Published: Autumn 2002
Every autumn, CNYC brings members together for a busy Sunday of
learning at its annual Housing Conference. This Conference is the premiere
educational event for shareholders and unit owners in New York housing
cooperatives and condominiums. At the 21st annual Conference on Sunday,
November 11, 2001, attorney Arthur I. Weinstein, a founder and vice
president of CNYC discussed the history of the Flip Tax and the ways
that a cooperative can implement this type of fee. Following are highlights
of his presentation.
Understanding Flip Taxes
If there's one issue that both confuses and entices board
members, it's the flip tax. More accurately described as
a "transfer fee", a flip tax is "a good way
of raising money" attorney Arthur Weinstein assured
workshop participants. That's the enticing part. The confusion
arises over the complexities involved in instituting and
enforcing a flip tax policy, since the legality a flip tax
often hinges on the cooperatives underlying documents.
It is rare to find flip taxes in condominiums, so this discussion
is confined to flip taxes in New York cooperatives.
A DIFFICULT BIRTH
Flip taxes began as an attempt to solve problems inherent in the housing
market during the early 1970's. As many rental buildings were offered
for conversion to cooperatives, two main issues surfaced: first, an
entrenched group of tenants living in rent controlled and rent stabilized
apartments could not afford high purchase prices; and second, many buildings
were in bad condition, for their owners had long deferred necessary
maintenance because their income from the apartments was severely limited
by rent regulation. Advocates representing tenants in conversion negotiations
needed to find a way to fund future repairs and improvements without
hitting shareholders with whopping assessments, while also keeping purchase
prices affordable. Thus, Mr. Weinstein and other attorneys at the time
came up with the concept of the flip tax: buyers pay a reasonable purchase
price up front, and when they sell their apartments, they are "taxed"
to bolster the buildings reserve fund.
This all seems simple enough, but problem soon surfaced as the legality
of some flip taxes was challenged. Generally speaking, in the early
years, the Courts sustained flip taxes as long as the proprietary lease
gave the board the power to enact them or if the bylaws included a provision
on flip taxes. However, flip taxes enacted by board decision alone were
soon overturned by the courts.
A SETBACK: The FeBland
In December, 1985, a crucial flip tax case, Febland v. Two Trees Management
Co., ultimately helped to set the stage for today's common use of the
flip tax. When Mr. FeBland challenged his buildings flip tax,
the Court upheld his position, determining that the board could institute
a flip tax only if this power was specifically stated in the proprietary
lease; however, if that flip tax wasnt not perfectly proportional,
each shareholder would most likely be treated in a different manner.
The court ruled that by not treating all shareholders equally, the flip
tax in question violated a basic concept of New York Business Corporate
Law (the BCL).
Chapter 598 of the Laws of 1986
Weinstein and other co-op advocates were angered by the FeBland decision.
They had just helped convert various cooperatives with substantial flip
taxes carefully negotiated to protect the buildings future, and
were worried that hundreds of thousands of dollars would be now litigated
away from these fledgling cooperatives. With the Council of New York
Cooperatives taking a leading role, a strong campaign was undertaken
to protect the ability of cooperatives to collect flip taxes. Then assembly
member G. Oliver Koppell sponsored a carefully worded amendment to Section
501(c) of the Business Corporation Law and shepherded it swiftly through
the legislature. On July 24, 1986, then Governor Cuomo signed into law
chapter 598 of the laws of 1986, which enables cooperatives to enforce
any form of flip tax, if and only if it is described in the original
offering plan or its subsequent amendments, or if it is adopted as an
amendment to the proprietary lease. Astutely, this legislation gave
retroactive sanctions to any flip tax that met these requirements.
Thus, it has been clear since 1986 that if a flip tax is not part of
your cooperatives organizing documents, the only legal way to
enact a flip tax is to amend the proprietary lease. This typically requires
an affirmative vote of two thirds of all outstanding shares. In some
buildings the requisite super majority is even greater.
This ensures full disclosure of the proposed flip tax to all shareholders.
No cooperative should try this process without the help of their attorney,
urged Mr. Weinstein. Corporation counsel will provide proper wording
of the flip tax amendment and can help explain the benefits of the flip
tax to the shareholders. Once it is voted in, it is binding even on
those who voted against it.
TYPES OF FLIP TAXES
There are several different types of flip taxes, each with its own merits
and problems. The choice you make should be the one best adapted to
the needs of your building and its shareholders.
Flip tax types include:
Per Share Amount. This is, of course, the most conventional
and simplest type of flip tax, and one found acceptable by the Court
in the FeBland case. It treats all shareholders equally by imposing
a flip tax of a fixed dollar amount per share. However, this method
can excessively benefit sellers who bought years ago and paid far
less than the current market rate, because they would be taxed the
same amount as those who bought more recently at higher prices.
