85TH ESTATES COMPANY - DECISION - 12/22/99. In the Matter of 85TH ESTATES COMPANY TAT (E) (UB) - DECISION

Transcription

1 85TH ESTATES COMPANY - DECISION - 12/22/99 In the Matter of 85TH ESTATES COMPANY TAT (E) (UB) - DECISION NEW YORK CITY TAX APPEALS TRIBUNAL APPEALS DIVISION UNINCORPORATED BUSINESS TAX PETITIONER, THE OWNER OF RENTAL APARTMENT BUILDINGS WHO CONVERTED SIX BUILDINGS TO COOPERATIVE OR CONDOMINIUM OWNERSHIP, WAS NOT, UNDER THESE FACTS AND CIRCUMSTANCES, IN THE TRADE OR BUSINESS OF CONVERTING RENTAL APARTMENTS TO CO-OPS AND CONDOS AND WAS NOT HOLDING THE SIX BUILDINGS PRIMARILY FOR SALE IN THE ORDINARY COURSE OF THAT TRADE OR BUSINESS. PETITIONER WAS NOT A DEALER FOR PURPOSES OF THE UBT AND IS ENTITLED TO THE EXEMPTION PROVIDED BY FORMER S46-2.0(d) OF THE NEW YORK CITY ADMINISTRATIVE CODE. DECEMBER 22, 1999

2 New York City Tax Appeals Tribunal x : In the Matter of : : DECISION 85TH ESTATES COMPANY : : TAT (E) (UB) Petitioner. : : x : 85th Estates ("Petitioner") filed an Exception to the Determination of an Administrative Law Judge ("ALJ") dated February 11, 1998, which sustained an unincorporated business tax ("UBT") deficiency asserted by the New York City Department of Finance (the "Department") for the calendar year 1986 (the "Tax Year"). Petitioner appeared by Robert J. Semaya, Esq., Kenneth G. Schwarz, Esq. and Alan Kazlow, Esq., of Fischbein Badillo Wagner Harding. The Commissioner of Finance of the City of New York (the "Commissioner" or "Respondent") appeared by George P. Lynch, Esq., Assistant Corporation Counsel, New York City Law Department. Both parties filed briefs and oral argument was granted by the Tribunal. I. A: PETITIONER'S BACKGROUND. Petitioner is a New York general partnership which is the surviving partnership in a merger of partnerships (the "Merger") pursuant to an agreement of merger (the "Agreement of Merger")

3 1 which was effective as of January 1, Prior to the Merger, Petitioner was known as 185 E. 85th St. Company and owned the building known as 185 East 85th Street, New York, New York ("85th Street"). At the time of the Merger, Petitioner changed its name to 85th Estates Company. The other partnerships (the "Partnerships") that were combined with Petitioner in the Merger were: Monway Co., a New York general partnership which owned the building at 288 Lexington Avenue, New York, New York ("Lexington"); Third and Thirty-Fifth Co., a New York general partnership which owned the building at 166 East 35th Street, New York, New York ("35th Street"); 301 E. 63rd Street 2 Associates, a New York general partnership which leased the fee of, and owned the building at 301 East 63rd Street, New York, New York ("63rd Street"); P & J Apartments, a New York general partnership which owned the building at 430 West 34th Street, New York, New York ("34th Street"); and 411 East 53rd Co., a New York general partnership which owned the building at 411 East 53rd Street, New York, New York ("53rd Street"). Contemporaneously with the Merger, the holders of all of the stock of 300 East 71 Realty Corp., a New York corporation (the "Corporation"), contributed all of their shares in the corporation 1 The ALJ incorporated into her Findings of Fact the substance of the facts included in a Stipulation between the parties. The ALJ's factual findings have generally been adopted herein for purposes of our decision. We note that Petitioner took exception to four of the ALJ's Findings of Fact as well as thirty-six of the ALJ's Conclusions of Law and submitted twenty-one "new or additional findings of fact, conclusions of fact and conclusions of law in place of those of [the ALJ]." Except to the extent noted we have neither modified nor changed those findings of fact of the ALJ to which Petitioner took exception, and we have not adopted Petitioner's new or additional findings of fact since they are either immaterial to our decision or unsupported by the record. 2 In the case of all the other buildings, ownership of the building presumably included ownership of the fee. -2-

4 to Petitioner as a contribution to its capital. Thereafter, Petitioner promptly liquidated the Corporation and took title to the building at 300 East 71st Street, New York, New York ("71st Street") that had been owned by the Corporation. Petitioner, the Partnerships, and the stock of the Corporation were each owned 50% by members of the Goldfein family and 50% by members of the Perlbinder family, with the exception of 301 E. 63rd Street Associates, which was owned 48% by members of the Perlbinder family, 48% by members of the Goldfein family, and 4% by a corporation, 966 Realty Corp., all of whose shares were owned by members of the Goldfein family. (The Partnerships and the Corporation are referred to hereinafter as the "Six Owning Entities." Petitioner and the Six Owning Entities are referred to collectively as the "Seven Owning Entities.") Immediately following the Merger, Petitioner was owned by members of the Goldfein family (the "Goldfein Partners") and members of the Perlbinder family (the "Perlbinder Partners"). B: THE BUILDINGS. Each of Lexington, 35th Street, 63rd Street, 34th Street, 53rd Street, and 71st Street (collectively the "Six Buildings") and 85th Street was built during the 1950's or 1960's by separate entities under the joint control of the Goldfein and Perlbinder families. (The Six Buildings and 85th Street are referred to collectively as the "Seven Buildings.") Certain of the Seven Buildings were built by certain of the Seven Owning Entities, who then retained ownership of their respective buildings until the Merger. Each of the remaining buildings was built by a related entity and, after construction was complete, was acquired by the one of the Seven Owning Entities which owned that building immediately prior to the Merger. Each of the Seven Buildings was held for investment and for the production of rental income from the time of its acquisition by one of the Seven Owning Entities until the Merger. -3-

