditionally or unconditionally) to receive any distribution not out of earnings and profits of the corporation except on a complete or partial liquidation of the corporation, and (D) 80 percent or more of the gross income of which for the taxable year in which the taxes and interest described in §216(a) are paid or incurred is derived from tenant- stockholders.

Section 216(b)(2) provides that the term “tenant stockholder” means a person who is a stockholder in a cooperative housing corporation, and whose stock is fully paid-up in an amount not less than an amount shown to the satisfaction of the Secretary as bearing a reasonable relationship to the portion of the value of the corporation’s equity in the houses or apartment building and the land on which situated which is attributable to the house or apartment which such person is entitled to occupy.

Section 1.216-1(e)(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 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. In other words, the stock must entitle the owner thereof to occupy the premises or to a lease of the premises. The fact that the right to continue to occupy the premises is dependent upon the payment of charges to the corporation in the nature of rentals or assessments is immaterial.

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

Rev. Rul. 90-35, 1990-1 C.B. 48, provides that Rev. Rul. 74-241 does not require that a unit presently contain all the facilities normally found in a principal residence in order to 4 PLR-100191-02

constitute an apartment in a building for purposes of §216(b)(1)(B). 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 feasability and cost; and (3) the applicable zoning, building, and fire codes permit both the conversion 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.

Rev. Rul. 90-35 considers the following facts:

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 5
PLR-100191-02
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.

Further, in Situation 2 of Rev. Rul. 90-35, the shares allocated to one of the professional offices will be sold to a third party, rather than 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.

Applying the above standards to the facts and representations submitted and subject to the below limitations, we conclude: (1) provided that Corporation satisfies the requirements of §216(b)(1)(A), (C), and (D) of the Code, neither the issuance of stock by Corporation to be allocated to the commercial unit, nor the possible nonresidential use of the commercial unit will prevent Corporation from qualifying as a cooperative housing corporation within the meaning of §216(b)(1) of the Code; and (2) a person who purchases the stock of Corporation attributable to the commercial unit for the commercial use of such space will qualify as a “tenant-stockholder” for purpose of
§216(b)(2), provided such stock is fully paid up and in an amount which bears a reasonable relationship to the portion of the value of Corporation’s equity in the building and land attributable to the unit which the purchaser is entitled to occupy.

Except as specifically ruled herein, we neither express nor imply any opinion concerning the federal tax consequences under the cited provisions or any other provision of the Code. This ruling is directed only to the taxpayer requesting it. §6110(k)(3) of the Code provides that it may not be used or cited as precedent.

The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. While this office has not verified any of the material submitted in support of the request for rulings, it is subject to verification on examination.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your representative. A copy of this letter must be attached to any income tax return to which it is relevant.

Sincerely,

Joseph H. Makurath
Special Technician Reviewer, Branch 7
Office of the Associate Chief Counsel
(Passthroughs and Special Industries)