New York City Independent Budget Office

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The Coop/Condo Abatement and
Residential Property Tax Reform
in New York City

In fiscal year 1997, the city began granting a partial property tax abatement to owners of coop and condominium apartments. The abatement, which currently costs the city $156 million in foregone tax collections, was intended to reduce the differences in tax burdens between owners of apartments and houses. Designed as a temporary three-year program intended to give way to a permanent solution to fully eliminate those differences, the abatement is scheduled to expire at the end of this fiscal year. As a result, the Mayor and the City Council will soon decide whether to ask the State Legislature to extend the program or find a new way to deliver the desired tax benefits. IBO has prepared this fiscal brief to provide policy makers and the public with information to help in evaluating the existing abatement and alternative proposals for residential property tax reform. Key findings include:

The tax treatment of different types of residential property varies widely and owners of coops and condos generally face higher burdens than do the owners of class 1 (one-, two-, and three-family) homes. Because a provision of state law forces the city to undervalue coops and condos, however, the disparity in tax treatment between class 1 and coops and condos is not nearly as great as initially appears.
Tax burdens on coops and condos in Manhattan are much lower than coop and condo burdens in other boroughs. In fact, tax burdens on many Manhattan coops and condos are below the burdens on class 1 homes—even before taking the tax abatement into account.
Another motivation for the current abatement was to assist coops, primarily outside of Manhattan, that were having financial difficulties in the wake of the collapse of housing prices during the last recession. However, more than three-quarters of all tax abatement dollars flow to Manhattan.
Because so much of the difference in tax burdens between coops and condos and class 1 homeowners is attributable to differences in assessment procedures, an abatement is a particularly ineffective tool for bridging the gap. The current abatement has seriously worsened the already significant inequities in tax burdens facing coops and condos in different areas of the city.
IBO estimates that $29 million—or 19 percent of the $156 million expended on the abatement during the current fiscal year—is being spent unnecessarily given the goal of the program is to equalize the tax treatment between coops and condos on the one hand and class 1 houses on the other.
Of that $29 million, $19 million flows to Manhattan coop and condo owners whose burdens are so low that they were being effectively taxed below the class 1 level before the abatement. An additional $10 million is being wasted where the abatement results in burdens being reduced below class 1 levels.
If reducing property taxes for coop and condo owners continues to be viewed as a desirable goal of city policy, then in the near term, these inefficiencies could be mitigated by reducing tax abatements for coops and condos in some Manhattan neighborhoods. An efficient and equitable long-term solution would require changing how coop and condo buildings are valued and assessed.

Introduction

The current coop/condo abatement was intended as an interim step towards fixing one of the problems with the city’s treatment of residential property for tax purposes: the difference in tax burdens between owners of houses and owners of apartments. With so much effort and tax expenditure directed towards reforming the tax treatment of coops and condos, policy makers have paid less attention to other problems in the residential class in recent years. These include strikingly slow growth in the property tax base due to assessment caps, statute-driven shifts of burdens from small to large apartment buildings, and very wide variations in property tax burdens between different types of residential properties, with rental buildings facing the highest.¹

Homeowners nationwide have received preferential tax treatment at all levels of government, the most substantial preference being the exclusion from income taxation of the imputed rental income from homeownership. Local practices vary widely in offering preferences to homeowners through the property tax, although in many areas private homes—and sometimes all residential property—do have lower effective tax rates than commercial properties. The relative burdens faced by rental properties vary depending on whether they are included with homeowners in an overall residential class and the extent of any homeowner or residential preferences.

New York City has always given preferential property tax treatment to one-, two-, and three-family houses, with the benefit made more explicit in recent decades. As shown below, even before the abatement program was put in place there was a less generous, but still substantial tax benefit given to owners of coop and condo apartments. However, as the city looks to extend the definition of those enjoying the full property tax benefits of homeownership, action may also be needed to reduce the very high burden on rental properties, in which over 65 percent of the city’s population resides.

Organization of the Report. To provide a context for a discussion of the tax treatment of coops and condos, this fiscal brief begins with a review of how different types of residential property are taxed under the city’s property tax system. This is followed by analysis of the extent to which tax burdens differ between coops and condos on the one hand, and one-, two-, and three-family homes on the other. Next we examine the development of the abatement and evaluate its effectiveness using equity and efficiency as criteria. The following section presents options for short- and long-term reforms that would be more effective than the current abatement at bringing tax burdens for coop and condo owners in line with those of conventional homeowners. Finally, a concluding section briefly touches broader issues in residential property tax reform.

