Letter Ruling 9651014
Background. Many churches have received gifts of land that they later would like to sell. Does the sale of such property jeopardize the church's tax-exempt status? Must the church pay the federal "unrelated business income tax" on the sales proceeds? These are important questions that were addressed by the IRS in a recent ruling.
The IRS ruling. A school was given 7 acres of land by a donor with the understanding that the school would use the land for school purposes and not sell it unless absolutely necessary. The school attempted to lease the property for many years, but the school's trustees eventually decided that the land had to be sold. The school asked the IRS if its tax-exempt status would be affected by the sale, and if the sales proceeds would be subject to the unrelated business income tax.
The IRS ruled that the school's exempt status would not be affected by the sale, since: (1) the sale would be an "insubstantial part" of the school's overall activities, and (2) the school would continue to be operated exclusively for exempt purposes.
The IRS also ruled that the sale of the land would not trigger the tax on unrelated business income. This tax is imposed on earnings generated by exempt organizations from an "unrelated trade or business" that is regularly carried on. There are a number of exceptions. For example, the tax code specifically exempts from this tax "all gains from the sale of property" other than "property held primarily for sale to customers in the ordinary course of the trade or business." The IRS referred to a Supreme Court ruling addressing the question of when property is held "primarily" for sale to customers in the ordinary course of business. The Court interpreted the word "primarily" to mean "of first importance" or "principally." The IRS concluded that "by this standard, ordinary income would not result unless a sales purpose is dominant." The IRS concluded that this standard had not been met in this case because of the following factors:
• the land was held for "a significant period of time" before it was sold (contrary to the "short turn around period experienced by a typical buyer and seller of property")
• the school did not "regularly sell real estate"
• the school's "management activities with respect to the property have been minimal," and have consisted of collecting rents and providing routine maintenance and repairs
• the school had not been "involved in any way with improving the land or providing services to tenants"
The IRS concluded that "these facts distinguish [this sale] from the sale of property held primarily for sale to customers in the ordinary course of business." Therefore "income from the sale of this property is excluded from the computation of unrelated business taxable income."
Relevance to church treasurers. Church treasurers often wonder if gains realized from the sale of church property are taxable. This ruling illustrates an important point—any gain realized by a tax-exempt organization from the sale of property is not taxable as unrelated business income unless the gain is from the sale of property "held primarily for sale to customers in the ordinary course of the trade or business."
Churches that realize gain from an occasional sale of donated property, or from the sale of current property as part of a relocation, ordinarily will not be subject to the tax on unrelated business income since the property in such cases is not "held primarily for sale to customers in the ordinary course of the trade or business."
Key point. The factors identified by the IRS in this ruling will be a helpful yardstick that church treasurers can use to evaluate whether a sale of property may be subject to the unrelated business income tax.
There are situations in which a church could be subject to the tax on unrelated business income as a result of gains realized from the sale of property. For example, assume that a church receives a large tract of donated property and subdivides it into individual lots that it attempts to market as a revenue-making project. It is likely that any gains realized from the sale of the lots would be taxable since the property in such a case could be viewed as "held primarily for sale to customers in the ordinary course of the [church's] trade or business."
Recommendation. If you have any question regarding the application of the unrelated business income tax to a particular transaction, consult with a tax attorney or CPA.