85TH ESTATES COMPANY - DETERMINATION - 02/11/98. In the Matter of 85TH ESTATES COMPANY TAT(H) (UB) - DETERMINATION

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1 85TH ESTATES COMPANY - DETERMINATION - 02/11/98 In the Matter of 85TH ESTATES COMPANY TAT(H) (UB) - DETERMINATION NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION UNINCORPORATED BUSINESS TAX - THE COMBINATION OF: (1) PETITIONER'S ACTIVITIES IN CONNECTION WITH THE CONVERSION OF SIX BUILDINGS IT OWNED TO COOPERATIVE AND CONDOMINIUM STATUS, AND (2) THE NUMBER OF SALES INVOLVED, WERE SUFFICIENT TO CAUSE PETITIONER TO BE CONSIDERED A DEALER SUBJECT TO THE UNINCORPORATED BUSINESS TAX (UBT) EVEN THOUGH, PRIOR TO CONVERSION, IT HAD HELD THESE BUILDINGS AS INVESTMENTS TO PRODUCE RENTAL INCOME, WHICH ACTIVITIES WERE EXEMPT FROM THE UBT. FEBRUARY 11, 1998

2 NEW YORK CITY TAX APPEALS TRIBUNAL ADMINISTRATIVE LAW JUDGE DIVISION : In the Matter of the Petition : DETERMINATION : of : TAT(H) (UB) : 85TH ESTATES COMPANY : : Schwartz, A.L.J.: Petitioner, 85th Estates Company, 429 East 52nd Street, New York, New York, 10022, filed a petition on February 9, 1990 with the Commissioner (the "Commissioner" or "Respondent") of the New York City ("City") Department of Finance requesting a redetermination of deficiencies of City Unincorporated Business Tax ("UBT") under Chapter 5 of Title 11 of the City Administrative Code ("Code") for the calendar year 1986 (the "Tax Year"). The parties entered into an extensive Stipulation of Facts (the "Stipulation"), dated August 29, 1996, that was initially submitted to this Tribunal on September 6, Petitioner filed a Motion for Summary Determination dated September 9, 1996 which was withdrawn on December 4, Thereafter, a Hearing was held before the undersigned on January 8, and February 5, 1997 at which testimony was taken and various documents including the Stipulation were entered into the record. The Stipulation included the agreement to certain facts and the admissibility of specific documents. On February 14, 1997 the parties filed an additional stipulation and accompanying exhibits, and on February 26, 1997 the record was closed. Petitioner submitted an Opening Brief and Proposed Findings of Fact and Conclusions of Law on May 23, 1997; on July 14, 1997, Respondent filed a Brief along with Proposed

3 Findings of Fact and Conclusions of Law. Petitioner filed a Reply Brief and a Response to Respondent's Proposed Findings of Fact and Conclusions of Law on July 25, 1997; Respondent filed his Reply Brief on August 14, By letter dated August 19, 1997, Petitioner's counsel advised the undersigned that they did not wish to file an additional brief. Petitioner was represented by Ralph B. Kelley, Esq., of Rosen & Reade, LLP and James G. Greilsheimer, Esq. and S. Sidney Mandel, Esq. of Tenzer Greenblatt LLP. At the Hearing, Respondent was represented by George P. Lynch, Esq., Assistant Corporation Counsel. Frances J. Henn, Esq., Assistant Corporation Counsel, also participated on the Briefs. ISSUE Whether Petitioner's activities in connection with the conversion of six buildings it owned to cooperative and condominium status were sufficient to cause it to be a "dealer" subject to the UBT. FINDINGS OF FACT 1 1. 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") that was effective as of January 1, Prior to the Merger, Petitioner was known as 185 E. 85 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. 2. The other partnerships (the "Partnerships") that were combined with Petitioner in the Merger were: Monway Co, a New York 1 The substance of the facts included in the Stipulation are incorporated into the Findings of Fact. 2

4 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 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"). 3. 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 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. 4. 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 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"). 5. Each of Lexington, 35th Street, 63rd Street, 34th Street, 3

5 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 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. 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 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 4

6 Entities has 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. 7. 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. 8. The rearrangement of the relationship between the two families in the Merger was designed to avoid the unfavorable tax consequences that would have resulted from a sale of the Seven Buildings 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. 5

7 9. Members of Petitioner were experienced builders and operators of buildings. As such, when the time came to establish the 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 their value were they to be converted to cooperatives or condominiums. 10. 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. 11. 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 6