Tax Classes and Assessments

How the city assesses and taxes real property is largely determined by provisions in the state’s real property tax law. The city’s property tax last underwent fundamental reform in 1981 when the current structure of four classes—each with its own assessment procedures, ratios, and tax rates—was created, although there has been almost constant tinkering over the years. The 1981 law (S-7000a) was enacted in response to a court decision affirming the requirement under long-standing state law that property be assessed at a uniform percentage of market value with a single tax rate. The city had long ignored the requirement of uniform assessments, taxing houses more lightly than commercial properties. With a classified system, uniformity of assessment is only required within each class, avoiding the massive shift in burdens from commercial and apartment properties to homes that would have occurred had a single uniform ratio been imposed for all properties. The 1981 legislation also introduced caps on assessment increases for houses in class 1, a process for phasing in assessment changes in the other classes, and a complex system to minimize changes in the share of the final tax levy borne by each class.

Under the 1981 law, which took effect for the 1983 fiscal year, residential property was divided among two of the newly created classes: class 1, consisting of one-, two- and three-family homes including small coop and condo buildings; and class 2, made up of rental apartment buildings and most coops and condos. In class 1, market values are determined using sales prices.² Assessment increases are capped at 6 percent per year and not more than 20 percent over five years. Although there is a target ratio of assessments to market values for the class—currently 8 percent—many properties were well below that level when classification was introduced, and with the assessment caps in place, many properties are still below it even after 15 years. While there is considerable variation across the city, the citywide average assessment ratio for one-, two-, and three-family houses is 7.42 percent.

Assessment practices are very different for class 2 properties. The target assessment ratio for class 2 property is 45 percent of market value. Although there are no caps on assessment increases for buildings with more than ten apartments, assessment increases (excluding those due to physical improvements) are phased in over five years.³ Market values in class 2 are set by capitalizing a building’s stream of income, net of expenses. To underscore that coops and condos were to be assessed by the same income-based methods used for the rest of class 2, rather than the sales-based method more suitable for such owner-occupied property, the 1981 legislation added a new section to the state’s real property tax law.

Section 581 stipulates that coops and condos are to be valued by imputing an income to the building from comparable rental buildings. In many parts of the city, however, the comparable buildings¾ based on age, size, and geographic proximity¾ are rent regulated. This is particularly true in the prime coop neighborhoods in Manhattan and Brooklyn where the coops tend to be older (pre-war) buildings with large apartments. Unlike rents in many parts of the city, regulated rents in these prime coop neighborhoods are usually well below market rate rents, so that the incomes imputed to the affected coops are significantly lower than they would be otherwise. Even in condos, which tend to be newer buildings, the appropriate comparable property is often rent regulated. As shown below, section 581 created significant tax benefits for coop and condo owners, even before the current abatement was put in place.

Comparing Tax Burdens Using Effective Tax Rates

To compare tax burdens for different types of residential property, IBO uses the effective tax rate (ETR) which measures the final tax levy as a percentage of the property’s market value. Because section 581 requires the city to use imputed rental income to determine market values, however, the official estimates of market value contained in the city’s assessment data files are virtually meaningless and cannot be used to compute true effective tax rates. To overcome this limitation, IBO estimated true, sales-based market values for coops and condos using a simple sales price methodology. Although the city’s assessors would use more complex comparative models and more comprehensive data, our approach is consistent with assessment procedures the city would use were coop and condo apartments shifted to class 1.⁴

Figure 1 illustrates how section 581 artificially depresses official market values for coops and condos. The ETRs shown in Figure 1 are computed without the current abatement. The per unit market values and ETRs in the first two columns are derived from market values determined by the Department of Finance under the constraints of the law.

In contrast, the third and fourth columns contain IBO’s estimates of true, sales-based market values. The difference is widest in Manhattan, where the average official market value is discounted by 75 percent from the sales-based market value. Discounts are highest in neighborhoods where the multi-family housing stock consists largely of coops, condos, and rent-regulated buildings, including the areas east and west of Central Park and in Greenwich Village. For example, on the Upper West Side between 59^th and 79^th streets, the average market value according to the city’s assessment files is $86,296, but IBO’s estimate of the average unit’s market value is 4.8 times higher at $414,260. The average effective tax rate of 0.92 percent translates into a tax bill of approximately $3,810 for the typical apartment in the neighborhood ($414,260 times 0.0092).

The discounts are smaller but still substantial outside of Manhattan, ranging from 64 percent in Brooklyn to 41 percent in the Bronx. As a result of this discounting of market values, true sales-based effective tax rates are also significantly lower than the official rates.

