How Leasehold Condominiums Can Save Not for Profits Money on Their New York City Real Estate TaxesJuly 31, 2018
Many not for profits in New York City (“NFPs”) including hospitals, schools and charitable organizations are eligible for an exemption on their real estate taxes. With the city’s real estate taxes among the highest in the nation, this can result in meaningful savings. But the law in this area normally makes the exemption available only to NFP’s that hold “legal title” to their property – a term that has been interpreted to mean fee ownership.
That law plays out in the real world in peculiar ways. For instance, a hospital that leases a building owned by a non-exempt commercial landlord will not qualify for an exemption, even if the hospital is clearly using the building for exempt purposes. In that scenario, the fee owning landlord must pay real estate taxes, and the hospital ultimately bears the brunt of that burden, because landlords typically pass on their operating costs to tenants.
But a solution to this problem does exist, and it’s called a leasehold condominium. In New York City, leased property that is used exclusively for non-residential purposes can be changed to this form of ownership, if the remaining term of the lease is at least 30 years. Under a leasehold condominium, a lease is divided into units (at least two of them), which are considered separate tax lots and are assessed separately for the purposes of determining real estate taxes. This scenario has been deemed to satisfy a NFPs need to hold legal title to its property, but several legal and technical hurdles need to be overcome along the way, all of which have associated costs.
At the outset, if the entire property is to be leased to the NFP, the NFP’s lease must allow it to create a leasehold condominium. A landlord may be encouraged to cooperate with this request, because the potential real estate tax savings makes rental properties very attractive to NFP tenants. The NFPs cost to negotiate this lease is likely to be greater than it would under normal circumstances. But in most scenarios, this up-front cost will be more than reasonable considering the resulting tax savings. The NFP tenant will also need to retain an architect to prepare the floor plans; and an attorney to prepare and record a condominium declaration, file the required government applications and guide it through the condominium process.
First, the Declarant of the leasehold condominium must obtain a “no-action letter” whereby the Attorney General waives the requirement to file an offering plan which would apply in the event that condominium units were being sold.
The condominium declaration will need to include a description of the land and the improvements involved in the conversion, a description of at least two units, including floor plans; and a description of the common elements and their allocation to each unit owner. In order to be eligible for the exemption, the declaration must provide that the owners of the units (and not the condominium board or the landlord) are responsible to pay all real estate taxes on their unit and the appurtenant common interest. Condominium by-laws must also be recorded, which outline the method of electing a board of managers and officers, the conduct for meetings, and how rules and regulations are made. Several other legal considerations must be satisfied before the declaration can be recorded, but they’re relatively straightforward.
Once the declaration has been recorded, the New York City Department of Finance (“DOF”) will assign a separate tax lot to each unit. The NFP can then convey one or more units to different related entities, which can then apply to DOF for a real estate tax exemption.
Scenarios Involving Parts of Buildings
This process is more complicated when less than an entire building is leased to an NFP - for instance, a walk-in clinic that occupies the ground floor of a large commercial building.
In that situation, the landlord would typically have to lease the entire building to an affiliate that meets the DOF requirements for a leasehold condominium, and then create a leasehold condominium of the affiliate lease. The landlord’s affiliate, as the declarant, could then transfer one or more units to an NFP who would then “own” the unit(s); and the landlord could lease the remaining units to third parties, which would be subject to real estate tax as usual. When less than all of the units are owned by the NFP, the declaration and the by-laws must also address the sometimes-complex relationship between the declarant, the condominium’s board of managers and the NFP. But in many ways this relationship mirrors that of a typical landlord and tenant, and as long as an NFP is leasing substantial space at market rents, this partial building scenario can be worthwhile for the landlord.
Risks and Other Considerations
A leasehold condominium structure has some risks when the unit owners are not affiliated. For example, each unit owner shares in the obligations under the lease according to its percentage of common interest, or another allocation determined in the declaration. These obligations are paid as common charges to the condominium’s board of managers, which then discharges the lease obligations on behalf of the unit owners collectively. This includes the payment of rent to the landlord. If less than all of the unit owners pay their common charges, the other unit owner(s) would need to make up the shortfall in order to keep the lease alive, unless some protection is written into the declaration. The board of managers could then foreclose on its lien for common charges and take over the non-paying units.
Whether an NFP finds it worthwhile to go through the leasehold condominium process will depend on several factors, including the willingness of the landlord to participate, and the NFP’s expected tax savings. Each scenario is obviously different, but with New York City’s high property taxes, the leasehold condominium option is a compelling option for many NFPs to consider.