In New York City, many co-ops and condos use a practice called a "flip tax" in order to boost building revenue. As most co-op and condo owners know, a flip tax is a fee paid to the building, either by the purchaser or seller, each time an apartment is sold, or "flipped."

The idea of a flip tax is not new; it actually had its genesis in the early 1980's, when hundreds of rental buildings were converting into co-ops. These buildings often needed major capital improvements, and once the dust settled, there wasn't much change left in the reserve fund. According to Stuart Saft, a real estate attorney with the Manhattan law firm of Wolf Haldenstein Freeman Adler & Herz, "The feeling at the time was that tenants who bought at low insider prices and could make quick profits by selling their apartments at market rates should give something back to the building.

"At first, [flip taxes] were basically only done in co-op conversions," continues Saft. "Then about nine or 10 years ago, existing co-ops started implementing flip taxes as they were looking for new sources of income for their reserve funds."

The idea caught on--and held on. Today, it's estimated that more than 60 percent of the city's co-ops have a flip tax in place, and a study by the law firm of Stroock Stroock & Lavan found that a majority of condos are now considering instituting flip taxes too. And why not? They can bring in money--and they can help buildings reduce common charges and maintenance fees without cutting back on services or amenities.

Not Only in New York

Though New York City is a unique animal in many ways, the concept of the flip tax is not exclusively a "New York thing." In New Jersey, for example, the basic idea of the flip tax exists in several forms--though the term "flip tax" is almost never used.

According to Edward S. Frank, a property manager with Arthur Edwards Inc. in River Vale, "People seem to shy away from a term that has the word 'tax' in it. That's why you don't hear the term 'flip tax' in New Jersey," he says. "On the co-op side they call it a 'realty transfer fee' and on the condo side they call them 'resale contributions.'"

Unlike New York, co-ops are not the dominant residential species in New Jersey--which is likely why flip taxes are not much heard of around the state's boards and associations. There is also case law that prohibits flip taxes in some instances.

Getting Flipped

Whether in New York or New Jersey, some things are universal: a board can not just decide to institute a flip tax--there are procedures that must be followed and some general standards that need to be met.

According to Phillip Miller of the Manhattan-based accounting firm of Miller & Cusenza, "Usually, flip taxes these days average between one and three percent [of the purchase price]--sometimes higher. There are some buildings-- one in Queens, for example--that have flip taxes as high as 45 percent. That's the highest one I know of. It's not common, but it figures that high do exist."

No matter what the percentage, however, "Flip taxes are illegal unless specifically authorized by the [co-op or condo's] governing body," says Ronald L. Perl, a partner in charge of the community association practice group with Hill Wallack, a law firm in Princeton, New Jersey. "They are permitted only if authorized in the original master deed or bylaws or included in amendments to them. I think New Jersey courts were concerned with giving governing boards--often just a handful of people -- the authority to impose this without some sort of vote by the owners."

"Ideally, the flip tax should be written into the offering prospectus or black book," says Miller. "Otherwise, shareholders have to vote on it, and it usually has to be approved by a super-majority--one-third, or 75 percent, say--to be put in effect."

Thomas Vincent Giaimo, an attorney based in Red Bank, believes that he represents the first condo association to adopt a realty transfer fee in New Jersey. The HOA in question put a 1.5 percent realty transfer fee upon acquisition into the bylaws and placed the onus on the buyer to contribute that percentage of the purchase price back to the association.

"It's a good thing," says Giaimo, "because in New Jersey, we're seeing unprecedented conveyances in title in real estate--in community association property in particular. We're seeing explosive development of new communities and seeing a lot of resale because property values are exploding. I think this is going to be the first in a series of dominoes to fall in this direction. It makes good economic sense for the community association."

Upsides

So say your building is contemplating a flip tax amendment--or already has one. Where does all that money go? Who benefits most from it? Are there other alternatives our building might explore?

First things first: Most pros feel that any flip tax revenue should serve the purpose flip taxes were invented to serve--they should be put into the building's reserve fund to pay for future capital expenditures.

