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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 cooperative’s 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 building’s 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 Case
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 building’s 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 wasn’t 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).

CLARIFYING LEGISLATION:
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 building’s 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 cooperative’s 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:

  1. 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.
  2. 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 Law.
  3. 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.
  4. 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.
  5. 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.

‘SELLING’ THE FLIP TAX
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 in place.

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. Don’t even try to convince someone who plans to sell this year or next that they should support a flip tax; it simply isn’t in their best interest. Don’t 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 accountant’s 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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