The IRS Addresses the "Neighborhood Land Rule"

IRS Letter Ruling 201206018

Background. Many churches rent some or all of their property. For example, a church purchases several homes adjacent to its property to facilitate future expansion. The church has no immediate plans to expand its facilities, so it rents the homes. One issue that arises in such cases is the application of the federal unrelated business income tax, which is a tax on the net income generated by a church or other public charity from an unrelated trade or business.

In general, rental income received by a church is exempt from the unrelated business income tax, but an exception applies with debt-financed property. Section 514 of the tax code states that income from dividends, interest, annuities, royalties, rents, and capital gains and losses must be included in the definition of unrelated business taxable income to the extent it derives from debt-financed property. The ...