8 pay Manufacturers the sum of $250,000 as an additional fee for 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 would 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. 12. 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. 13. 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 7

9 concerned about the economic effect of the rent stabilization law 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 in New York real property laws that would make conversions to cooperatives and condominiums more difficult. 14. 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. 15. Two bills were introduced into 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. 16. 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 8

10 property as they: (a) limited the extent to which "passive losses" 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. 17. 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. 18. 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. 19. 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 the New York State Department of Law (the "Law Department") had to accept for filing. 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 9

11 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. 20. 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 the 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 looked to its sales agents for guidance, Petitioner ultimately had to approve all the terms of the conversion plans. 21. Petitioner was the sponsor of six non-eviction conversion plans, one for each of the Six Buildings. Each plan required that 2 a minimum of fifteen percent of the apartments in a particular 2 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 this Determination, sales of units in a cooperative conversion will be referred to as sales of "apartments." 10

12 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. 22. 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. 23. 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 recom- 11

13 mended to him by one of Petitioner's sales agents or attorneys, he did not follow it. 24. In the case of the Group B (Perlbinder) Building that was converted, 53rd Street, the attorney for the tenants' committee negotiated directly with Julius Perlbinder without the participation of the sales agent. 25. 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 financing was provided in the interest of Petitioner to make it possible 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 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 12

14 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, 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 that Petitioner had cleaned up and provided for that purpose. Each of these apartments were 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 411 East 53rd Street. Petitioner did not maintain any sales office nor engage in any direct sales activity with specific purchasers. 27. Sometime before the Black Books were accepted for filing, only a few apartments in each of the Six Buildings were vacant and could be offered for sale to Outsiders. 3 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: 3 Books. See, section entitled "Introduction" in each of the Black 13

15 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. 28. Insiders bought their own apartments "as is." Petitioner sometimes offered a package of improvements to the purchaser of a vacant apartment. The prices of these packages ($10,000 to $15,000) were substantially at Petitioner's cost. 29. 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 4 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 4 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 p

16 30. 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. 31. 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. 5 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. 5 See the section entitled either "Contract of Exchange" or "Contract of Sale or Exchange" in each of the Black Books. 15

17 32. The date on which Lexington, 34th Street, 35th Street, 63rd Street, and the residential condominium 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 closings 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. 33. The proceeds of 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: Total Number Number Number Building Apartments Sold Distributed Retained Lexington th Street rd Street th Street st Street Total

18 34. 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 $ 4,214,209 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 Totals $36,247,900 $5,884,870 $42,132, 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, 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 4½% in the case of sales to Outsiders. The agreements for the other Group 6 A Buildings were similar. The agreement between Petitioner and 6 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. 17

19 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, 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 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. 38. 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. 39. The City Department of Finance issued a Notice of Determination, dated November 13, 1989, to Petitioner asserting the following UBT deficiency for 1986: 18

20 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. 40. On February 9, 1990, Petitioner filed a timely Petition for redetermination of the above deficiency. 41. During pre-hearing conferences, Respondent requested information about other entities that might have been owned by some of Petitioner's partners and about the real estate activities of Petitioner's partners in their individual capacities. In its Memorandum in Support of the Motion for Summary Determination, Petitioner asserted that the activities of its partners in their individual capacities and the activities of other partnerships in which these individuals may have had an interest were not relevant to the question of whether Petitioner was a dealer in real property, citing authority for that proposition. 7 Petitioner's representatives requested that I advise them whether information about the partners' other activities would be relevant and admissible at the hearing. I directed Respondent to include in his Memorandum in Opposition to Petitioner's Motion for Summary Determination any authorities that would support a finding that information about any outside activities of the partners or other entities is relevant. Respondent did not provide this information. 7 Riddell v. Scales, 406 F.2d 210 (9th Cir. 1969); Cary v. Commissioner, 32 T.C.M. 913 (1973); Williams v. United States, 84-1 U.S.T.C (N.D. Tex, 1984); Van Drunen v. Commissioner, 23 T.C.M. 903 (1964). 19

21 Instead he 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. 8 STATEMENTS OF POSITIONS Petitioner asserts 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 claims 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 asserts that this provision does not apply. Petitioner also claims that it was not a real estate developer who sold property as improved lots. Respondent does not directly address these points except to assert that this reference to a developer in the Regulation was by way of example. Petitioner also claims 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 8 For years beginning on or after January 1, 1996, section (a)(1)has been amended to provide that:... an individual or unincorporated entity shall not be treated as a dealer based solely on such individual's or entity's ownership of an interest in an entity that is a dealer and provided, further, that an unincorporated entity shall not be treated as a dealer based solely on the ownership by a dealer of an interest in that unincorporated entity. 20