The money collected from these methods can be used either for operating expenses or just to build up the reserves.

"The [fees] I have seen are mostly utilized to offset regular operating budget or used for enhancements," adds Perl. "Rebuilding a deteriorated wall at the entrance to a community, for an example. If there is a heavy winter storm and there's more snow removal than anticipated, these funds provide a ready source of cash."

According to Miller, "The advantages are that buildings can have a tremendous amount of revenue coming in--especially in today's market, when taxes are based on a percentage of the sale. That translates into a huge influx of income in places like Park or 5th Avenue. Real estate taxes and other expenses are also really going up, and in order for buildings to meet those expenses, they're using flip taxes to lessen the burden of those increases, rather than driving up maintenance."

For condo buildings and developments, transfer fee contributions show a sign of good faith by the new owners. Associations want new owners to make contributions to the reserve account because they feel as though it's only a fair thing to do because they are new to the community and everyone who has been there for years has contributed.

More Upsides

Another perk that comes with a flip tax is more "good" income in light of what's called the "80/20 rule." Co-ops with significant amounts of non-shareholder income--usually from retail tenants or parking facilities --are probably well aware of Section 216 of the Internal Revenue Code, which mandates that in order for co-op buildings to deduct mortgage interest and real estate taxes on their federal tax returns, no more than 20 percent of the building's annual income can come from non-shareholder sources.

According to Gerald Marsden, a CPA with the firm of Eisner & Lubin in Manhattan, a flip tax is considered "good" income under the 80/20 rule if it is put into the operating fund. If funds go into the reserve fund, they are considered income neutral under the 80/20 rule and therefore have no effect on that calculation.

"The 80/20 rule is a very important component--especially in New York City when outside income exceeds 20 percent, and co-ops have a problem," says Marsden, adding that buildings are constantly trying to find ways to comply with the rule.

Downsides?

So with all the benefits that flip taxes and/or transfer fees impart to a co-op or condo (or suburban homeowners association), is there a downside? Sort of--like anything to do with money, flip taxes go better when they're properly managed and assiduously applied.

For example, says Saft, boards should resist the temptation to earmark flip tax monies for operating expenses or count on them as a regular source of income, because flip tax income is unpredictable, and therefore difficult to budget. Market conditions and the size of apartments sold affects the amount of tax paid to the building--while the sale of a single large penthouse might generate a healthy chunk of change, another year might see just a few studios sell, which in turn would generate much less revenue.

By diverting flip tax income into operating funds, buildings may also be masking and compounding financial problems into the following year. Consider, for example, a co-op that needs to raise maintenance fees five percent to cover operating expenses. What if the building opts to use flip tax money to fill the gap, rather than biting the bullet and presenting shareholders with an increase? It could theoretically work, but what happens next year when sales are slow or non-existent and that flip tax money isn't there? The board may have to raise maintenance 10 percent instead of the more palatable five percent.

Hefty taxes can generate big bucks for buildings, but they may have a chilling effect when it comes to actually closing a sale. "[A big tax] could potentially discourage people from buying when buildings want the buyer to absorb the cost of the tax," says Miller. "If the burden is on the sales party, it might be discouraging, but usually you're just talking about two or three percent, so it's not that much of a downside. Transfer fees can also create tax problems because obviously, if your building has a balanced budget and you incur flip taxes, that's going to blow your balance and put you well in excess of your expenses-over-income. So you can wind up with some taxable income."

All in all, though, says Frank, "There are no real drawbacks. The offset to any negative aspect is that we live on the East Coast where people are used to spending a big chunk of change for a nice piece of real estate--another $300 or $3,000 is not something that's likely to turn them off. In the long run, if you go to sell, or your neighbor goes to sell, they are going to be kicking in this money. Your building is going to get a payback of this 10 times over."

Miller agrees. "I've never known of a board that abolished a flip tax after enacting one," he says. "The advantages just so outweigh any disadvantages."