5 The years in which each of the Seven Buildings began to be used for rental purposes are as follows: Building Date Lexington th Street rd Street th Street st Street rd Street th Street 1966 Before the Merger, the Seven Owning Entities operated all Seven Buildings through managing agents. Each building's managing agent was authorized to conduct day-to-day routine activities, including: renting apartments; hiring and firing employees such as superintendents, porters and doormen; and approving repairs up to a stated cost amount. All major repairs, capital improvements, mortgage financing, real estate assessments, certiorari matters, and insurance were the sole province of Stanley Goldfein ("Mr. Goldfein") and Julius Perlbinder ("Mr. Perlbinder"). From the time of the formation of the Seven Owning Entities in the 1950's and 1960's to the time of the Merger in 1979, none of the Seven Owning Entities had purchased any properties or sold any properties. However, in 1971, 53rd Street was the subject of an offering plan for conversion to cooperative ownership which was subsequently withdrawn. -4-

6 C: THE 1979 MERGER. The Merger came about because of increasing disagreements and differences in view between members of the Goldfein and Perlbinder families. The Merger provided a mechanism for the two families to continue to be co-owners of all Seven Buildings, while having separate responsibilities for the management of particular buildings. Under the Agreement of Merger, Mr. Goldfein, designated the "Goldfein Managing Partner," had responsibility for managing Lexington, 35th Street, 63rd Street, 34th Street and 71st Street (the "Group A Buildings"), and Mr. Perlbinder, designated the "Perlbinder Managing Partner" had responsibility for managing 53rd Street and 85th Street (the "Group B Buildings"). While net cash receipts from the Group A Buildings were allocated only among the Goldfein Partners, and net cash receipts from the Group B Buildings were allocated only among the Perlbinder Partners, gain or loss on any sale or other disposition of any of the Seven Buildings was to be allocated among all partners, and any sale or other disposition of any building had to have the approval of both Managing Partners. At the time of the Merger, the two families had no plans for converting any of the Seven Buildings to cooperative or condominium ownership. They wanted to keep the buildings as rental properties. Following the Merger, all Seven Buildings were used by Petitioner for rental purposes. The rearrangement of the relationship between the two families, as accomplished by the Merger, was designed to avoid the unfavorable tax consequences that would have resulted if the Seven Buildings had been sold in order to sever the business relationship between the two families. For federal income tax purposes, the holding periods and tax bases of the Six Buildings in the hands of the Six Entities were carried over to Petitioner. Members of Petitioner were experienced builders and operators of buildings. As such, when the time came to establish the -5-

7 relative values of the properties involved in the Merger, the partners did not seek outside consultants but made their own determination of the Seven Buildings' values based on operating cash flow and not based on sales value. The total agreed value of the Six Buildings, as of January 1, 1979, was $21,075,000, representing approximately half the value ascribable to them if they were to be converted to cooperatives or condominiums. D: CHANGING CIRCUMSTANCES. The ground lease at 63rd Street (one of the Group A Buildings), which was entered into in 1957, provided that upon renewal of the lease term at the end of 25 years, the rent would be reset on the basis of the then value of the land (in 1982). In 1981, during negotiations for the renewal of that lease, Petitioner and the landowner disagreed as to the value of the land and an arbitration proceeding was begun. Even using the value proposed by Petitioner's expert, it was apparent that the new rent level would make the building uneconomical. Through negotiations, Mr. Goldfein learned that the fee owner would be more reasonable about the amount of the renewal rent if Petitioner agreed to convert the building to cooperative status and to give him a share of the proceeds. During the time that Mr. Goldfein was experiencing difficulty in negotiating the renewal of the ground lease at 63rd Street, Mr. Perlbinder learned that Jamaica Savings Bank would renew its mortgage on the building at 53rd Street (one of the Group B Buildings), which was maturing in July, 1981, only on terms that could not be carried by the building's cash flow. Mr. Perlbinder arranged to refinance the balloon mortgage debt through Manufacturers Hanover Trust Company ("Manufacturers") with the condition that, if the building was converted to cooperative or condominium status during the term of the loan, he personally would pay Manufacturers the sum of $250,000 as an additional fee for -6-