22 further asserts 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 asserts that the liquidation of investment analysis does not apply to these facts. Respondent further asserts that since he was precluded from using any interests in other entities that Petitioner's 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 a means of avoiding the tax. In addition, Petitioner contends that applying the "Winthrop Factors" that are described in the federal real estate dealer cases, its activities did not rise to the level needed to find it a dealer. It asserts that it had an intent to liquidate its investments and did 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 a dealer. CONCLUSIONS OF LAW This is a case of first impression. It addresses the applicability of the UBT to owners of rental apartment buildings who convert their property to cooperative or condominium ownership. During the Tax Year, the UBT was imposed by former Code section S46-3.0(a) (now section [a]) on "the unincorporated business taxable income of every unincorporated business wholly or partly carried on within the city." 21

23 Petitioner's activities were carried on within the City and they certainly constituted a business in the colloquial sense. Nevertheless, because of certain exemption provisions of the UBT, taxpayers engaging in specified activities are deemed not to be engaged in an unincorporated business, and not subject to the UBT. One such exemption applied to owners or lessees who held, leased or managed real property. Former Code section S46-2.0(e) (now section (d)). This exemption, which is not at issue here, presumably would have applied to Petitioner at least prior to the time the conversion activities began. Another exemption from tax was provided by former Code section S46-2.0(d) (now section (c)) for the purchase and sale of property for one's own account. During the Tax Year, former Code section S46-2.0(d) provided in pertinent part: (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.] UBT Regulation 2-7(a) (now 19 RCNY 28-02(g)(1)) promulgated under former Code section S46-2.0(d) provided, in pertinent part, as follows: (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 customers; 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 unincorporated business tax purposes. Petitioner claims that it is entitled to the exemption from 22

24 tax for purchases and sales for one's own account. Petitioner asserts that it was not a dealer because it did not purchase property and resell it to customers nor did it regularly build homes or develop land by the addition of roads, streets, etc. Petitioner's argument, interpreting UBT Regulation 2-7(a) too narrowly, fails. The first portion of the Regulation directly tracks the federal regulation involving dealers in securities, Treas. Reg , which provides in pertinent part that:... a dealer in securities is a merchant of securities,... with an established place of business, regularly engaged in the purchase of securities and their resale to customers; that is, one who as a merchant buys securities and sells them to customers with a view to the gains and profits that may be derived therefrom.... There is no analogous federal regulation involving dealers in real property. However, there is an extensive body of federal case law on this issue and many of these cases involve developers who subdivide property. 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 (d) by restricting the definition of a dealer to these examples only. "An 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.'" Grace v. State Tax Comm., 37 N.Y.2d 193, 196 (1975) and cases cited therein. Accordingly, Petitioner's narrow reading of UBT Regulation 2-7(a) does not protect Petitioner from taxation. There are no City precedents, and no pertinent authority under the former New York State UBT addressing the issue of whether or 23

25 when a coop or condo converter would be a dealer. However, the issue of whether someone is a dealer for federal income tax 9 purposes arises frequently in determining whether gain from a sale of property is ordinary income or capital gains. That is because 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 ("I.R.C.") section 1221(1). A limited body of federal case law exists regarding when the converter of rental property to condominium units is a dealer. See, e.g., Robert Erfurth et al. v. Commissioner, T.C. Memo , P-H T.C.M. 87,232; Gangi v. Commissioner, T.C. Memo , P-H T.C.M. 87,561. In Erfurth, the Tax Court relying on a long line of cases involving real estate developers applied the principles which were applicable to sales of real property generally to a condominium conversion. The Court noted: There is no specific provision in the Internal Revenue Code regarding the taxation of condominium sales following a conversion of rental property to condominium status. The parties have not cited and we have not found any cases dealing with this specific issue. This dearth of cases is no doubt due to the fact that normally such a conversion from rental operation to sales of condominium units would generate ordinary income. In other words the owner of the apartment building would simply change his operation from that of a rental business to that of a dealer in condominium units, selling the property to customers in the ordinary course of his new trade or business. Id. at pp There are no federal cases regarding when a coop converter is 9 Former Code section S46-1.0(a) (now section (a)) 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

