Housing Co-Ops and 1031 Exchanges

What is a Housing Co-Op?

A housing cooperative, or co-op, is a type of residential community in which individuals do not own their units outright. Instead, they own shares in a nonprofit corporation that owns the entire property. These shares grant each member the right to occupy a specific unit under a proprietary lease or occupancy agreement as well as a voice in how the community is governed.

Co-ops function like businesses, with a board of directors elected by its residents. The board makes decisions about the policies, management, maintenance, and finances of the co-op. Membership often involves a monthly fee to cover building expenses such as mortgage payments, property taxes, utilities, and maintenance.

Types of housing co-ops can include:

• Townhouses and Condominiums
• Midrise and High-rise Apartment Complexes
• Senior Housing
• Special-Needs Housing
• Mobile Home Parks

This housing model can offer residents lower overall costs and more community input and control as opposed to traditional renting but includes unique responsibilities and important legal distinctions that set them apart from regular renting.

Why Are Co-Ops Popular?

Housing co-ops offer a number of unique advantages that make them an appealing option for many, primarily in urban markets where affordability and stability are prevalent issues. Two of primary reasons co-ops are so popular are affordability and long-term stability they can offer.

Affordability

Co-ops can provide a more affordable path to property ownership compared to traditional condos or single-family homes. Since members buy shares in a nonprofit corporation rather than purchasing real estate directly, upfront purchase costs, as well as closing costs, are typically lower.

Monthly maintenance fees cover shared expenses like mortgage payments, property taxes, insurance, building maintenance, and staff wages. In larger co-ops, a professional management company or in-house team usually handles repairs, landscaping, security, and maintenance, reducing individual burden. Even in smaller, self-managed co-ops, residents often share responsibilities, keeping costs low through collective responsibilities and work.

Stability and Security

As well as affordability, co-ops are typically known for the stability and security they can provide. Instead of receiving a deed to a specific unit, individuals who buy into a co-op purchase shares in the corporation that owns the entire property. These shares grant them a proprietary lease, which gives them the right to occupy a designated unit within the building. Proprietary leases in co-ops tend to be long-term leases, often 30 years or more, and can be automatically renewed as long as the leaseholder is in good standing with the co-op. This structure offers long-term, stable housing similar to traditional ownership, but without the unpredictability of the rental market or the burdens of individual property ownership.

Co-Ops and 1031 Exchanges

In 2020, the IRS updated its rules for like-kind exchanges under Section 1031, providing several important clarifications. One significant change was the recognition of “stock in a cooperative housing corporation” as real property for exchange purposes. The final Regulations expanded the definition of real property to include interests such as ownership, co-ownership, leaseholds, purchase options, easements, and similar rights, explicitly confirming that co-op shares held by tenant-stockholders qualify as real property.

In a typical co-op housing arrangement, individuals own shares in a corporation that holds title to the property. These shares provide the shareholder with a proprietary lease to occupy a specific unit. Historically, for federal tax purposes, such co-op interests were generally treated as personal property, making them ineligible for like-kind exchange treatment under IRC §1031, which is limited to real property held for investment or business use. This is similar to a land trust property holding which is technically a personal property interest. In the case of the land trust, there is an actual ruling, Rev. Ruling. 92-105, that allows it to be eligible for a 1031 real estate exchange.

Prior to the 2020 regulations, the IRS’s classification of co-op shares as real property was inconsistent and often dependent on state law. Notably, in Private Letter Rulings PLR 200137032 (issued in 2001) and PLR 00631012 (issued in 2006), the IRS acknowledged that co-op shares, when coupled with a proprietary lease, could be treated as real property under New York and California law. These rulings demonstrated that state law could influence the federal tax classification of such interests, potentially allowing co-op shares to qualify for Section 1031 treatment if they were considered real property at the state level. The 2020 regulatory change standardized this treatment, aligning the definition of real property for Section 1031 purposes with the approach used in REIT regulations, which already recognized co-op shares as real property interests.

Since the qualifications for a 1031 Exchange still depend on how the property is owned and used under state law, investors should consult a tax advisor or real estate attorney familiar with both state and federal laws to determine if their co-op shares qualify for a 1031 Exchange.

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.

Sources:

https://www.mcc4tax.com/new-york-co-op-1031-exchange/

https://www.realtor.com/advice/buy/the-basics-of-co-op-housing/?msockid=075286d8373a6e99323c935136006f35

https://activerain.com/blogsview/5863419/everything-you-need-to-know-about-new-york-co-ops--a-deep-dive

https://homesight.org/the-role-of-housing-cooperatives-in-affordable-living/#google_vignette