8 making the loan. Manufacturers agreed that interest on the loan would be payable only to the extent that there was sufficient cash flow and that the balance of the interest would accrue. In July, 1981, shortly after the loan was refinanced, Manufacturers told Mr. Perlbinder that the loan did not look right on its books and that the bank would like to dispose of the loan. Manufacturers told Mr. Perlbinder that, if the building were to be converted to a condominium, the bank would provide releases from the mortgage for individual apartments upon the payment of approximately $5,000 per room. Since the conversion of any of the Group A or Group B Buildings required the approval of both Managing Partners, the Goldfein Partners and the Perlbinder Partners entered into an amendment to the Agreement of Merger dated as of January 1, 1982 (the "1982 Amendment"). That amendment provided that, upon the sale, exchange or other disposition of 63rd Street, any gain or loss on that building would be apportioned among only the Goldfein Partners and, upon the sale, exchange or other disposition of 53rd Street, any gain or loss on that building would be apportioned among only the Perlbinder Partners. Through the 1982 Amendment, each family was able to deal with the problem affecting the building that it managed without being responsible to the other family and without being affected by the outcome with respect to the other building. By 1984, Mr. Goldfein's health was deteriorating slightly and he wanted to take more time off. The next generation in his family was not interested in becoming active in the management of the properties. Mr. Goldfein believed that real estate generally was out of favor as an investment. He was worried that, to avoid abusive tax shelters, the tax laws would change to have a negative impact on real property values. He was also concerned about the tightening of funds for mortgage loans. In addition, he was concerned about the economic effect of the rent stabilization law, -7-

9 since all Seven Buildings were subject to rent stabilization and the allowable rent increases were minimal. Mr. Goldfein knew that, once a rent stabilized building was converted to cooperative or condominium status, unsold apartments that became vacant were then free of rent stabilization and could be rented without restrictions. However, he was concerned about threatened changes to New York real property laws that would make conversions to cooperatives and condominiums more difficult. Mr. Goldfein decided that the best course of action was to convert the remaining Group A Buildings to cooperatives. Mr. Perlbinder, however, did not want to convert the building at 185 East 85th Street (the remaining Group B Building). The partners decided, therefore, to give each family greater autonomy over the remaining buildings so that each family could go its own way. This was done by entering into a second amendment to the Agreement of Merger, dated as of January 1, 1984 (the "1984 Amendment"). The 1984 Amendment gave each family the power to deal with its group of buildings for all purposes, including sale or conversion, without being responsible to the other family. This amendment also apportioned gain or loss on the disposition of any building among the partners from the appropriate family only. Two bills were introduced in the 208th Session of the New York State Legislature (beginning January 9, 1985 and ending September 18, 1985) that, if enacted, would have made conversions of the buildings more difficult by increasing the percentage of purchasers needed for a non-eviction plan. Another bill would have imposed a 3-year moratorium on eviction conversions in New York County and certain other counties. The Tax Reform Act of 1986 ("TRA 1986") was adopted in 1986 and became effective January 1, Certain provisions of TRA 1986 had material adverse effects on owners and sellers of real property as they: (a) limited the extent to which "passive losses" -8-

10 from real estate activities could be deducted against income from other sources; (b) capped the federal tax rate on long-term capital gains at 28%, plus a 5% interim supplemental tax; and (c) extended the "at-risk" rules (which limited taxpayers' ability to deduct losses from operations) to real estate activities. E: CONVERSION OF THE BUILDINGS. Before beginning the conversion of each of the Six Buildings, Petitioner hired a sales agent to handle that conversion. Charles H. Greenthal & Co. ("Greenthal") was Petitioner's exclusive sales agent for the conversions of 53rd Street and of Lexington. Petitioner's sales agent for the conversion of the other four Group A Buildings was Steiner Clateman & Associates, Inc. ("Steiner Clateman"), an entity historically related to Greenthal. The sales agents reported to Petitioner frequently throughout the conversion process. Some of the Perlbinder Partners (other than Julius) had ownership interests in Greenthal. Greenthal, however, had been the managing agent for 53rd Street for many years before any Perlbinder Partner had acquired any interest in it. Julius Perlbinder made the decisions of Petitioner with respect to the Group B Buildings, rather than those Perlbinder Partners who held an interest in Greenthal. For the conversion of each of the Six Buildings, the sales agents hired by Petitioner recommended legal counsel, which Petitioner hired. The sales agent and Petitioner's counsel then worked together to develop the terms of the conversion plan, which were contained in an offering memorandum that was submitted to the -9-

11 New York State Department of Law (the "Law Department") for filing. 3 A draft of the proposed conversion plan ("Red Herring") was first submitted to Petitioner for its review and approval. During this period of some weeks, Petitioner, through its partners, reviewed the draft and asked questions of its attorneys. Once Petitioner approved the draft, the Red Herring was submitted to the Law Department for review. The Law Department objected to many parts of the plan. After negotiations between Petitioner's attorney and the Law Department, a revised plan (the "Black Book") was submitted to the Law Department and was accepted for filing and distributed to the tenants. This process typically took six to seven months. The contents of the Black Book were also provided to Petitioner for review and approval. No plan could be submitted to the Law Department without Petitioner's approval. The contents of the offering plans included proposed budgets for the cooperatives or condominiums, the pricing for the apartments to non-tenant purchasers ("Outsiders"), the discounts for bona fide residential tenants in occupancy ("Insiders"), share allocations (in the case of the cooperative plans) and percentages of the common elements (in the case of condominium plans) for the apartment units, and the amount of the reserve funds and working capital funds that the sponsor would provide to the cooperative housing corporation or to the condominium board. The terms were proposed by the sales agents, who were experienced in converting buildings and knew what the market would bear. While Petitioner 3 The ALJ's Finding of Fact 19 stated, in relevant part, that "[t]he sales agent and Petitioner's counsel then worked together to develop the terms of the conversion plan, which were contained in an offering memorandum that the New York State Department of Law (the "Law Department") had to accept for filing." Petitioner took exception to that portion of the finding that "alleged that the New York State Department of Law `had to accept for filing' the conversion plans submitted by [P]etitioner." While the remainder of the ALJ's factual findings make it clear that the Law Department was not required to accept Petitioner's filing as is, we have modified the finding to avoid any confusion. -10-