26 a dealer. While there are technical differences in how coop and 10 condo conversions are structured, these differences have little impact on the kinds of activities a sponsor needs to engage in in order to convert a building. Accordingly, it is appropriate to look to the federal cases involving condominium conversions and, by extension, the body of case law regarding dealers in real property generally for guidance. Representatives of both Petitioner and the Commissioner have relied on those cases and assumed that this body of law would control. One who repeatedly purchases land, subdivides and develops it, sells lots, and reinvests the proceeds in more land, would no doubt be a dealer. However, the federal cases cover a much wider group of taxpayers. For example, a taxpayer was held to be a dealer when, because expenses exceeded the income from inherited rental property, it sold its property and did not reinvest the proceeds in other property. Parkside, Inc. v. Commissioner, 571 F.2d 1092, 41 A.F.T.R.2d (9th Cir. 1977). To ascertain whether Petitioner was 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 that trade or business. Suburban Realty Co. v. United States, 615 F.2d 171 (5th Cir. 1980), cert. denied, 449 U.S. 920 (1980). Although the weight given to the different factors depends on the facts of a particular case, the real estate dealer cases look to certain factors, "the Winthrop Factors" to help answer these three questions: the time and effort the taxpayer habitually devoted to the sales; the extent and nature of the taxpayer's efforts to sell the property; the number, extent, continuity, and substantiality of the sales; the extent of subdividing, developing, 10 See, Findings of Fact 31 and 35, supra. 25

27 and advertising to increase sales; the use of a business office for the sale of the property; the character and degree of supervision or control exercised by the taxpayer over the representative selling the property; and the nature and purpose of the acquisition of the property and the duration of ownership. United States v. Winthrop, 417 F.2d 905, 910 (5th Cir. 1969). Each case is fact specific and any decision here may or may not provide sufficient guidance the next time the issue arises. As the Fifth Circuit Court of Appeals noted in Biedenharn Realty Co., Inc. v. United States, 526 F.2d 409, 415 (5th Cir. 1976), cert. denied, 429 U.S. 819 (1976): Assuredly, we would much prefer one or two clearly defined, easily employed tests which lead to predictable, perhaps automatic, conclusions. However...[n]o one set of criteria is applicable to all economic structures. Moreover, within a collection of tests, individual factors have varying weights and magnitudes, depending on the facts of the case. The relationship among the factors and their mutual interaction is altered as each criteria increases or diminishes in strength, sometimes changing the controversy's outcome. As such, there can be no mathematical formula capable of finding the X of capital gains or ordinary income in this complicated field. With this caveat in mind, the various Winthrop Factors, to the extent applicable, will be considered below. A. The extent and nature of the taxpayer's efforts to sell the property and the time and effort the taxpayer habitually devoted to the sales. These two factors will be considered together. Unlike a typical sale of real property where a seller can go from advertising to contract to closing in a very short time, because of the nature of the conversion process, sales efforts must extend over a substantial period of time even for one conversion, and the preparatory work before actual selling can begin easily can take a year or more. Here, because six conversions were involved, the sales activity embraced an overall period of four years and eight 26

28 months measured from March 14, 1984, (the time the Black Book for 53rd Street was accepted for filing) and ending on November 17, 1988, (the Conveyance Date for 34th Street). In reality, preparation for the actual selling period began at least a year earlier in February, 1983, when the sales agent for 71st Street was engaged and probably during 1982 at least for 53rd Street and 63rd Street. The record demonstrates that to sell its buildings, Petitioner engaged in significant activities directly through its partners. Petitioner's partners worked with the attorneys and sales agents to prepare and review the Red Herrings and subsequently the Black Books for submission to the Law Department, and to physically prepare the buildings for sales by making needed renovations. Once each Black Book was accepted for filing and selling could legally begin, Petitioner's partners attended negotiating meetings with the representatives of the tenants' committees with a view towards negotiating a deal that would be acceptable to a sufficient number of Insiders to enable the conversions to go forward. Meetings took place every three to four weeks during the negotiating period for a particular building until an acceptable deal had been made. The Black Book for 53rd Street was accepted for filing in March, 1984, and an acceptable deal for 34th Street was agreed to in July, In between those two dates Petitioner was actively involved in negotiations for one or more of the Six Buildings on an almost continuous basis. During these negotiations, Petitioner agreed to extensions of offering periods, price reductions, increased reserve funds, more favorable mortgage terms, moving allowances for vacating tenants, provision of sponsor financing, payments of purchasers' closing costs, payments of fees for the attorneys of the tenants' committees, all of which are relected in the amendments to the various Black Books. Petitioner also arranged for a package of improvements to purchasers of certain vacant units. In order to 27