Co-Op Real Estate Taxes Not Deductible for AMT

TAX CASE

axpayers generally can deduct expenditures they incur directly, but not expenditures paid by others on their behalf. IRC section 216, however, allows tenant-stockholders to deduct a proportionate share of real estate taxes paid by a cooperative housing corporation (co-op). Ostrow v. Commissioner addressed the deductibility of these taxes when computing a tenant-shareholder’s alternative minimum tax (AMT) liability.

The Ostrows, who were subject to AMT, deducted real estate taxes paid by the co-op on their joint return; the IRS disallowed the deduction. The couple argued that since the section 216 deduction had not been specifically disallowed, it was permitted in computing the AMT. The Tax Court disagreed, saying a tenant-shareholder’s share of the co-op’s real estate taxes was not deductible for purposes of determining the AMT. The taxpayers appealed to the Second Circuit Court of Appeals.

Result . For the IRS. IRC section 164(a)(1) allows taxpayers to deduct real property taxes paid or accrued during the taxable year. In the case of a co-op, this section permits the corporation to deduct real estate taxes it pays relating to the houses or apartment building it owns. IRC section 216 expands section 164 to reach tenant-stockholders of co-ops. Specifically, section 216(a)(1) allows a tenant-stockholder to deduct his or her proportionate share of the real estate taxes the co-op can deduct under section 164.

Taxpayers are required to pay a minimum amount of taxes, referred to as the AMT, pursuant to IRC section 55. Some deductions allowed for regular tax purposes are disallowed in the computation of AMT; one such item is taxes. IRC section 56(b)(1)(A)(ii) disallows the deduction for any “taxes described in” section 164(a). However, section 56 does not specifically provide that a deduction allowed under section 216 is disallowed in computing a taxpayer’s AMT.

The issue before the court—one not previously heard by the Second Circuit or any other court of appeals—was whether the deduction for real property taxes permitted by section 216 had been disallowed for AMT purposes. The taxpayers argued that since the adjustments for AMT had not expressly included section 216, the deduction was permitted. They cited other IRC provisions that list sections 164 and 216 separately to prove that Congress had specifically included section 216 when it intended for another provision to apply to it.

The IRS argued that the section 216 deduction was disallowed for AMT purposes because it related to a tax described in section 164(a). It also said the language of section 56 did not disallow deductions for real property taxes provided by a particular section. Rather, the IRS argued, the phrase “taxes described in” caused all real property taxes to be disallowed, regardless of which section permitted the deduction for regular tax purposes. Section 164 allows a deduction for state and local real property taxes, and section 216 explicitly incorporates section 164. The only distinction is that the section 216 taxes are paid by the co-op rather than directly by the taxpayer. Thus, because the section 216 deduction in this case related to a tax described in section 164(a), it was disallowed for AMT purposes.

The Second Circuit agreed with the IRS and affirmed the Tax Court’s decision. In disallowing the deduction, the court reviewed the history of section 216. Prior to 1942, the courts had held that tenant-stockholders could not take deductions for taxes paid by a co-op. However, in an effort to treat them the same as homeowners, Congress added a provision to the tax code specifically allowing tenant-shareholders to deduct such taxes. The Senate Finance Committee report said the purpose of the new deduction was “to place the tenant stockholders of a cooperative apartment in the same position as the owner of a dwelling house so far as deductions for interest and taxes are concerned.” Accordingly, Congress intended for taxpayers to deduct real estate taxes whether they paid the taxes directly or indirectly through a co-op. However, taxpayers who pay real estate taxes indirectly should not receive benefits denied to those who pay taxes directly. Allowing tenant-shareholders to deduct real estate taxes for AMT purposes would do just that and is not consistent with the stated purpose of section 216. Consequently, no taxpayer can deduct real estate taxes for AMT purposes—whether the taxes are paid directly or indirectly.

Ostrow v. Commissioner, Docket no. 05-0261, CA-2.

Prepared by Laura Lee Mannino, CPA, LLM, assistant professor of accounting and taxation, St. John’s University, Jamaica, New York.