DHCR Clarifies 421-a Surcharges for Market-Rate Units

Established in 1971 when NYC officials were concerned about the drop in residential construction as residents were moving to the suburbs, the 421-a tax exemption program gave developers an incentive to build on vacant land. The program offered a 10-year tax exemption for building multi-unit residential projects. Specifically, the developer of a project on vacant or mostly vacant land is exempt from paying the taxes it would usually have to pay for a construction period of up to three years. This is followed by a 10-year-long exemption period, during which the exemption becomes more of an abatement. Every two years during that period, the tax break is reduced by 20 percent, until it’s all gone.

When the housing market in the city improved, “geographic exclusion areas” were created. These are areas where the 421-a program wouldn’t be available, at least not for just new development. A developer could benefit from the 421-a program within a geographic exclusion area by building 25 to 30 percent low-income units in their development.

We’ll discuss the recent DHCR Policy Statement 2017-2, which discusses the 421-a tax benefit and clarifies the application of the 2.2 percent surcharge under the 421-a program.

Subject to Rent Stabilization

If a new building is constructed under the 421-a program, the owner can receive an abatement/exemption from real estate taxes for a prescribed period from the city. In return for this tax benefit, the building is placed under rent stabilization. After the benefits expire, rent stabilization coverage may expire if the owner follows the correct procedure.

Under the 421-a program, if the apartment became subject to rent stabilization after July 1, 1984, the apartment will undergo deregulation if the owner has included a prominent notice in the lease and each renewal that stabilization coverage will expire following expiration of the tax benefit and the approximate date of such expiration. The protection will continue until the end of the last lease signed while the benefit period was in effect.

In buildings where construction began before June 30, 2008, the failure to include this notice in all leases for the tenant in occupancy at the time the tax benefits expire means that the apartment will remain under rent regulation and the tenant can continue to renew her rent-stabilized lease. The apartment remains rent regulated until the tenant vacates the apartment.

The inclusion of the required notice in all leases deregulates the apartment at the end of the last lease entered into during the tax benefit period.

And generally, in buildings where construction began on or after June 30, 2008, those apartments in 421-a buildings designated as “affordable” units must remain rent stabilized for 35 years, even if a tenant vacates and a new tenant moves into the apartment. Tenants in occupancy at the end of the 35-year period remain under rent stabilization until they vacate the apartment.

Apartments in buildings constructed under the 421-a program that became subject to rent stabilization before July 1, 1984, remain rent-stabilized tenants until the first vacancy occurs after the expiration of the tax benefits, even if the vacancy occurs long after the tax benefits have expired. This vacancy deregulation does not occur if the vacating tenant was forced out through harassment.

421-a Rent Increases

Owners of 421-a buildings are allowed to tack on an additional 2.2 percent increase for the decrease in the value of the tax exemption over the period of the abatement. The collection of the 2.2 percent surcharge is triggered by the commencement of the phase-out period. The 421-a benefits begin to phase out in different years depending upon the length of the benefits as follows:

• 10-year 421-a benefits in Year 3;
• 15-year 421-a benefits in Year 12;
• 20-year 421-a benefits in Year 13; and
• 25-year 421-a benefits in Year 22.

The 2.2 percent surcharge can be increased annually during the phase-out period up until the date upon which the 421-a benefits expire. It’s calculated for each year as a percentage of the legal rent that’s in effect on the date that the phase-out begins, and it can never exceed 19.8 percent of the legal rent that’s in effect on the date that the phase-out begins.

The 2.2 percent surcharge is not part of the legal rent and cannot be compounded by Rent Guidelines Board increases for one- and two-year leases or by any other lawful rent increases including, but not limited to, major capital improvement (MCI) or individual apartment improvement (IAI) rent increases. The collection of the 2.2 percent surcharge also is not affected by a DHCR order reducing rent for decreased services. Finally, the 2.2 percent surcharge can be charged only once a year, regardless of how many leases have been executed in any given year.

The total surcharge assessed against market-rate units upon the expiration of the 421-a benefits is a fixed amount (Final Surcharge) that may continue to be charged in each year thereafter. However, no additional 2.2 percent increases can be added to the Final Surcharge after the 421-a tax benefits expire and the Final Surcharge never can exceed 19.8 percent of the legal rent that’s in effect on the date that the phase-out began. The collection of the Final Surcharge terminates when the tenant who’s in occupancy on the date the 421-a benefits expire vacates the apartment. If the apartment is legally deregulated at the end of the lease that’s in effect upon the expiration of the 421-a benefits, the collection of the Final Surcharge also terminates.

Policy Statement 2017-2

The DHCR recently issued a policy statement clarifying its policy with respect to the lawful collection of 2.2 percent surcharges. The DHCR clarified that it’s available only to market-rate units in 421-a buildings that are required to have a certain percentage of low-income units. A market-rate unit in these buildings is subject to rent stabilization unless, in the absence of 421-a benefits, the owner would be entitled to remove the unit from rent stabilization upon vacancy by reason of the monthly rent exceeding the deregulation limit.

Notice Requirements

No owner can collect the 2.2 percent surcharge unless the applicable lease includes a rider that is signed by the tenant, notifying the tenant of the owner’s right to collect the 2.2 percent surcharge and the approximate date of expiration of the 421-a benefits (Surcharge Notice). If the owner does not include the Surcharge Notice in a tenant’s first lease for a dwelling unit, the DHCR will allow owners to add it to the tenant’s renewal lease and only collect the 2.2 percent surcharge prospectively. If the owner provides the Surcharge Notice but failed to collect it in any prior year(s) for which it was entitled to do so, the owner can prospectively collect the total 2.2 percent surcharge, including any prior annual increases the tenant wasn’t previously charged.

A tenant who moves into a multiple dwelling during the phase-out of such building’s 421-a benefits, provided that she receives the Surcharge Notice, can be prospectively charged the surcharge amount that had been or could have been charged to the prior tenant, plus any future lawful annual surcharge increases.