With true effective tax rates computed for coops and condos, we can now compare the tax burdens on different types of property in the city. For tax classes 1 and 4, and for the rental buildings in tax class 2, we have used the city’s official market values in computing the ETRs. Effective tax rates for 1999 for major types of property are shown in Figure 2. For coops and condos, ETRs with and without the section 581 constraint are shown. The differences between property types are striking, particularly in relation to class 1. The highest burden is on large rental buildings where the ETR is 5.1 times larger than that on class 1.

Coops and condos also have ETRs that are significantly higher than the average for class 1 houses: 1.6 times higher for coops and 1.95 times higher for condos. It is these differences in tax burdens among homeowners that have spurred the interest in property tax reform for coops and condos. For the balance of this fiscal brief we have assumed that the ultimate goal of long-term reform is to eliminate this difference in tax burdens—which we refer to as the "class 1 gap"—for owner-occupants of coops and condos. To measure this gap we use a target class 1 effective rate of 0.8679.⁵ The gap for each coop or condo property is measured by subtracting the target class 1 ETR from the ETR on the building. Based on 1999 values, entirely eliminating the class 1 gap in 1999 for owner-occupied apartments would cost $270 million in lost revenues.⁶

The Coop/Condo Abatement

Background. Reducing or eliminating the class 1 gap for coops and condos—particularly those in the boroughs other than Manhattan—has dominated discussions of property tax reform since the Property Tax Reform Commission chaired by Stanley Grayson issued its report in December 1993.⁷ While the need for tax relief for coop and condo owners was one of several problems cited by the Grayson Commission, it is the only one that has been addressed. In the spring of 1994, the Mayor and the City Council agreed to work together to develop a plan to gradually eliminate the gap over a number of years, beginning in fiscal year 1996.⁸ The phasing in of the gap reduction was intended to ease the fiscal impact to the city, then projected to be over $500 million. It was assumed that ultimately coops and condos—at least owner-occupied units—would be shifted from class 2 to class 1 and then valued using sales prices.

Although the cost of eliminating the gap was a significant obstacle, there were also substantial administrative problems to be resolved as well. Most coop and condo buildings have units that were never sold and are instead rented by the building sponsor (the company that originally converted or developed the building)⁹. Earlier this decade, the share of unsold units was over 50 percent in much of the city, particularly in coops outside of Manhattan that had been converted in the late 1980s.¹⁰ Many such buildings came on the market just as housing prices collapsed during the last recession. Although the share of unsold units has fallen in recent years as the economy improved, IBO estimates that the median share of unsold units remains high¾ 23 percent in Manhattan 43 percent elsewhere. If long-term reform is to extend only to owner-occupied (or perhaps non-sponsor owned) apartments and not the unsold units being rented by the sponsor, reform will have to implemented in such a way as to avoid giving an undesired windfall to sponsors.¹¹ The alternative of extending class 1 treatment to entire coop and condo buildings, regardless of how many units are sold, would raise the cost of eliminating the class 1 gap by more than 50 percent.

After nearly two years of consideration, the administration and the council agreed on legislation that was enacted in 1996 for the 1997 fiscal year. Although the objective of eventually moving coops and condos to tax class 1—or at least assessing and taxing such properties as if they were in class 1—remained in the legislation, the previous system was left intact for at least three more years. The law called upon the Mayor to submit a report to the New York State Legislature by the end of 1996 detailing how they would accomplish long-term reform for coop and condo owners. In December 1996, the city submitted a letter explaining that given the limited data available, it would not be possible to prepare such a report.

As an interim step to provide some tax relief for owners of coop and condo apartments before long-term reform could be implemented, the 1996 legislation established a partial property tax abatement for fiscal years 1997, 1998, and 1999. The value of the abatement is equal to a percentage of an apartment’s property tax bill, with a lower percentage for buildings with average per unit assessments above $15,000. For 1997, the abatements were 1.25 percent (buildings with average per unit assessments above $15,000) and 2.0 percent (buildings with average per unit assessments less than or equal to $15,000); for 1998 they were 10.75 percent and 16.0 percent; and for 1999 they are 17.5 percent and 25.0 percent. Without new action by the city and state, the abatement will expire in fiscal 1999. IBO projects that the abatement will cost the city $156 million in 1999, thereby eliminating 58 percent of the class 1 gap for owners of coops and condos.

