SERVICE OFFERS GUIDANCE ON DETERMINATION OF CO-OP TAXABLE INCOME.

Rev. Rul. 90-36

ISSUES

(1) Does section 277 of the Internal Revenue Code apply to limit the deductions of a "cooperative housing corporation," as defined in section 216(b)(1)?

(2) If section 277 of the Code applies to a section 216 cooperative housing corporation, how is the cooperative housing corporation's taxable income determined?

(3) If section 277 of the Code applies to a section 216 cooperative housing corporation, what is the proper method of allocating the amount of the deductions disallowed under section 277 for purposes of determining the deductions allowed the cooperative housing corporation, as well as the deductions allowed the tenant- stockholders under section 216(a)?

FACTS

COOP, a cooperative housing corporation described in section 216(b)(1) of the Code, owns an apartment building and the land on which it is situated. COOP has nine tenant-stockholders, all of whom reside in identical apartments in the building and together occupy 90 percent of the space in the building. COOP rents the remaining 10 percent of the space in the building to a commercial tenant. COOP and its tenant-stockholders file federal income tax returns on a calendar year basis and use the cash receipts and disbursements method of accounting.

In 1987, COOP (1) received $18,000 in income from the tenant- stockholders and $4,500 in rent from the commercial tenant, (2) incurred expenses of $13,500 for real estate taxes and interest on a mortgage and $9,000 for general operating expenses, and (3) determined the depreciation deduction on the building for 1987 to be $10,000.

LAW AND ANALYSIS -- ISSUE (1). -- APPLICATION OF SECTION 277.

Section 216(a) of the Code allows a deduction in the case of tenant-stockholders for 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 the real estate taxes and interest allowable as deductions to the corporation under sections 164 and 163, respectively.

Section 216(b)(1) of the Code defines "cooperative housing corporation" as a corporation (A) having one and only one class of stock outstanding, (B) each of the stockholders of which is entitled, solely because of ownership of stock in the corporation, to occupy for dwelling purposes a house, or an apartment in a building, owned or leased by the corporation, (C) no stockholder of which is either conditionally or unconditionally entitled to receive any distribution not out of earnings and profits of the corporation (except upon a complete or partial liquidation thereof), and (D) 80 percent or more of the gross income of which for the taxable year in which the taxes and interest described in section 216(a) are paid or incurred is derived from the tenant-stockholders.

Section 277(a) of the Code provides that, in the case of a social club or other membership organization that is operated primarily to furnish services or goods to members and that is not exempt from taxation, deductions for the taxable year attributable to furnishing services, insurance, goods, or other items of value to members are allowed only to the extent of income derived during the year from members or transactions with members. If for any taxable year such deductions exceed such income, the excess is treated as a deduction attributable to furnishing services and other items to members paid or incurred in the succeeding taxable year.

Cooperative housing corporations described in section 216(b)(1) of the Code satisfy the three requirements set forth above for the application of section 277(a). First, a cooperative housing corporation is a membership organization. The tenant-stockholders of the corporation, who by virtue of their stock ownership are entitled to live in a house or apartment owned by the corporation, are the corporation's members. Second, a cooperative housing corporation furnishes housing and maintenance services to its tenant- stockholders. Because section 216(b)(1)(D) requires that 80 percent or more of the gross income of a cooperative housing corporation be derived from its tenant-stockholders, a cooperative housing corporation is operated primarily to furnish services to its stockholders. Finally, there is no provision exempting cooperative housing corporations described in section 216(b)(1) from federal income taxation.

In Concord Consumers Housing Cooperative v. Commissioner, 89 T.C. 105 (1987), section 277 of the Code was applied to a nonprofit, nonstock corporation providing housing to its members whose income was generally required not to exceed specified amounts. The application of section 277 by the court in Concord to the taxpayer corporation, whose members were entitled to occupy units in a building owned by the corporation, supports the application of section 277 to cooperative housing corporations described in section 216(b)(1), which similarly provide housing to their tenant- stockholders (members).

In addition, in connection with a 1976 amendment to section 216(c) of the Code, which expressly allows cooperative housing corporations to take depreciation deductions for property leased to their tenant-stockholders, the Senate Finance Committee indicated its understanding that section 277 is applicable to cooperative housing corporations described in section 216(b)(1) as follows:

The committee does not believe that a clarification of the rules relating to the cooperative housing corporation's ability to take depreciation deductions with respect to property leased to tenant-stockholders will create tax avoidance possibilities because the provisions of existing law (sec. 277) generally prevent nonexempt membership organizations from offsetting nonmember income with losses from dealings with members.

S. Rep. No. 938, 94th Cong., 2d Sess. 398, 1976-3 (Vol. 3) C.B. 49, 436.

LAW AND ANALYSIS -- ISSUE (2). -- TAXABLE INCOME.

Section 277(a) of the Code limits the deductions attributable to furnishing services or items to members to the income received from the members. Thus, the expenses of COOP must be allocated between those attributable to furnishing services or items to its tenant- stockholders (members) and those attributable to furnishing services or items to its nontenant-stockholder (nonmember). Generally, the proper allocation of expenses under section 277(a) will depend on the facts and circumstances. In many cases, an allocation based on the relative fair market values of the space used by the tenant- stockholders and the nontenant-stockholders will be reasonable. Other methods of allocating the expenses, however, may be appropriate.