12 looked to its sales agents for guidance, Petitioner ultimately had to approve all the terms of the conversion plans. Petitioner was the sponsor of six non-eviction conversion plans, one for each of the Six Buildings. Each plan required that 4 a minimum of fifteen percent of the apartments in a particular building be sold in order for the plan for that building to become effective. Under the law applicable to such conversions, Insiders had the exclusive right to purchase their apartments for a ninety day period after the plan was presented to the tenants, which exclusive period could be extended by the plan's sponsor by amending the plan. Tenants had the choice to buy or not to buy their apartments. An Insider could not be evicted for failing to buy and had the right to remain as a tenant indefinitely subject to the rent stabilization rules. As was customary in the industry, Insiders were offered a reduced cash sales price. In each of the Six Buildings, the tenants formed committees to represent them, retaining counsel and, in some cases, an engineer. The tenants committees' attorneys generally collected no-buy agreements from the tenants, so that no tenant would buy an apartment unless a specified number of tenants agreed to buy. This enabled the Insiders to negotiate with Petitioner as a block. 4 The ALJ noted that, technically, in a cooperative conversion, ownership of the apartment building is transferred to a corporation and blocks of shares in this corporation are sold. Blocks of shares are allocated to each apartment that is for sale in the building. Ownership of a specific block of shares entitles the owner to a proprietary lease to the apartment to which that block of shares is allocated. However, for convenience, in her Determination, the ALJ referred to the sale of shares of units in a cooperative conversion as sales of "apartments" and we will do the same. However, we note that the factual findings in this decision (as well as the ALJ's Findings of Fact) contain a description of the cooperative conversions (p. 16) and a description of the condominium conversion (p. 18). -11-

13 Sales of apartments could begin only after the Black Book for that building was accepted for filing by the Law Department. In the case of each of the Group A (Goldfein) Buildings, during the period when negotiations occurred, meetings took place every three to four weeks between representatives of the tenants' committee and Petitioner. The matters discussed at these meetings included the building's condition, the magnitude of the price discount to Insiders, and the amount of the reserve fund. All negotiations of any kind with a tenants' committee regarding a particular conversion took place at those meetings. Mr. Goldfein participated in most of these meetings, and other members of Petitioner also occasionally attended. When Mr. Goldfein did not attend a meeting, Petitioner's sales agent and counsel reported the substance of the meeting to him. Mr. Goldfein had the ultimate authority respecting the Group A Buildings. When he disagreed with the advice given to him by one of Petitioner's sales agents or attorneys, he did not follow it. In the case of 53rd Street, the Group B (Perlbinder) Building that was converted, the attorney for the tenants' committee negotiated directly with Julius Perlbinder without the participation of the sales agent. When Petitioner and a building's tenants' committee agreed on the terms of the deal, those terms would be reflected in an amendment to the Black Book. Generally, Insiders were then given a new exclusive period in which to purchase their apartments. In each case, negotiations with the tenants' committee resulted in the terms of the deal becoming significantly more attractive. In each of the Group A Buildings, the amount of the reserve fund and working capital fund was increased significantly. The Insiders' prices were reduced by almost fifty percent at 34th Street, and by approximately twenty-five percent at the other four buildings. The terms of the mortgages were improved. Petitioner offered sponsor financing in certain cases. At Lexington, temporary bridge -12-

14 financing was provided, because of Petitioner's desire to close before the end of 1986, rather than on or after January 1, 1987 when the capital gains rates increased. At 34th Street, sponsor financing was provided to tenants who had been refused loans by two banks in order to sell the minimum fifteen percent of the apartments needed to make the plan effective. Petitioner also offered sponsor financing at 53rd Street, although this was used by fewer than six buyers. At 53rd Street, Petitioner offered to pay certain closing costs for tenants who purchased within a specified time period. In all of the conversions, Petitioner agreed to pay the tenants' committee's attorney's fee if the offering plan was declared effective, which happened in all six cases. The dates on which the Black Books for each of the Six Buildings were accepted for filing by the Law Department and the date of each amendment reflecting the final negotiated deal ("Deal") for each of the Six Buildings are: Date of Amendment Building Date Accepted for Filing Reflecting Deal Lexington June 4, 1986 September 16, th Street December 20, 1985 June 18, rd Street March 29, 1985 November 25, th Street September 17, 1987 July 11, st Street September 30, 1985 March 31, rd Street March 14, 1984 March 28, 1985 In accordance with their sales agency agreements with Petitioner, the sales agents maintained a sales office at each of the Group A Buildings. These offices were located in vacant apartments which Petitioner had cleaned up and provided for that purpose. Each of these apartments was freshly painted; the floors were scraped; the kitchens were modernized; and the bathrooms were restored. These sales offices were also displayed to prospective purchasers. A sales office was not maintained at 53rd Street. -13-

