Tax Breaks from Condo and Co-op Ownership

My 2/12/17 blog post introduced the fictional apartment building 123 Anyplace Ave., and followed the money as the building transitioned from rental apartments to condo and co-op, and showed what residents pay — and why — with each form of ownership. A follow-up 2/18/17 blog post demonstrated why it can be worthwhile for people to choose co-op or condo ownership even though ownership required front-end investment and a lot more red tape but produced little savings in monthly costs. The answer: substantial build-up of equity value (one’s investment) even if the real estate market stagnates. But there’s one more thing in favor of ownership: tax breaks, substantial and valuable tax breaks.

Recapping the Basics

Table 1 reviews the assumed monthly apartment-dweller’s cost for each of the three ways 123 Anyplace Ave. can be owned. It shows how much the resident pays and more important, why the resident pays what he or she pays; where the money goes in each case. (Details on where the specific numbers come from are spelled out in the earlier posts.)

Table 1

	Monthly Payments for Apartment – Basic Analysis
	Tenant- Renter	Condo Owner	Co-op Shareholder
Total $ per month	2,380.95	2,249.72	2,249.72
What it consists of . . .
Operating Expenses	1,047.62	1,047.62	1,047.62
Real Estate Tax	500.00	500.00	500.00
Payment for Building Mortgage	351.05	0.00	351.05
Payment for Resident’s Mortgage	0.00	702.10	351.05
Landlord’s Profit	482.28	0.00	0.00

Enter the I.R.S.

There are tax implications everywhere. In all cases for everyone, tax must be paid on income , which is calculated as money one receives minus deductions (money that has to be spent to generate the income). That’s a very simple way of putting it; the Tax Code and IRS Regulations are lengthy and complicated. But through it all, that’s the basic idea.

The landlord reports the profit portion of rent as income and pays tax on it. That’s to be expected. Condo owners and Co-op shareholders don’t do likewise because this is not a profit making business for them. They pay taxes on their salaries or profits they earn from whatever other activities they engage in.

For the landlord, the key is the focus on profit. He gets to deduct all appropriate building expenses before coming up with a number that will be used as a basis for computing his tax.

This might lead one to assume that those expenses are meaningless from a tax point of view)for co-op and condo owners since they are not using them to generate taxable rental profit. In a world where no “loopholes” exist, that would be true.  But we live in the real world, one with tons of loopholes and there are two that are important here.

• One is that real estate taxes paid to local governments are deducted before considering federal tax liability.
• The other is that interest paid on mortgages is deductible too. Other kinds of interest (i.e. credit card interest) are not deductible. This reflects a government “policy” that tries to favor home ownership. (The Tax Code is often used to further broader social-political goals.)

This is why it was worthwhile to decompose monthly housing cost as I did in Figure 1. Some portions of the total are tax deductible by the residents, even though they are not in the real estate business and even though they don’t pay tax on real estate profit. The deductions are socio-political gifts, loopholes, courtesy of the government. Table 2 summarizes which items are deductible by residents.

Table 2

	What Expenses can provide Tax Advantages to Residents?
	Tenant- Renter	Condo Owner	Co-op Shareholder
Operating Expenses	No	No	No
Real Estate Tax	No	Yes	Yes
Payment for Building Mortgage	No	No	Yes
Payment for Resident’s Mortgage	No	Yes	Yes
Landlord’s Profit	No	– –	– –

Note the Tenant-Renter column. They get no deductions for anything. Those deductions belong to the one who pays tax on the profit, the landlord.

The Numbers

Table 3 recapitulates the items that make up the monthly expense, this time in more detail than we saw in Table 1. The extra detail allows us to make some adjustments to the items that are tax deductible.

Table 3

	Monthly Payments for Apartment – More Detail
	Tenant- Renter	Condo Owner	Co-op Shareholder
Total $ per month	2,380.95	2,249.72	2,249.72
What it consists of . . .
Operating Expenses	1,047.62	1,047.62	1,047.62
Real Estate Tax	500.00	500.00	500.00
Principal on Building Mortgage	106.05	0.00	106.05
Interest on Building Mortgage	245.00	0.00	245.00
Principal on Resident’s Mortgage	0.00	212.10	106.05
Interest on Building Mortgage	0.00	490.00	245.00
Landlord’s Profit	482.28	0.00	0.00

Table 4 is the big one. It restates the deductible numbers to present what the resident really pays, the dollars spent for real estate taxes and the mortgage minus the dollars the resident gets to keep away from income tax because he or she owns rather than rents. These figures can be referred to as “after-tax” or “tax-adjusted” numbers. In all cases, I assumed a 30% tax rate.(Obviously, the exact amount will be different for everybody based on their own individual circumstances; I made a representative generic assumption for purposes of illustration.)

Table 4

	Effective (After Tax) Monthly Payments for Apartment
	Tenant- Renter	Condo Owner	Co-op Shareholder
Total $ per month	2,380.95	1,952.72	1,952.72
What it consists of . . .
Operating Expenses	1,047.62	1,047.62	1,047.62
Real Estate Tax	500.00	350.00	350.00
Principal on Building Mortgage	106.05	0.00	106.05
Interest on Building Mortgage	245.00	0.00	171.50
Principal on Resident’s Mortgage	0.00	212.10	106.05
Interest on Building Mortgage	0.00	343.00	171.50
Landlord’s Profit	482.28	0.00	0.00

 

Notice the first line of Table 4. Condo and co-op owners really do save money, every month, when they count the amount they get to avoid paying in taxes. And this can be made quite real. If a renter buys a co-op or condo, he or she can go to the Human Resources department of his or her company and ask that the number of exemptions (don’t fret the terminology; the HR folks, or at least those who work with payroll, will know what this means) be changed in order to reduce the amount of taxes that get withheld form each paycheck based on the new expected lower tax liability.

This is big. Table 5 summarizes the amount of tax savings.

Table 5

	$ Tax Benefit (Money Saved)
	Tenant- Renter	Condo Owner	Co-op Shareholder
Basic Pre-Tax Monthly Payment	2,380.95	2,249.72	2,249.72
–  Effective After-Tax Monthly Payment	2,380.95	1,952.72	1,952.72
= Monthly Saving	0.00	297.00	297.00
Annual Saving	0.00	3,564.00	3,564.00

That’s not chump change. That can add up t a lot of movie outings, restaurant meals, clothes shopping, a new iPhone after just a few months without needing to put anything on the credit card, etc.

In the alternative, you can use the extra money each month to voluntarily increase how much you pay on your mortgage (direct the bank  to apply it to principal). That way, the equity buildup demonstrated in my last post will occur even more quickly. Now you’re doing some serious personal financial planning!

Next . . . 

Having reduced the financial impact of co-op or condo ownership to a single number, a single measurement, we now have a way to compare valuations we see in the marketplace much more effectively than we could by focusing on price, or even price per square foot (assuming one can get good square footage data for co-ops). That will be introduced in my next post.