Background. Many churches lease a portion of their property to outside groups. Examples include aerobics classes, child care, and office space. Some churches lease their premises to other congregations. There are a number of potential legal and tax consequences associated with such arrangements that often are not fully understood by church leaders. One consequence is the impact on the church's property tax exemption. A recent case illustrates this problem.
Facts. A charity entered into a 72-year lease with a local hospital. A few years later, a tax assessor informed the charity that its property no longer was exempt from property tax because of the lease. The charity insisted that a lease to another charity (the hospital) should not affect its property tax exemption. The case was appealed to the Virginia Supreme Court.
The court's ruling. The court noted that property tax exemptions are "strictly construed," and that "any doubt is resolved against the one claiming the exemption." It quoted from the state property tax exemption statute, which contained the following limitation: "Whenever any building or land, or part thereof, exempt from taxation … is leased or is otherwise a source of revenue or profit, all of such buildings and land shall be liable to taxation." The court concluded that the charity's lease of its property to the hospital caused the property to lose its tax-exempt status.
The court suggested that a charity's property tax exemption may not be affected if property is leased to another charity for an "incidental" fee, and the rental income is used to "immediately and directly promote the objects and purposes" of the charity. It concluded that this potential exception was not available in this case, for two reasons. First, the amount of rent received from the hospital was not incidental. And second, it pointed out that any rental income received by a charity will be used for the charity's exempt purposes. But this fact is irrelevant, since "it is the use to which property is put, not the use to which profits that are realized from such property are put, that determines whether the property shall be exempt." This principle applies even though the lessee is a tax-exempt organization.
Relevance to church treasurers. Does your church rent a portion of its premises to one or more outside groups? If so, you need to recognize that such an arrangement may jeopardize your property's tax-exempt status. Consider the following:
* Check the property tax exemption statute under your state law. It will describe the consequences of leasing your property. Most statutes provide for a loss of exemption if the property is leased.
* In some states, your property's tax-exempt status may not be affected if you lease the premises to another charity that pays you a "facilities use fee" designed to compensate you for your actual costs (such as utilities, insurance, and custodial services). It can be argued that such an arrangement is not a "lease" in a technical sense, since the church will realize no profit. Check with a local attorney, or with your tax assessor's office, to see if such an exception is recognized in your state. If so, then have an attorney assist you in drafting a standard "facilities use" agreement that bases your fee on actual costs.
* Be sure to consider other legal and tax issues, including (1) the unrelated business income tax, (2) zoning law, and (3) liability issues associated with injuries on your premises while being used by the lessee organization. Mariner's Museum v. City of Newport News, 495 S.E.2d 251 (Va. 1998).