15 Petitioner did not maintain any sales office nor engage in any direct sales activity with specific purchasers. At some time before the Black Books were accepted for filing, only a few apartments in each of the Six Buildings were vacant and 5 could be offered for sale to Outsiders. Advertising for sales of vacant apartments in a particular building was limited to signs on that building and to newspaper advertisements placed by the sales agent. All advertising was required to be approved by Petitioner. The amounts expended by Petitioner for advertising in connection with the sale of vacant apartments in the Six Buildings and the number of vacant apartments in each building were: Building Advertising Costs Vacant Apartments Lexington th Street rd Street 5, th Street 47, st Street 6, rd Street 10,136 3 Total $69, All advertising and sales efforts for a particular building were terminated (and not renewed) when all vacant apartments in that building were sold or contracted to be sold. This generally took six to eight weeks. Books. 5 See section entitled "Introduction" in each of the Black -14-

16 Insiders bought their own apartments "as is." Petitioner sometimes offered a package of improvements to the purchaser of a vacant apartment. The cost of these packages ($10,000 to $15,000) was substantially borne by Petitioner. Petitioner made renovations only with respect to vacant apartments used as sales offices and, to some extent, in refurbishing the halls and other common areas in the Group A Buildings. While the record is not entirely clear, it appears that Petitioner may also have made renovations to certain other vacant 6 apartments. In deciding where renovations were needed, Petitioner relied heavily on the advice of the sales agents. The cost for renovation of each of the Six Buildings was: Building Renovation Costs Lexington $ 91,839 35th Street 56,309 63rd Street 15,907 34th Street 212,737 71st Street 30,238 53rd Street 0 Total $407,030 At 35th Street and 34th Street, moving allowances were offered to tenants who would agree to vacate their apartments. A vacant apartment could either be sold for the higher Outsider's price or could be retained as an unsold apartment and rented without rent stabilization limitations. 6 The ALJ noted that there is an inconsistency between the Stipulation and the testimony. See Tribunal's Exhibit 1, 21-h, 22-h, 23-h, 24-h, 25-h and TR at

17 After a sufficient number of purchasers had contracted to purchase apartments in a particular building, the conversion was effectuated. In the case of each of Lexington, 34th Street, 35th Street, and 63rd Street, the real property was conveyed to a cooperative housing corporation ("CHC") that had been formed for this purpose. In all cases except 63rd Street, the buildings were encumbered by wrap-around mortgages held by Petitioner. 63rd Street was conveyed subject to an existing mortgage. Purchasers who had previously subscribed for the shares paid the cash price for the shares to the CHC which issued the shares directly to them. The CHC paid Petitioner the cash price from the sales of these shares less the amount of certain expenses. The CHC also issued any unsold shares to Petitioner. Accordingly, Petitioner received as the price for each of these buildings, the cash, the unsold shares, and the amount of the mortgage notes. 7 The conversion of 71st Street was structured as a "cond-op" The property was converted to a condominium consisting of a residential unit and a commercial unit. The residential unit, which consisted of 282 residential apartments was conveyed to a CHC in exchange for cash, unsold shares, and a wrap-around mortgage as described above. Petitioner retained the commercial unit which consisted of retail stores and a garage. Petitioner continues to use the commercial unit for rental purposes. 7 See the section entitled either "Contract of Exchange" or "Contract of Sale or Exchange" in each of the Black Books. -16-

18 The date on which Lexington, 34th Street, 35th Street, 63rd Street, and the residential unit of 71st Street were each conveyed to its respective CHC is referred to as its "Conveyance Date." The Conveyance Dates were: Building Conveyance Date Lexington December 18, th Street November 18, rd Street February 27, th Street November 17, st Street August 7, 1986 In most cases, the closing of the individual purchases of apartments occurred on the Conveyance Date for that property. In isolated instances, purchasers who contracted to buy units during the offering period asked to close shortly after the relevant Conveyance Date. The proceeds from the conversion of the Group A Buildings, and all the remaining unsold apartments from those conversions, were promptly divided among the Goldfein Partners (except for 13 apartments that were retained by Petitioner because they could not readily be divided among the partners). Petitioner's partners or their designees continue to hold all of the unsold apartments for rental purposes. The number of apartments in each of the Group A Buildings that were offered for sale, the number of apartments sold, the number of apartments unsold but distributed to Petitioner's partners, and the number of apartments retained by Petitioner are: -17-