Problems of Using an Abatement. By using an abatement, the city was able to speed tax relief to apartment owners, but at the cost of being able to target the relief to those with the biggest class 1 gaps. The coop/condo abatement, like most abatements, is applied against a property’s tax bill and has no effect on the assessment procedures and tax rates used to generate the tax bill. In this case, the pre-abatement tax bills are based on the section 581-constrained assessments. As we have seen above, the impact of section 581 is unevenly distributed across the city, leaving ETRs much lower in Manhattan than in the other boroughs. Using an abatement to deliver relief means that apartments with small—or even no—class 1 gaps get the same percentage reduction in their tax bills as do apartments with higher ETRs and hence larger class 1 gaps.

A second problem with an abatement as a tool for equalizing ETRs is their lack of flexibility. When the abatement percentages were set in 1996, it was expected that the class 1 gaps would be reduced by approximately 25 percent by 1999. In the intervening years, however, coop and condo values have appreciated faster than projected—although the growth has been uneven and concentrated in Manhattan—so that ETRs are lower and the resulting class 1 gaps to be addressed are smaller. With the abatement percentages fixed in the law, however, the ETR reductions cannot be recalibrated to take these smaller class 1 gaps into account. As noted above, the current abatement will eliminate 58 percent of the estimated class 1 gap in 1999, as compared with the 25 percent reduction originally forecast. Conversely, if coop and condo prices were to collapse as they did in the early 1990s, the fixed abatement percentages might be too low to achieve the desired reduction in the class 1 gap. While this inflexibility may be acceptable when the abatement is an interim measure, it would be much less so if the abatement were to become the tool for permanently reducing the class 1 gap.

Distribution of Benefits

IBO estimates that 278,600 apartment owners citywide will benefit from the abatement in fiscal year 1999 at a cost to the city of $156 million.¹² The average savings for each apartment is $560. Thanks to a higher share of eligible units, coops—with 83 percent of the eligible apartments—account for 87 percent of the apartments receiving the abatement. However, because coops have lower tax burdens, and therefore smaller tax bills to be abated, their share of the benefits is slightly lower at 84 percent.

Manhattan, with 50 percent of the eligible apartments, accounts for over half of the recipients and over three-quarters of all the abatement dollars. Manhattan apartment owners who qualify for the abatement will receive an average of $762. This concentration of benefits reflects the concentration of apartments with higher assessments and taxes—even with the constraints imposed by section 581—in the borough and the fact that the borough’s share of qualified units is above the citywide average. Measured either by recipients or dollar benefits, Queens ranks second, followed by Brooklyn and the Bronx. In these three boroughs, the share of qualified units is also well below the level in Manhattan. Staten Island, with very few eligible buildings, ranks last in both the number of recipients and amount of benefits. The average tax savings for each of the boroughs outside of Manhattan is less than one-half the Manhattan level.

Figure 3 also reports these measures for selected neighborhoods in which the number of eligible buildings is large enough to make the analysis statistically reliable. Manhattan shows the widest differences in average benefits across neighborhoods. The two east side neighborhoods bordering Central Park account for 13 percent of eligible apartments in the city but receive 30 percent of all 1999 abatement dollars. The average benefit in each neighborhood is over $1,000. Once again, the high concentration of benefits reflects the higher assessments and taxes in these neighborhoods and their higher than average share of qualifying units. If we include the neighborhoods to the west of the park, 26 percent of all abatement recipients live between 59^th Street and 96^th Street in Manhattan; this group will receive 38 percent of the total abatement. The two midtown neighborhoods have high shares of benefits compared to the number of qualified units, reflecting the higher assessments and tax bills in these areas. Although Tribeca has a relatively small share of the benefit dollars, the average benefit is the largest in the city at $1,203. Of the neighborhoods shown, eligible apartments in the East Village have the lowest average benefit in Manhattan, $339 per unit.

In Brooklyn and Queens there is less variation in average benefits within each borough than there is in Manhattan. Unlike most of the Manhattan neighborhoods, those in both Brooklyn and Queens generally have smaller shares of citywide benefits than they do of recipients. Again, this is because assessments and tax bills are usually lower outside of Manhattan and the value of the abatement is determined as a percentage of the bill for qualified apartments.

Evaluating the Abatement

Closing the Gap. The public policy goal of coop/condo reform is to diminish or eliminate the disparity in tax treatment between coops and condos on the one hand and class 1 properties on the other. By measuring the class 1 gaps before and after the abatement, we can evaluate how successful the current program has been in achieving this goal.¹³

IBO estimates that overall the abatement reduces the class 1 gap for qualified owners by 57.8 percent in 1999. Qualified units in higher value buildings (average assessed value per apartment over $15,000) have their gaps cut by 59.9 percent, while those in lower value buildings have reductions of 48.9 percent. These reductions are more than twice as large as were originally projected when the abatement was enacted.