Flat Fee. A second method is to charge a certain
flat dollar amount per transaction (e.g., $5,000 per transfer). This
method benefits the owners of larger units who pay the same amount
as the seller of a studio. It can, however, be the best compromise
for a building where all the apartments are relatively similar in
size. This form of flip tax, if properly enacted, is also perfectly
legal under the amended Section 501(c) of the Business Corporation
Percentage of Sales Price. Another acceptable form
of flip tax is a percentage of the gross sale price. While this method
is straightforward, says Mr. Weinstein, it can, like the per share
and flat fee flip taxes, be unfair to those who lose money on their
sale. In addition, it can prompt collusion between seller and buyer
to "beat the system" , for example by agreeing on a sales
price of $100,000 for the apartment (subject to the flip tax), and
a separate transaction of $50,000 for the built-in bookcases and the
kitchen counters (which should, of course be a part of the overall
sales price) . If your building decides to base its flip tax on gross
sale price, Weinstein advised, it is wise to get an affidavit from
the buyer and seller, ensuring that there is no other consideration
flowing between them.
Percentage of Net Profit. Perhaps the most controversial
form of flip tax is one based on net profit. In this case, the cooperative
must very carefully define exactly what its formula will be for determining
the net profit; and the formula must be strictly and consistently
applied. If your formula allows the seller to subtract from the sales
price provision for improvements made to the apartment, there will
be an incentive to pad costs in order to lower the net profit figure
that will form the basis for the flip tax. Evidence of payment of
invoices for improvements should be required.
Combining Methods. It is also possible to set up a
flip tax that combines two or more of the above methods. For instance,
your flip tax could be a percentage of the gross sale price provided
it exceeds the original purchase price. Or, protections could be put
in so that somebody who has not made a profit on a deal can pay a
lower fee. "Since BCL 501(c) was amended, you have the power
to make a variable impact flip tax to be fair," says Mr. Weinstein.
But he warns that the more fair a board tries to make its flip tax,
"the more convoluted it gets and the more opposition you get."
Thus, as much as possible, he advised boards to keep things simple.
WHO PAYS THE FLIP TAX?
The standard form of contract for sale of a cooperative apartment has
a paragraph that discloses who the cooperative requires to pay the flip
tax. Because attorneys carefully protect their client cooperatives from
running afoul of the important 80/20 provisions of Section 216 of the
Internal Revenue Code, cooperatives will look to the seller to pay the
flip tax before allowing the apartment to change hands. Mr. Weinstein
estimates that 95% percent of flip taxes in New York are paid by the
seller. However, the seller is not prevented from putting in a contract
provision to make the buyer responsible for actually providing these
additional dollars. Many cooperatives would then add the amount of the
flip tax to the price if the calculation is based on sale price.
Because flip taxes are now widely used, they do not generally have
an adverse effect on sales or sales prices. However, if someone who
has had a bid of a certain amount accepted for an apartment and is later
told that they would be expected to pay a flip tax, this could quash
the sale. "No one appreciates it if they negotiated one price and
are then given a higher price", Weinstein noted.
How can you persuade shareholders to vote in large numbers to forfeit
part of the profits from the sale of their units to bolster the reserves
of a building that they will be leaving? The board that decides to institute
a flip tax must face this question head on. Their best allies will be
shareholders who intend to stay on in the building forever
(or at least for the next six to ten years). They should clearly see
that the turnover of apartments will accrue to their benefit, for they
plan to be around long enough to see building projects funded by flip
tax proceeds, which would otherwise have come out of their own pockets,
either as maintenance increases, assessments or additional debt service.
Document this advantage by making a chart of the capital improvements
actually made in the building in, say, the last five years, and the
sales that took place during the same time. Calculate what would have
come in through a flip tax, using one or more of the methods described
above. Show, for example, that half of the cost of the new elevator
cab could have been recaptured, or that the phased window replacement
project could have proceeded twice as quickly if a flip tax had been
It is important that your board present a united front in supporting
the flip tax project. You will all have to work hard to convince your
neighbors to vote for it. Do hold informational meetings and answer
all questions that arise. Do be practical and realistic in your planning.
Dont even try to convince someone who plans to sell this year
or next that they should support a flip tax; it simply isnt in
their best interest. Dont try to amend the proprietary lease in
a vote at one meeting. Proprietary leases can be amended by written
consent that may be obtained from individual shareholders over a period
of time such as 30 days.
Once you have successfully enacted a flip tax, keep shareholders aware
of how it is working for them; in addition to the accountants
notes in the annual financial statement, a wise board will report periodically
on how the flip tax is helping to fund building improvements.
A SMOOTH EXIT STRATEGY
Regardless of who pays the flip tax or what type of flip tax your building
puts in place, make sure your board enforces it clearly and fairly.
Mr. Weinstein advises that the board should never let the managing agent
or attorney schedule a closing without prior clear agreement from all
parties as to what the flip tax is going to be and who is going to pay
it. Notes Mr. Weinstein: "The fewer surprises you present, the
fewer headaches you will have."
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