19 Total Number Number Number Building Apartments Sold Distributed Retained Lexington th Street rd Street th Street st Street Total The amounts realized from the sales of apartments to Insiders and Outsiders in each of the Group A Buildings were: Amount from Amount from Building Insiders Outsiders Total Lexington $ 3,839,409 $ 374,800 $ 4,212,209 35th Street 4,478, ,010 5,320,535 63rd Street 5,718, ,540 6,325,026 34th Street 3,526,918 1,923,200 5,450,118 71st Street 18,684,562 2,138,320 20,822,882 Total $36,247,900 $5,884,870 $42,132,770 In the case of the condominium conversion of 53rd Street, the property was converted to condominium status on December 30, 1986 (the "Conversion Date"). When a building is converted to condominium status, each unit becomes a separate parcel of real property that can be transferred from Petitioner to a unit purchaser by deed. In isolated instances, purchasers who contracted to buy apartments during the offering period asked to close after the Conversion Date. Of the 189 units in the building, 125 were sold to Insiders and 5 were sold to Outsiders for a total amount of $18,939,726. The remaining 59 unsold units were sold to Perlbinder Partners or to their controlled entities in exchange for promissory notes of $9,266,

20 The agreement between Petitioner and Steiner Clateman regarding the conversion of 71st Street, dated February, 1983, provided for a retainer against a sales commission of 3% of the cash purchase price in the case of sales to Insiders, and 4.5% in the case of sales to Outsiders. The agreements for the other Group 8 A Buildings were similar. The agreement between Petitioner and Greenthal for the conversion of 53rd Street provided for a commission of 1.875% of gross sales for the first $16 million of sales and 4% of gross sales in excess of that amount. On its U.S. Partnership Return of Income (Form 1065) for the Tax Year, Petitioner listed the following amounts for commissions and professional fees paid or accrued during that year in connection with the conversions that closed during that year: Building Commissions Professional Fees Lexington $ 123,213 $125,233 35th Street 186, ,951 63rd Street 279, ,353 71st Street 623, ,900 53rd Street 372,446 29,500 Total $1,584,137 $754,937 After the close of the offering period for each conversion, Petitioner, or agents on its behalf, did not purchase or sell or exchange, or offer to purchase or sell or exchange, any unit of Petitioner's property related to that conversion, except in the case of 63rd Street, pursuant to Amendment No. 18 (dated April 9, 1996) in which Petitioner and other holders of unsold shares offered five of the original tenants the opportunity to purchase 8 The ALJ noted that, although the agreements could not be located, Mr. Goldfein credibly testified that the terms of the sales agreements for all Group A Buildings were similar. -19-

21 their apartments. (No tenant accepted the offer.) Petitioner has not purchased any properties or sold any properties other than in connection with the conversions of the Six Buildings. Petitioner's Federal and New York State income tax returns for the Tax Year reported the profit on the sales of the Six Buildings as long-term capital gains. F: PROCEEDINGS BELOW. The Department issued to Petitioner a Notice of Determination, dated November 13, 1989, asserting the following UBT deficiency for 1986: Principal $1,482, Substantial Understatement Penalty 148, Interest to November 13, , Late Payment Penalty 24, Total $1,985, The explanation on the Notice of Determination states: A Real Estate Developer who sells property as improved lots is considered to be a Dealer for Unincorporated Business Tax purposes. On February 9, 1990, Petitioner filed a timely Petition for redetermination of the above deficiency. 9 9 We have omitted the ALJ's Finding of Fact 41 and referred to that finding in that part of the decision which addresses Respondent's contentions at the hearing. See infra fn

22 At hearing, Petitioner asserted that it did not hold the property for sale to customers and that it did not regularly engage in the purchase of property and its resale within the meaning of the UBT regulations. It claimed that these provisions apply only to taxpayers who purchase property wholesale and sell it retail, where their profit is based on a mark-up related to those activities. Since Petitioner did not purchase property and since the only potential customers for the occupied units were the Insiders, Petitioner asserted that this provision does not apply. Petitioner also claimed that it was not a real estate developer who sold property as improved lots. Respondent did not directly address these points except to assert that the reference to a developer in the Regulation was by way of example. Petitioner also claimed that it did not hold property primarily for sale to customers because the Six Buildings had been held for investment and rental and were sold through the conversion process when Petitioner decided to liquidate those investments. Petitioner further asserted that, because for federal income tax purposes the tax bases and holding periods of the Six Buildings were carried over from the Six Entities to Petitioner, the purpose for which the Six Entities held the Six Buildings and the duration of their ownership should be imputed to Petitioner. Respondent claims that the primary purpose for which property is held can change and that, regardless of the purposes for which the property may have been held in the past, at the time of the conversions the Six Buildings were being held primarily for sale. Respondent asserted that the liquidation of investment analysis does not apply to these facts. Respondent further asserted that, since he was precluded from using any interest in other entities that Petitioner's individual partners may have held as a basis for imposing the UBT, it would be improper and illogical to consider the activities of Petitioner's predecessors, the Six Entities, as -21-

23 a means of avoiding the tax. 10 In addition, Petitioner contended that applying the "Winthrop Factors", as described in the federal real estate dealer cases, shows that its activities did not rise to the level needed to find it a dealer. It asserted that it had an intent to liquidate its investments and engaged in only those activities necessary to effectuate such liquidation. Respondent counters that the level of Petitioner's activities and the quantum of its transactions cause it to be dealer. The ALJ found that, during the Tax Year, Petitioner was in the trade or business of converting rental apartment buildings to cooperatives and condominiums and that Petitioner was holding the Six Buildings primarily for sale in the ordinary course of that trade or business. The ALJ found that Petitioner was a dealer and thus was not entitled to the exemption from UBT provided by former S46-2.0(d) of the New York City Administrative Code (the "Code") [currently (c)] for the purchase and sale of property for one's own account. G: ARGUMENTS ON EXCEPTION. On appeal, Petitioner contends that: (1) It is exempt from UBT because it held, leased and managed the 10 The ALJ in Finding of Fact 41 indicated that Respondent submitted a letter dated December 3, 1996, stating in pertinent part the following:... [P]lease be advised that the respondent, in litigating this case, will not assert the ownership interests of individuals or entities other than the taxpayer 85th Estates Company as a basis for the imposition of unincorporated business tax. -22-