This doubling in the extent of the reduction is largely due to sharp increases in sales prices in the intervening years that have produced lower effective tax rates and hence smaller than expected class 1 gaps. However, as noted above, a fall in coop and condo prices would widen the gap, leaving apartment owners worse off relative to class 1 owners. Likewise, even doubling the value of the abatement—which would close the gap today—would not guarantee that it remained closed.

Equalizing Coop/Condo Tax Burdens by Borough and Neighborhood. Unfortunately, the coop/condo abatement as currently implemented has seriously worsened the already significant inequities in tax burdens facing coops and condos in different areas of the city. Inequities have widened because the chosen policy tool—an abatement whose value is determined by taxes computed under section 581 constraints—cannot reflect the extensive differences in pre-abatement effective tax rates across the city. Given these variations in effective tax rates, and hence the size of the class 1 gaps, a uniform percentage reduction in tax bills produces uneven reductions in the class 1 gaps. Moreover, the areas of the city receiving the smallest reductions in the class 1 gaps are those which had the largest gaps and the greatest need for relief.

Looking first at the borough statistics in Figure 4, we see that Manhattan, which had a small class 1 gap to begin with, has had the gap virtually eliminated by the abatement. The median effective tax rate for the borough is now just slightly above the class 1 target, which means that nearly half of all Manhattan coop and condo owners now pay lower property taxes than they would pay if their property were a single family home.

In contrast, the abatement reduced but did not eliminate the class 1 gap in the other boroughs. In the Bronx, where the median pre-abatement ETR of 2.6 is 75 percent larger than the citywide median of 1.49, the abatement yields the smallest percentage reduction in tax bills and in the class 1 gaps. For a coop apartment in the Bronx with a market value of $50,000, the abatement reduces the tax bill from $1,300 to $995. However, if the same unit were actually assessed and taxed as a class 1 home, the tax would be $434. This $561 difference—the remaining class 1 gap—is 3.5 times larger in percentage terms than it is for the city as a whole. In Queens, the abatement produces a 23.1 percent reduction in median tax bills and a 39.1 percent reduction in the class 1 gap. Taxes on a $100,000 apartment were cut by $490 to $1,630. The class 1 gap has been reduced from $1,250 to $760. However, if we compare the gap for Queens to the gap for the city as a whole, it has actually grown from 1.9 times as large to 2.4 times as large. Brooklyn, with its abundance of four to ten unit coops (tax class 2C) which benefit from assessment caps, had a relatively low overall ETR before the abatement of 1.6; after the abatement, Brooklyn’s ETR fell to 1.23, reducing the class 1 gap by 49.6 percent. Although the change was smaller than in the Bronx and Queens, the ratio of the gap in Brooklyn to the gap for the city as a whole is also larger than it was before the abatement.

The neighborhood statistics in Figure 4 follow these same patterns. In Manhattan neighborhoods with low ETRs before the abatement, the class 1 gap has been entirely eliminated. Other Manhattan neighborhoods show large percentage reductions in their gaps. In Queens and Brooklyn, with the exception of Park Slope (which has many small coop buildings with relatively low ETRs), the reductions in the gap are smaller than in Manhattan.

Taxing Efficiently. Policy initiatives should be designed so that tax expenditures are targeted at those who need them as defined by the goals of the program. In the case of the coop/condo abatement, the goal is to begin reducing the class 1 gap for apartment owners. IBO estimates that $29.2 million—or 19 percent of the $155.9 million spent on the abatement—is being wasted if the goal of the program is to give coop and condo owners no more than class 1 treatment. Of the $29.2 million, $19.3 million is flowing to apartments with ETRs already below the class 1 target before the abatement. For these apartments, the abatement is working to further reduce tax rates, bringing them even more below the class 1 target. An additional $9.9 million is being spent on reductions below the class 1 target for apartments whose abatements are larger than their class 1 gaps. As shown in the rightmost column of Figure 4, virtually all of this unnecessary spending is occurring in Manhattan, particularly in the prime neighborhoods east and west of Central Park.

Such inefficiency is all but inevitable given the choice of an abatement based on the section-581 constrained assessments and tax bills as the tool for reducing tax burdens. Although this level of waste may be acceptable as part of an interim solution, it would presumably be unacceptable in any long-term solution.

One potential consequence of spending $29 million to bring some Manhattan apartments below the class 1 target rate is that tax reductions in other parts of the city are less than they would be otherwise. If the city were spending all of the $156 million on apartments with positive class 1 gaps, then gap reductions for everyone else could be larger. Such a change would also shift more of the benefits from Manhattan to the other boroughs where the class 1 gaps are widest.

