Issue

Many exempt organizations pay taxes on rental income from “debt-financed” property.  But, colleges generally don’t have to.

Situation

Troas Bible College (TBC) is a private college exempt under Internal Revenue Code section 501(c)(3) and section 170(b)(1)(A)(ii).  They are required to file Form 990 annually.  TBC’s CFO calls and tells us that they have recently taken out a loan to purchase a building.   In addition, they are renting space in the building to an architectural firm.  They do not provide any services to this lessor other than those associated with a customary “triple net lease.”

The CFO asks if TBC should be paying unrelated business income taxes on the net income from this rental.

We say, “No.”  Generally, exempt organizations are subject to UBIT on the net rental income of “debt-financed” property, but “schools” have a nice exclusion from the debt-financed rules.  There is a lot involved with this concept.  Further, we tell the CFO that if TBC provided “substantial” services to the tenant, that a “dual-use” facilities situation may arise – resulting in potential UBIT implications.

Rules

From I.R.C. section 514(c)(9):

(A) In General, except as provided in subparagraph (B)[concerning partnerships, trusts, etc.], the term “acquisition indebtedness” does not, for purposes of this section, include indebtedness incurred by a qualified organization in acquiring or improving any real property

(C) For purposes of this paragraph, the term “qualified organization” means:

  • an organization described in section 170(b)(1)(A)(ii) (i.e., a school, college or university); and
  • its affiliated support organizations described in section 509(a)(3)

From I.R.C. Section 170(b)(1)(A)(ii):

An educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.

From IRS Publication 598:

Dual use of assets or facilities. If an asset or facility necessary to the conduct of exempt functions is also used in commercial activities, its use for exempt functions doesn’t, by itself, make the commercial activities a related trade or business. The test, as discussed earlier, is whether the activities contribute importantly to the accomplishment of exempt purposes. (page 4)

Services provided with a lease. An exempt university leases its football stadium during several months of the year to a professional foot-ball team for a fixed fee. Under the lease agreement, the university furnishes heat, light, and water and is responsible for all ground maintenance. It also provides dressing room, linen, and stadium security services for the professional team.

Leasing of the stadium is an unrelated trade or business. In addition, the substantial services furnished for the convenience of the lessee go beyond those usually provided with the rental of space for occupancy only. Therefore, the in-come from this lease is rent from real property and unrelated business taxable income. (page 6)

Bottom Line

  • Rental income from real property is generally excluded from UBIT
  • If an exempt organization has “acquisition debt” on the rented property, it will generally be subject to UBIT at a rate based upon the average acquisition debt for the year divided by the average basis in the property for the year
  • Qualified organizations (“schools”) are excluded from the debt-financed rules by I.R.C. section 514(c)(9)(A)
  • Generally, colleges should never file a Form 990-T with Schedule E (Unrelated Debt-Financed Income) completed to report facilities rentals
  • Beware of “dual-use facilities” rentals where substantial services are provided

 

Specific questions? Email Dave Moja.

The information provided herein presents general information and should not be relied on as accounting, tax, or legal advice when analyzing and resolving a specific tax issue. If you have specific questions regarding a particular fact situation, please consult with competent accounting, tax, and/or legal counsel about the facts and laws that apply.