24 buildings as investments and did not act as a dealer who acquires property primarily for sale to its customers; (2) (a) Petitioner, consisting of two sub-partnerships, each controlled respectively by the Perlbinder and Goldfein families, was an investor forced to liquidate its investment in the 53rd Street and 63rd Street properties as a result of factors that were unforeseen. (b) The liquidation of the remaining Group A Buildings to cooperative ownership and one to a "cond-op" did not transform Petitioner into a dealer. 3) Contrary to the ALJ's Determination, the sale of the Group A Buildings to separate CHCs involved a transfer to a single purchaser, not multiple sales of individual apartments. Respondent contends that the ALJ's Determination should be sustained in full, as Petitioner during the Tax Year was subject to the UBT as a dealer. Respondent asserts that the ALJ was correct in turning to federal law and related cases for guidance, because this is a case of first impression under the UBT; and that the ALJ correctly applied the relevant judicial standards (the Winthrop Factors) in determining whether Petitioner was a dealer for UBT purposes. Further, Respondent offers four additional criteria to be added to the seven used by the ALJ. Also, Respondent asserts that Petitioner ignores the rules of substance over form and the step transaction doctrine when it claims, at least with respect to the Group A Buildings, that the transactions were not multiple sales of individual apartments but a transfer to a single purchaser, the CHC. -23-

25 II. For the reasons stated below, we reverse the ALJ's Determination and find that Petitioner is exempt from UBT for the Tax Year. A: THE STATUTORY FRAMEWORK. As the ALJ stated in her Determination, the issue of the applicability of UBT to owners of rental apartment buildings who convert their real property to cooperative or condominium ownership is a case of first impression. During the Tax Year, the UBT was imposed by former S46-3.0(a) of the Code [currently (a)] on "the unincorporated business taxable income of every unincorporated business wholly or partly carried on within the city." However, the UBT statute contains exemption provisions by which taxpayers engaging in specified activities are deemed not to be engaged in an unincorporated business, and thus are not subject to the UBT. One of the UBT exemption provisions is contained in former S46-2.0(e) of the Code [currently (d)] which provides: (e) Holding, leasing or managing real property.--an owner of real property, a lessee or a fiduciary shall not be deemed engaged in an unincorporated business solely by reason of holding, leasing or managing real property. 11 Another one of the UBT exemption provisions is contained in former S46-2.0(d) of the Code [currently (c)] and provides, in pertinent part: 11 While the ALJ stated in her Determination that "although this exemption is not at issue in the matter at bar, it presumably would have applied to Petitioner at least prior to the time the conversion activities began", Petitioner argues on appeal that this exemption is applicable. -24-

26 (d) Purchase and sale for own account. -- An individual or other unincorporated entity, except a dealer holding property primarily for sale to customers in the ordinary course of his trade or business, shall not be deemed engaged in an unincorporated business solely by reason of the purchase and sale of property... for his own account.... [Emphasis added.] Former UBT Regulation 2-7(a) [currently 19 RCNY 28-02(g)(1)] provides, in pertinent part: (a)... For purposes of this section, a dealer in real or personal property is an individual or an unincorporated entity with an established place of business, regularly engaged in the purchase of property and its resale to customer; that is, one who (as a merchant) buys property and sells it to customers with a view to the gains and profits that may be derived therefrom.... A builder or real estate developer who regularly subdivides real property and sells it as improved or unimproved lots likewise is considered to be a dealer for [UBT] purposes. B: ARGUMENTS REJECTED ON APPEAL. 12 Although Petitioner asserts on appeal that the exemption for holding, leasing or managing real property is applicable in this matter, Petitioner never explains how it falls within the parameters of this exemption with respect to the Six Buildings, or offers any support for its assertion. Clearly, Petitioner's activities during the Tax Year with respect to the conversion of the Six Buildings to cooperative or condominium ownership are not entirely included within the categories of holding, leasing or managing real property. 12 See supra fn

