In recent years, we have seen an explosive growth in the acceptance and value of digital assets such as cryptocurrencies and non-fungible tokens (“NFTs”). While the value of such assets can be subject to significant fluctuations, it is estimated that these digital assets are worth in excess of $2 trillion. These highly valued assets represent a growing portion of wealth and investable assets for sophisticated purchasers of real estate, and merit special attention and consideration in the context of the sale of a co-operative residential apartment (“Co-op”).
Co-ops represent a significant portion of the housing stock of New York City and constitute approximately 70% of the supply of apartments available in Manhattan. Co-ops are subject to the approval of the board of the directors of the specific co-op corporation, and such boards have wide discretion, including a review of the financials and tax returns of any prospective purchaser, in determining if they will approve or reject a transaction. It is critical that the parties demonstrate the most complete and favorable financial portrait of the purchaser to the Co-op board of directors to achieve the highest likelihood of success of the transaction.
Co-op board members are elected volunteers from the shareholder-owners of said co-op corporation, and have varying levels of experience with cryptocurrencies and NFTs. In order to successfully navigate the transaction, it is important that all of the professionals supporting the purchaser and seller understand the assets, disclosures, and approval process.
When vetting a prospective purchaser, the listing agent for the seller will typically require the purchaser to complete a statement of net worth. The commonly accepted statement of net worth does not have a category for cryptocurrency and NFTs. It is important for the listing agent to understand if the cryptocurrency is widely recognized with many investors, or if it is relatively new with only a few investors, which can lead to wild fluctuations, or if is it a “stable coin” that is linked to a specific exchange rate to a fiat currency. The professionals representing the seller need to ensure that the purchaser will disclose these assets in the correct way and provide the necessary asset valuation that they expect to be represented in the co-op corporation’s purchase application.
There are also potential tax considerations that a seller would be wise to consider when determining the net worth of a purchaser. Federal, state and local governments are reviewing their tax policies on digital assets, and we should expect them to continue to evolve. Many owners of these digital assets are regularly trading the asset on a short-term basis which could trigger a different rate of transaction than a long-term investment. There is a rightful concern as to whether the government will tax these assets as capital investments or currencies in the future, and there is concern that exchanges are consistently and fully reporting transactions. Investors in NFTs could also be viewed as having those assets as a hobby which would be subject to a different and higher rate of taxation than a long-term capital investment. The seller would be well advised to make inquires to determine that all taxes due in connection with these digital assets have or will be duly paid, to ensure that they are in compliance with tax laws and to have an accurate depiction of the net worth of the purchaser. After all, a sophisticated co-op board of directors would be making these same considerations in deciding if they will approve the transaction.
As a purchaser, it is critical that one completes the co-op corporation’s application diligently and properly. The typical Co-op purchase contract requires that a purchaser apply in “good faith” for the approval of the co-op corporation. While a Co-op purchaser will typically be refunded their contract deposit in the event of a rejection by the co-op’s board of directors, in the event a purchaser applies in bad faith, the seller will have a case to retain their contract deposit as damages. As cryptocurrencies and NFTs can significantly fluctuate in value during the weeks between contract signing and the application to the co-op corporation, it is critical that purchasers work closely with knowledgeable attorneys that will craft the contract provisions correctly to ensure that they properly disclose the assets and use a proper valuation of said assets, and not put their contract deposit at risk.
Co-op boards, as well as mortgage lenders, have legitimate concerns about sourcing the digital asset accounts as well. As cryptocurrencies rely on blockchain technology, which allows for a decentralized and semi-autonomous control and ownership, purchasers need to be prepared not only to document their ownership of said assets, but to provide documentation from the source of fiat currency at their initial investment. Co-op boards expect to see detailed statements and documentation regarding purchaser assets, and have the right to request additional information—even if said requirements are not on the original board application.
Co-op boards need to prepare themselves as to their policies and procedures surrounding cryptocurrencies and NFTs. Co-op boards should expect to see a growing number of purchasers owning significant digital assets, and would be remiss in their fiduciary duty to their shareholders if they did not understand the risks and value of these assets in determining whether to approve a transaction. For those co-op boards that can adapt, they will be able to increase the pool of qualified purchasers of units their community and ultimately increase the value of their building.
Steven R. Ebert is a partner at Cassin & Cassin LLP in their Purchase, New York office where he focuses on residential and commercial real estate transactions and related tax and financing matters.