Legislative Options

As shown above, the abatement as currently structured is seriously flawed. Benefits cannot be effectively targeted at buildings with the widest class 1 gaps and there is no way to avoid giving benefits to buildings once the class 1 gap has been closed. Although these flaws can be diminished, it is not possible to eliminate them entirely because an abatement simply reduces the final tax bill and does nothing to reduce the large differences in the underlying effective tax rates.

Because any long-term solutions to the class 1 tax gap for coops and condos are likely to require significant lead-time to implement, however, a temporary tax abatement could be used to provide interim relief. One possible abatement plan that reduces—but does not eliminate—the most glaring problems with the current abatement program is discussed below.

In the long run, however, eliminating the gap in a way that is both efficient and helps to equalize tax burdens for coop and condo apartments requires changing how these buildings are valued and assessed. One potential long-term solution that efficiently targets the benefits on owner-occupied apartments while enhancing horizontal equity within the coop/condo class is discussed below.

Improving the Temporary Abatement. As shown in Figure 4, most of the unneeded coop and condo abatement dollars flow to Manhattan neighborhoods east and west of Central Park. Buildings in these areas have very low effective tax rates; the median ETR before the abatement is 1.1 and many buildings are taxed at less than the class 1 target rate. By comparison, the citywide median effective rate for units qualifying for the abatement is 1.5. Lower effective tax rates translate into smaller class 1 gaps. Because their class 1 gaps are smaller, apartment-owners on the Upper East Side and Upper West Side of Manhattan have relatively less need for tax relief than do their counterparts elsewhere in the city.

IBO has modeled a change in the current program that defines a reduced abatement zone running from 59^th Street to 116^th Street from Central Park West to the Hudson River and from 59^th Street to 110^th Street from Fifth Avenue to the East River.¹⁴ For buildings in the reduced abatement zone, the abatement percentage would be cut from 17.5 percent to 12.5 percent for buildings with average assessed values between $25,000 and $50,000 per unit, while buildings with average assessed values over $50,000 per unit would receive no abatement. While eliminating the abatement for buildings with average assessed values over $50,000 may appear harsh, it is important to bear in mind that assessed values computed under the constraints of section 581 bear little relation to market values. On the Upper West Side, where market values are approximately four times higher than official city market values, an apartment with an assessed value of $50,000 would sell for nearly $450,000.

IBO estimates that these geographic restrictions would reduce the annual cost of the abatement by over a third to $92 million. The geographically restricted abatement would be significantly more efficient than the current abatement program; the amount of unneeded benefits would be cut by nearly 75 percent—from $29.2 million to $7.2 million. Even with the less-generous abatement, the median effective tax rate in the zone would be reduced to 1.04, which means that the class 1 gap would be closed by 28 percent—that is nearly equal to the originally intended reduction of 25 percent.

Long-Term Solutions. Although the current abatement program can be made more efficient, no abatement program can address inequities that are attributable to differences in assessment procedures. If reducing property taxes for coop and condo owners is seen as a desirable goal of city policy, an effective long-term solution will require changing how coop and condo buildings are valued and assessed. One possible long-term solution would be to shift coops and condos to a new tax class and then tax them in a way that gives apartment owners the benefits of effective class 1 treatment while avoiding major tax reductions for sponsor-owned units.¹⁵ Coop and condo buildings would be valued with sales-based methods, but the assessment ratio would be set at 14 percent rather than the class 1 target ratio of 8 percent. This higher ratio, in combination with the class 1 tax rate, yields an effective tax rate that is close to revenue-neutral, at least citywide (some rental units in coops and condos would face tax increases while others would receive reductions).¹⁶ Adding a homestead exemption equal to 6 percent of true market value lowers the effective rate for owner-occupants to the class 1 target.¹⁷ Depending on how buildings presently below the class 1 effective rate are treated, the cost of this option would range from $249 million to $270 million. Because the exemption is only available for apartment owners, the average tax burden on sponsor-owned rental units is essentially unchanged.¹⁸

The program’s benefits are targeted only to owner-occupants, and although it requires a two-step process to get apartment owners to the class 1 effective rate, the flaws inherent in an abatement would be avoided. The program is more equitable than an abatement, because using sales prices to determine the initial values along with the homestead exemptions equalizes effective tax rates. The program is also more efficient than an abatement, because there would be no additional benefits for buildings currently below the class 1 target.