27 Petitioner also asserts, as it did below, that it is exempt from UBT pursuant to the exemption for purchases and sales for one's own account. Petitioner contends that, contrary to the ALJ's finding it was not, for UBT purposes during the Tax Year, a dealer as that term is used in former S46-2.0(d) of the Code and in former UBT Regulation 2-7(a), because it neither regularly engaged in the purchase of property and its resale to customers nor regularly subdivided real property and sold it as improved or unimproved lots. However, we find, as did the ALJ, that Petitioner's reading of former UBT Regulation 2-7(a) is overly narrow. With respect to the issue of exemption from taxation, the Court of Appeals stated in Grace v. New York State Tax Commissioner, 37 N.Y.2d 193, 196 (1975); reh'g denied 37 N.Y.2d 816 (1975) that: "[a]n exemption from taxation 'must clearly appear, and the party claiming it must be able to point to some provision of law plainly giving the exemption' [citations omitted]." Furthermore, the ALJ in her Determination stated that:... While the UBT Regulation contains examples of the kinds of activities that make one a dealer, there is no indication that this is intended to be an exhaustive list or that the Commissioner, in promulgating this Regulation, intended to expand the scope of the exemption provided in former Code section S46-2.0(d) by restricting the definition of a dealer to these examples only. Determination at 23 Nevertheless, even if Petitioner is not definitionally outside the purview of the regulation, its argument that it purchased no buildings whatsoever, from a point starting many years before the conversion and extending at least through (and subsequent to) the Tax Year, supports its contention that the conversions were a plan of liquidation (see infra p. 32) rather than a part of Petitioner's ordinary course of business. -26-

28 C: FEDERAL PRECEDENT AND THE WINTHROP FACTORS. In light of the absence of City precedents, and of relevant authority under the former New York State UBT, addressing the issue of whether a cooperative or condominium converter is a dealer, we look, as did the ALJ, to the internal revenue code and related 13 federal cases for guidance. The issue of whether someone is a dealer for federal income tax purposes arises frequently in determining whether gain from a sale of property is ordinary income 14 or capital gain. While a limited body of federal case law exists regarding when the converter of rental property to condominium units is a dealer, there are no federal cases regarding when a cooperative converter is a dealer. Thus, the ALJ looked to the federal cases involving condominium conversions and the body of case law regarding dealers in real property for guidance in reaching her conclusions. While we do not disagree with the ALJ's use of the federal cases as guidance, we disagree with her conclusions that the deficiency should be affirmed and that Petitioner is a dealer for UBT purposes. To ascertain whether Petitioner is a dealer, it must be determined whether: (1) the property was held primarily for sale; (2) Petitioner was engaged in the trade or business of selling its property; and (3) the sales were made in the ordinary course of 13 Former S46-1.0(a) [currently (a)] of the Code provided in pertinent part: Unless a different meaning is clearly required, any term used in the title shall have the same meaning as when used in a comparable context in the laws of the United States relating to federal income taxes Gains from sales of "property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business," that is, by a "dealer" are not capital gains. Internal Revenue Code section 1221(1). -27-

29 that trade or business. Suburban Realty Company v. United States, 615 F.2d 171 (5th Cir. 1980); cert. denied, 449 U.S. 920 (1980). The real estate dealer cases, in determining the answer to the three questions above, look to the following factors, set forth in United States v. Winthrop, 417 F.2d 905, 910 (5th Cir. 1969).("the Winthrop Factors"): (1) the nature and purpose of the acquisition of the property and the duration of ownership; (2) the extent and nature of the taxpayer's efforts to sell the property; (3) the number, extent, continuity, and substantiality of the sales; (4) the extent of subdividing, developing, and advertising to increase sales; (5) the use of a business office for the sale of the property; (6) the character and degree of supervision or control exercised by the taxpayer over the representative selling the property; and (7) the time and effort the taxpayer habitually devoted to the sales. In applying the Winthrop Factors in this matter, the ALJ concluded that with respect to all the factors except Factor 1 [the nature and purpose of the acquisition of the property and the duration of ownership], "[Petitioner's] activities are more than sufficient to establish that, in 1986, Petitioner was in the business of converting rental buildings and that the sales of those buildings were made in the ordinary course of that business." Determination at 33. The ALJ's conclusions were based on the fact that she found that Petitioner spent substantial amounts of time and effort in converting the Six Buildings and selling the apartments. These efforts were reflected in the large dollar -28-

30 amounts involved generally, the number of sales of real property and the very large number of subscriptions for apartments, and the amounts spent on renovations and advertising to try to sell approximately sixty-two apartments. Further, Petitioner bore a significant part of the cost of maintaining a sales office by providing the use of apartments in five of the Six Buildings as sales offices, and Petitioner exerted a significant degree of supervision and control over the representative selling the property. With respect to the "nature and purpose of the acquisition of the property and the duration of ownership" the ALJ looked to the activities of Petitioner's predecessors in interest, in addition to Petitioner's activities, and found that: the Six Entities had held the Six Properties for investment and rental purposes for many years; the Merger was effectuated as a means of changing the business relationships between the Goldfein and Perlbinder families and not to change the purpose for which the Six Buildings were held; Petitioner acquired each of the Six Buildings originally for investment and rental purposes and not for sale; and Petitioner held the Six Buildings for an additional period ranging from over seven years to almost ten years, during which time the apartments in the Six Buildings continued to be rented. However, in the end, the ALJ concluded that: Petitioner spent $69,587 to advertise 62 units. It spent $1,584,137 on brokerage fees and $754,937 on other professional fees to effectuate the conversions that closed in 1986 alone. In addition, apart from the extensive activities conducted by the sales agents, Petitioner, through its partners, directly spent a substantial amount of time and effort over a four year and eight month period to make sure these conversions were successful. Based on both the amount of activity expended by Petitioner and the lack of a clear liquidation intent, I find that [Petitioner's] -29-