In this case, since 90 percent of the space in COOP's building is used by its tenant-stockholders and 10 percent of the space in the building is used by a nontenant-stockholder, it is reasonable to attribute 90 percent of COOP's $32,500 of total fixed expenses and general operating expenses to furnishing services and other items to its tenant-stockholders and 10 percent of such expenses to furnishing services and other items to its nontenant-stockholder renter. Thus, membership (tenant-stockholder) income and deductions for 1987 are as shown in Table 1:

                                Table 1

In 1987 COOP's gross income attributable to nonmember use of its building exceeds its deductions attributable to nonmember use by $1,250. Thus, COOP is taxable on this $1,250 as illustrated in Table 2.

                                Table 2

The manner in which the disallowed $11,250 in membership deductions is allocated among COOP's various membership expenses is important because section 216(a) of the Code generally allows the tenant-stockholders of a cooperative housing corporation to deduct amounts paid or accrued by them to the corporation representing their proportionate share of the real estate taxes and interest paid by the corporation. Specifically, section 216(a) allows tenant-stockholders to deduct such amounts to the extent the amounts represent "real estate taxes ALLOWABLE AS A DEDUCTION TO THE CORPORATION under section 164" and "interest ALLOWABLE AS A DEDUCTION TO THE CORPORATION under section 163." (Emphasis added).

The Senate Finance Committee, in commenting on the predecessor of section 216(a) of the Code, stated that the purpose of the real estate tax and interest pass-through deductions was "to place the tenant-stockholders of a cooperative apartment in the same position as the owner of a dwelling house so far as deductions for interest and taxes are concerned." S. Rep. No. 1631, 77th Cong., 2d Sess. 51 (1942), 1942-2 C.B. 504, 546.

To minimize the conflict between the application of the deduction disallowance provisions in section 277 of the Code to section 216 cooperative housing corporation deductions at the corporate level and the deduction pass-through objectives of section 216(a) at the tenant-stockholder level, amounts disallowed under section 277 will be deemed attributable first to expenses other than interest and real estate taxes (to the extent of such other expenses), and then to interest and real estate taxes if such attribution to the other expenses is used fully. Thus, amounts allowed in the first year (i.e., amounts not disallowed under section 277) will be deemed attributable first to interest and real estate taxes, and then to expenses other than interest and real estate taxes. To determine the amount of each type of deduction allowed a cooperative housing corporation each year, a proportionate part of the amount disallowed under section 277 which is deemed attributable to a category of expenses is allowed to each type of expenses in the category.

Applying this approach to the facts of this revenue ruling, the $11,250 disallowance of membership deductions under section 277 of the Code for 1987 will be allocated first to depreciation and other expenses attributable to the portion of COOP's building occupied by the tenant-stockholders. Because these expenses ($9,000 + $8,100 = $17,100) exceed the amount disallowed by section 277 ($11,250), COOP's deductions in 1987 for real estate taxes and interest attributable to the portion of the building used by its members ($12,150) will be unaffected by section 277. Consequently, COOP's tenant-stockholder deductions representing real estate taxes and interest are not reduced by section 277 in 1987.

Since the entire $11,250 disallowance is deemed attributable to COOP's other expenses and depreciation deductions attributable to the portion of the building used by its members, only $5,850 of the total $17,100 of these expenses will be deductible in 1987. Of the $5,850 deductible in 1987, the other expense portion is $2,771.05 (8,100/17,100 x 5,850) and the depreciation portion is $3,078.95 (9,000/17,100 x 5,850). Of the $11,250 disallowed portion of these expenses which is carried over to 1988, the other expense portion is $5,328.95 (8,100/17,100 x 11,250) and the depreciation portion is $5,921.05 (9,000/17,100x 11,250).

HOLDINGS

(1) Section 277 of the Code applies to limit the deductions of cooperative housing corporations, as defined in section 216(b)(1).

(2) For purposes of determining the cooperative housing corporation's taxable income, in this case it is reasonable to attribute the fixed expenses and general operating expenses paid or incurred by the corporation on a space-used basis between tenant- stockholder gross income and nontenant-stockholder gross income. Such attributed expenses are then subtracted from the respective gross income amounts to determine the corporation's taxable income.

(3) For purposes of determining the deductions allowed the cooperative housing corporation and the deductions allowed the tenant-shareholders under section 216(a) for their proportionate shares of the interest and real estate taxes paid or accrued by the cooperative housing corporation, any deduction disallowed under section 277 of the Code is attributed first to expenses other than interest and real estate taxes (to the extent of such other expenses) and then to interest and real estate taxes if such attribution to the other expenses is used fully. For purposes of determining the amount of each type of deduction allowed a cooperative housing corporation each year, a proportionate part of the amount disallowed under section 277 which is deemed attributable to a category of expenses is allocated to each type of expense in the category.

DRAFTING INFORMATION

The principal author of this revenue ruling is David L. Click of the Office of Assistant Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue ruling contact David Click on (202) 566-4821 (not a toll-free call).