Under such a program, the distribution of benefits among coop and condo owners would be remarkably different from the distribution resulting from the current abatement. Manhattan, which currently receives 76 percent of the abatement dollars would receive only 63 percent of the tax savings under this option. As shown in Figure 5, the other boroughs receive larger shares of the benefits. The reductions in effective tax rates are also much larger in the boroughs outside Manhattan than they are in Manhattan. This is not surprising, given that this option works to eliminate the class 1 gaps and the gaps are smaller or even negative in Manhattan.

One potential problem with this option stems from the property tax law’s complex process for allocating shares of the tax levy among the four tax classes. Fixing the shares of the levy is the final step in setting the tax rates each year.¹⁹In recent years, the City Council has used its role in manipulating the tax rates to protect not only class 1, but also to moderate class 2 rate increases. If coops and condos are shifted out of class 2, however, the constituency for keeping class 2 rates low would be weakened and already-high class 2 tax burdens could well grow through discretionary shifting in the levy shares.

A Final Thought

Property tax reform has been framed in terms of the inequitable tax treatment of owner-occupied properties in class 1 and class 2. But over two-thirds of all the taxable housing units in New York City are rentals, and the nearly one million households in large conventional (unconverted) class 2 buildings is more than the total of class 1 and 2 homeowners combined. Is residential tax equity achieved when class 2 rentals are left out of the reform?

As we saw above, the effective tax rate for large class 2 rental properties is over three times the rate on class 2 coops, two and one-half times the rate for condos and five times the rate for class 1 housing (see Figure 2). At the same time, the average household income of tenants in buildings taxed as large class 2 rentals (approximately $33,000) is barely more than half of the average income of class 1 homeowners ($60,000) and less than a fifth of the average for coop-condo apartment owners ($177,000).²⁰

The higher effective rates on large rental properties have been implicitly justified by the assumption that the taxes on rentals are borne by the property owners, who—unlike homeowners—are recipients of rental incomes assuring an ability to pay. However, the relatively heavy tax burden on large rental buildings has consequences not only for the landlords who own the buildings, but also for the rents paid by tenants who reside in them.

It should be noted that IBO estimated mean per unit market values using neighborhood and borough averages of per unit sales prices from publicly available data on coop and condo transactions from 1995 to 1997. Access to property sales data recorded by the Department of Finance would have permitted more robust estimates of apartment market values.

FOOTNOTES

The impact of capping assessment increases on the growth in property tax revenues is discussed in IBO's Fiscal Outlook (February 1997), pp 31-34.
Rather than relying on simple comparable sales to determine market values, the city uses sophisticated computer models that take into account both quantitative and qualitative features of each property. Jack Eichenbaum, "Location as a Factor in Determining Property Values," Property Tax Journal, Vol. 8, No. 2, June 1989.
In 1985, rental buildings with four to six units were given the benefit of caps that paralleled those in class 1: assessment increases are capped at 8 percent per year and no more than 30 percent over five years. In 1988, the benefit was extended to rental buildings with seven to ten units. Finally, in 1994, coops and condos with four to ten units were added to the subclass benefiting from assessment caps.
Some advocates for coop and condo owners have argued that sales-based valuation is not appropriate for their properties since the goods (apartments) being purchased are encumbered with common benefits and obligations that distort the price. These advocates would have the city continue with an income-based assessment method. This argument is not persuasive for a number of reasons. First, in the case of condos, what one buys when purchasing a unit is full ownership rights in a particular apartment along with the right to use some commonly held property. Such a transaction is only slightly different from the purchase of a single family home and can be readily used in comparative sales modeling.

Second, while purchasing a coop entails buying both more (a share of the underlying mortgage and a share of the burden of capital improvements for the building) and less (stock in the corporation and tenancy in the apartment rather than ownership of real property), these negative aspects of coop ownership are reflected in sales prices. Indeed, a coop equal in size and quality to a condo will almost always sell at a discount.

Third, to the extent that the limitations and restrictions imposed on owners of apartments reduce their desirability compared to conventional homes, this too will be captured in sales prices. Assuming that the city has appropriate data on the characteristics of apartments being sold (some of this data was collected when processing the current abatement applications), and that a sufficient number of arms-length sales occur (a condition easily met in most parts of the city each year), it should be quite feasible for the Finance Department to develop sales-based models to derive fair market values for such buildings.

