How Co-ops can become Condos ?

Please note that SSG is not a law firm, and that we highly recommend consulting a specialized lawyer before applying for a liquor license.

Once in a while, a client looking to buy an apartment in NYC will remark that since co-ops are cheaper than condos it would be great to purchase an apartment in a co-op right before it converts into a condo. Suddenly, not only would the apartment become more valuable but it would also be easier to not have to deal with co-ops rules.

Unfortunately, such a scenario is very unlikely to happen. Even though the conversion process from co-ops to condos is not legally complicated, few practical and financial obstacles stand on its ways. 

In fact, from a legal standpoint, the shareholders simply need to adopt a resolution to end all the proprietary leases, dissolve the corporation and have the assets transferred to the individual owner. However, four important points can explain why the conversion is such a rare occurrence.

The Majority of Shareholders need to agree to a Conversion: 

By-laws in co-ops often require at least 2/3 of all the shareholders to agree to terminate all the proprietary leases which effectively end the co-op regime. However, that 2/3 threshold can sometimes be higher in some co-ops. The people who would not vote in favor do fall into two categories: the ones who are against and the one who are too busy to care about voting. These two groups alone would usually represent more than 1/3 of the co-ops. In fact, many people did want to live in co-op for the quality of life it can offer by encouraging long-term owners.

Condo-Declaration and Bylaws

Assuming that shareholders would want to convert the their co-ops into a condo, they would then need to negotiate the terms of the declaration and of the bylaws. Given the numerous points discussed in these documents, it would be a very cumbersome process to find an agreement among the shareholders. For instance: one question could be if there is a damage inside an apartment that is not due to the owner's fault, who would pay for the repair? Another contentious point could be related to the control the board would have over who can buy or lease the apartment.

Repayment of Underlying Mortgages & the Individual Loan Share

If there is an underlying mortgage in a co-op, amid the conversion process, the residents would need to assume their pro-rata share of the mortgage. Unfortunately, such repayment could come with a mortgage pre-payment penalty. Additionally, the shareholders who financed their shares will also need to replace their share loans with a mortgage on their new condo units. For the shareholders, this process would most likely cost them some legal fees and fees from the bank.

Phantom Tax

One major issue with a condo conversion is that the IRS treats the exchange of a share in a co-op for a deed in a condo as a taxable event. The individual shareholders would need to pay an income tax on the difference between the original cost of the apartment plus capital improvements and the fair market value of the apartment at the time the exchange occurs even though the owner does not actually sell his apartment. Also, shareholder who have used the apartment as their principal residence for 2 of the last 5 years could also substract $250,000 for an individual or $500,000 for married couples from any resulting gain. Thus, the co-op to condo conversion could result in a substantial tax liability for the co-op shareholders.

Over the years, the number of co-ops which have become condos have been more the exception than the rule. It wouldn't be a wise decision for anyone to purchase an apartment in a co-op with the hope that one day it would become a condo.