Is your organization thinking of becoming a landlord? You’re not alone.
We see various tax-exempt organizations, especially churches, weighing that potentiality. Many churches rent out their extra space, and growing congregations sometimes acquire extra space as they expand, so they can turn a profit on the excess.
So, if your church or organization is in this boat, what do you need to know?
It is a myth that a nonprofit cannot earn a profit. But if yours does, 1) it should not be too substantial and 2) it could be taxable despite your tax-exempt status.
This article contains some basic advice to consider before you foray into using your property for rental profit. But first, note that this is not meant to be a comprehensive discussion. Tax law is complex, so it’s always a good idea to seek out the expertise of a lawyer who specializes in 501(c)(3) law on matters like this. Here, we’ll only cover a few basics at the federal level.
The Nuts & Bolts of Taxes
When it comes to federal taxes, the distinction between profits that are “related” versus “unrelated” to your declared mission is key.
To know what activities are taxable and which aren’t, you must look at whether the activity “contributes substantially” to the purposes your organization declared when it was founded to the IRS, rather than where the profits go.
Profit-generating activities that are related to your mission are not taxable; in many cases, they might be necessary for the organization to survive. But unrelated activities may incur what’s called Unrelated Business Income Tax (UBIT) on earnings.
For an organization to be charged UBIT, it must be engaging in some kind of for-profit trade on a regular basis.While engaging in unrelated for-profit activities usually does not jeopardize a nonprofit’s status—unless it becomes substantial—UBIT is designed to prevent nonprofits from exercising an unfair commercial advantage over their for-profit counterparts.
To protect your nonprofit status, we recommend:
* Keep any profitable unrelated activities small.
* Avoid spending staff time on unrelated activities.
* Don’t hire someone to perform them.
To protect your nonprofit status, we recommend:
* Keep any profitable unrelated activities small.
* Avoid spending staff time on unrelated activities.
* Don’t hire someone to perform them.
The Passive Income Exemption
The difference between “related” and “unrelated” activities can get confusing, but happily the IRS has created a list of activities that aren’t taxable, regardless. These include things like the sale of donated property, work by all-volunteer labor and commerce provided as a “simple convenience” to members, students, patients, employees, etc.—such as a hospital or school cafeteria or perhaps a church café.
They also include income from “passive investments.” Income from renting real estate is generally considered one of those.
To qualify for this exemption an organization must only rent out space and not provide any personal services. (Rental of parking lot space or boarding rooms would likely garner taxable income due to the additional services provided). Also, income from renting out personal property does not fall under this exemption; nor does income tied to the success of the renter, which could be considered a joint business venture.
Basically, if you provide only basic landlord services and nothing more, your rental income may therefore be tax-free under the passive income exemption.
However, there’s an important wrench in the gears here. If your facility is debt-financed (this means by a mortgage or even a loan for remodeling), rental income is generally considered taxable.
It bears mentioning that if you rent to a for-profit organization, things could get trickier. (Many nonprofits seek to rent only to other nonprofits, because that’s simpler—and then there’s the church-and-state issue, one reason why many churches nowadays rent extra space to other churches.) If you rent to a for-profit organization and your property is exempt from local real estate tax, there’s a chance you could lose that property exemption.
In such cases, you might consider passing the additional tax cost on to the tenant. Of course that’s a state tax issue, and each state has its own regulations. Another discussion for another time.
Development Advisors does not provide counsel on specific legal or tax issues but recommends that you consult with professionals for this advice. Advisors provides A-Z services for Front Range churches looking to expand. For more information, contact Scott McLean at scott@developco.com.