This assumes assessment at the city's target of 8.0 percent of full market value multiplied by the 1997/98 class 1 tax rate of 0.10849. (The 1998/99 tax rates were set in late November-too late to be used for this study-due to disagreements between the City Council and the Mayor over how the shares of the levy should be distributed.) Due to caps on assessment increases, many class 1 properties are currently assessed at less than 8 percent of market value, which results in the average effective tax rate of 0.741 for one-, two-, and three-family houses. However, since new homes coming on the tax rolls are initially assessed using an 8 percent assessment ratio, were coops and condos shifted to class 1 treatment, they too would begin with an 8 percent assessment ratio.
If, as part of the shift to class 1 treatment, taxes for those apartments already below the target class 1 ETR were raised to the target level, the resulting $21 million in new revenues would reduce the cost of eliminating the gap to $249 million.
Final Report of the Property Tax Reform Commission, December 31, 1993.
New York City Executive Budget Fiscal Year 1995, Message of the Mayor, May 1994, p. 13.
There are many additional apartments that were purchased from sponsors but are now rented out by their new owners. Providing the owner of a rented apartment owns no more than three apartments in a building and has no connection to the sponsor who originally sold or developed the building, these units are eligible for the abatement even though they are not owner-occupied. When we refer to owner-occupied units in this brief these units are included.
When buildings are converted from rental status to coop or condo status with a non-eviction plan, the sponsor only needs commitments to purchase from 15 percent of the current tenants. In the case of rent-regulated buildings that are converted, unsold units shift to unregulated status once the tenant at the time of conversion moves out. This provision creates an incentive for landlords to begin the process of conversion, even if they don't really intend or expect to be able to sell all of the units.
An additional complication in implementing long-term reform is that, while for condos each unit is a taxable entity and receives its own tax bill, for coops the taxable entity is the entire building, rather than the individual apartments. Therefore, to distribute any benefit intended only for apartment owners (other than the sponsor) in a coop, a mechanism must be established to ensure that the sponsor passes on the benefits to the intended recipients through lower maintenance fees.
Because the number of apartments qualifying for the abatement is much higher than the city projected when the program was enacted in 1996, the cost has ballooned as well. The original estimate for the 1999 cost was $120 million.
Class 1 gaps or the change in gaps for a group of buildings (such as all coops in a borough or neighborhood, or coops with per unit average assessed value over $15,000) are measured using the median effective tax rate for the group.
Although property tax law generally assumes that similar properties throughout the city are treated equally, there are other city tax benefit programs that are defined geographically. For example, the abatements offered as part of the downtown commercial revitalization program, the ICIP exemption, and the J-51 exemption include geographic boundaries in defining eligibility.
Because this solution would alter the distribution of market value and tax levy among the tax classes, it would require a careful re-calibration of the existing class share system. Approximately $60 billion in previously unrecognized market value would be brought into the system while the class 2 share of market value and the levy would be reduced by the shift of coops and condos to the new class.
IBO's analysis indicates that the revenue-neutral assessment ratio is closer to 13.5 percent. However, given the possibility that effective rates might once again climb if apartment prices slacken, it seems prudent to round this figure up.
As a result of the current abatement, recently changed eligibility for veteran's and senior citizen exemptions in coops, and the new STAR exemption, the city has gained significant experience with processing tax benefits directed at owner-occupied units of coops. Given this experience, the city is capable of administering a homestead exemption directed at individual coop apartments. (Because condo units are treated as discrete pieces of real estate, it has always been fairly easy for the city to direct tax benefits to specific condo units.)
If all coop and condo units were shifted to class 1, $167 million in tax cuts would flow to sponsor-owned units. The other alternative-shifting owner-occupied units to class 1 while remaining sponsor-owned units remain in class 2-would impose significant administrative burdens on the Department of Finance, whose assessors would be forced to value the same property using two different assessment methods.
While change in the relative class shares is capped at no more than 5 percent per year, the City Council is free to allocate any increase that exceeds the cap among the other classes. In recent years, with market value growth in class 1 exceeding that in the other classes, the Council and the Mayor have worked together in Albany to secure passage of a series of one-year stopgap laws lowering the cap on class share changes. By lowering the cap, the potential increase in the class 1 tax rate has been moderated, although with some of the excess shifted to other classes, their tax rates are higher than they would have otherwise been.
These estimates are based on data originally compiled for the 1993 Grayson Commission, updated to reflect income growth in the intervening years.

This IBO Fiscal Brief was authored by George Sweeting with contributions from David Belkin and Lisa Melamed under the supervision of Ronnie Lowenstein, Deputy Director and Chief Economist.

Independent Budget Office
110 William Street, 14th Floor
New York, New York 10038
(212) 442-0632 · 442-0350 (fax)
Web Site Address: www.ibo.nyc.ny.us — E-mail Address: ibo@ibo.nyc.ny.us

Douglas A. Criscitello, Director