Housing Co-Ops and 1031 Exchanges

What is a Housing Co-Op?

A housing cooperative, nicknamed a co-op, is a residential community where people are not the complete owners of their unit(s). Rather, they all own individual shares in a nonprofit corporation, who ultimately is the owner of the whole property.  In this way, each share allows the members to occupy a unit through the implementation of a proprietary lease or occupancy agreement.  It furthermore allows them a say in community management.

A co-op functions in the same manner as a business, with a board of directors, each of whom are elected by the co-op’s residents. The board functions as the sole decision-making body, ruling on issues concerning policies, management, maintenance, and finances of the co-op. As a resident of a co-op, membership often involves a monthly fee to cover building expenses such as mortgage payments, property taxes, utilities, and maintenance.

Townhouses, Condominiums, Mid and High rise Apartment Complexes, Senior Citizen and Special-Needs Housing, and Mobile Home Parks can all be different types of co-ops.

Unlike traditional renting, co-ops offer both lower total costs and more community control for residents. However, it subsequently includes unique responsibilities and significant legal distinctions which definitively set co-ops apart from traditional renting.

Why Are Co-Ops Popular?

Under a co-op, residents are afforded various unique advantages, making them an appealing choice.  This is especially true for those in urban markets where affordability and long-term stability are constant pressing issues­ – these issues, too, are the major drivers behind the popularity of co-ops.

Affordability

In contrast to owning either a single-family home or a condominium, a co-op provides a more affordable path towards owning property. This is primarily due to the co-op’s lower purchase and closing costs, since co-op members only buy shares in a nonprofit corporation and do not directly purchase real estate themselves. 

Any shared expenses, such as mortgage payments, property taxes, insurance, building maintenance, and staff wages are paid for with monthly maintenance fees. As a member of a larger co-op, your burden is reduced by the professional management company or in-house team that frequently are a part of larger co-op communities.  They handle issues such as repairs, landscaping, security, and maintenance. In small, self-managed co-ops, however, residents can expect to share responsibilities, which allows costs to remain low because of their collective responsibilities and work.

Stability and Security

Co-ops are well known for their stability and security.  Buyers do not receive a specific unit deed, rather they purchase shares in the corporation that owns the property. In this way, owners are granted something called a proprietary lease, giving them the right of occupancy in a specifically designated unit in the building. These leases are often long-term leases of at least 30 years, but are automatically renewable if the leaseholder is in good standing within the co-op.  This housing structure lacks the burdens of full ownership and the unstable and unpredictable rental market, and instead affords owners long-term stability in housing as if they were traditional owners.

Co-Ops and 1031 Exchanges

In 2020, the IRS overhauled its rules for like-kind exchanges under Section 1031, making changes in the recognition of “stock in a cooperative housing corporation” as real property for exchange purposes. The definition of real property now includes interests like ownership, co-ownership, leaseholds, purchase options, easements, and similar rights, wherein it was explicitly confirmed that co-op shares qualify as real property.

In co-ops, people own shares in the corporation that owns the property, each of which provide the shareholder with a proprietary lease to occupy a specific unit. To best serve federal tax purposes, such co-op interests historically were treated as personal property, making them ineligible for like-kind exchange under IRC §1031, given that it was limited solely to real property being used for investment or business purposes— similar to a land trust property holding, which is technically a personal property interest. However, in the case of the land trust, there is a real ruling, Rev. Ruling. 92-105, that makes it eligible for a 1031 real estate exchange.

Before 2020, the IRS was inconsistent in their classification of co-op shares as real property. In Private Letter Rulings PLR 200137032 (issued in 2001) and PLR 00631012 (issued in 2006), the IRS acknowledged that co-op shares can be considered real property under New York and California law if they are paired with a proprietary lease. This exemplifies how state law influences the federal tax classification of these interests, potentially allowing co-ops to qualify for Section 1031 treatment, if they’re considered real property at the state level. REIT regulations already recognize co-ops as real property interests. Thus, this regulatory change standardized this 1031 treatment, ultimately aligning the definition of real property for Section 1031 purposes with the approach used in REIT regulations.

The qualifications for a 1031 Exchange, however, still depend on the ownership of the property. If used under state law, investors are advised to consult a real estate attorney or a tax advisor – someone familiar with both state and federal laws – to figure out if their co-op shares qualify for a 1031 Exchange.

1031 Asset Solutions has dedicated specialist to help with your 1031 Exchange inquiries. Give us a call today at 844-401-1031.