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Court holds co-op owners may deduct casualty losses

Real Estate Tax Talk

It seems like U.S. real estate has been taking a beating lately. A physical beating.

Property owners all over the country have suffered billions in casualty losses — damage to property caused by sudden events like floods, earthquakes or storms, including Hurricane Sandy, the Nemo storm and other calamities.

Not all casualty losses are fully insured or insured at all. Property owners who pay for casualty losses out of their own pockets may deduct these costs when filing tax returns.

Where common areas of condominium developments suffer uninsured casualty losses, the individual unit owners may deduct the amount of any special assessments imposed on them by their homeowners association to pay for repairs. This makes sense since each individual owner is a property owner with a deed giving him or her a fractional interest in the common areas.

But what about stock cooperatives? Unlike the case of condominiums, co-op owners receive no deed to a specific unit or interest in common areas. Instead, each owner obtains shares of stock in a cooperative corporation that owns the building. Along with the stock comes the exclusive right to occupy a unit under a proprietary lease and to use the common areas.

Arguably, owners of stock cooperatives are shareholders in a corporation, and the co-op is the property owner. Losses incurred by a corporation are not normally deductible by its stockholders. Anyway, this is what the IRS claimed when it refused to allow one co-op owner to take a casualty loss.

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The case involved the Castle Gardens Cooperative, a 589-unit co-op on Manhattan’s Upper West Side. The co-op had to pay $25 million for repairs after a 70-foot high retaining wall collapsed onto the Henry Hudson Parkway below. Each Castle Gardens owner was assessed about $26,000 to pay for the repairs.

Christina Alphonso attempted to deduct the assessment as a casualty loss on her tax return. The IRS denied the deduction. It argued that Alphonso could deduct casualty losses to her individual unit only, not to the shared retaining wall. The Tax Court agreed with the IRS, holding that the stock cooperative owned the retaining wall, not any of the individual shareholders.

However, the determined Alphonso appealed to the Second Circuit Court of Appeals and won. The Court of Appeals held that under New York law, a stock cooperative owners’ exclusive right to use the common areas, shared solely with the other co-op owners and their guests, qualified as a real property ownership interest. As such, each co-op owner could deduct his or her share of casualty losses to the common areas (Alphonso v. Commissioner of Internal Revenue, 11-2364-ag (2d Cir. Feb. 6, 2013)).

Stock cooperatives account for only about 6 percent of common-interest ownership housing and about 1 percent of all housing units. So this decision won’t have a far-ranging nationwide impact. But it will be important in places like New York City that still have large numbers of stock co-ops and that have suffered substantial casualty losses from recent natural disasters.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including "Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants," "Deduct It," "Working as an Independent Contractor," and "Working with Independent Contractors." He welcomes your questions for this weekly column.

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