Background. Many churches rent a portion of their property to outside groups. Is rental income generated by such arrangements subject to the unrelated business income tax (UBIT)? We have addressed this question in a number of articles in this newsletter. In general, rental income received by a church is not subject to UBIT so long as the property that is rented is not subject to any indebtedness. A recent IRS ruling addresses a unique question—what if a charity rents property that it owns debt-free to another organization that incurs debt in developing the property? Does the debt incurred by the lessee affect the charity's exemption from UBIT?
Facts of the case. A charity acquired property consisting of land and a building, and later acquired additional land adjacent to the building. All the property was acquired for cash and none of the property was ever subject to debt. The charity decided to "develop" the property through a lease arrangement to protect its investment, maximize its rate of return, and ensure that office space on the property would be up to market standards. In 1996, it entered into negotiations with another organization for a 97-year lease that would allow the lessee to develop the property, constructing a multi-story office tower and cinema. The charity and lessee proposed to sign a lease agreement calling for the lessee to pay the charity "base monthly rent" plus "additional" rent payments based on the greater of a fixed amount or a percentage of gross receipts received by the lessee.