Each year I review all published and unpublished rulings by state appellate and federal courts pertaining to religious organizations and clergy. This research is laborious, because I categorize each case after reviewing it. But doing so reveals patterns, providing invaluable data each year on the top reasons why churches and clergy end up in court.
I recently finished my review of 2011 cases. The seventh-most common reason churches went to court is an issue I’m frequently asked about: challenges to property tax exemptions.
This should come as no surprise. In all the years that I have tracked church litigation, I have seen an inverse relationship between economic conditions and the number of cases addressing the application of property tax exemptions to property owned by religious organizations. As tax revenues decline amidst recessionary pressures, tax assessors look for additional revenue by more narrowly construing tax exemptions. Often, churches are caught in the crosshairs.
Little doubt exists regarding the exemption of buildings used exclusively for religious worship. Every state exempts such buildings from taxation. To illustrate, many state laws exempt “houses of religious worship.” Others exempt “places used for religious worship” or “buildings for religious worship” or “property used exclusively for worship.” Many states simply exempt all property used exclusively for religious purposes or religious worship. Such an exemption certainly is broad enough to include buildings used for religious worship.
Questions may arise, however, including:
- What if a portion of the church property is rented or otherwise used for commercial or investment purposes?
- If a portion of church-owned property is rented or otherwise used for nonexempt purposes, does the entire property lose its exempt status, or only the portion rented?
- What if the sanctuary is under construction?
Some, or all, of these questions may not be addressed in an exemption statute, and this can lead to confusion and even litigation. Those and other issues are addressed below.
1. Effect of rental income
Churches occasionally rent a portion of their property. How does this affect the exempt status of the property? Consider three scenarios:
(1) the partial exemption rule
Many states recognize the “partial exemption” rule. Under this rule, property that is used in part for exclusively religious purposes is entitled to a partial exemption based on the percentage of use or occupancy that is devoted to an exempt use. However, a few courts have ruled that if any part of a building is used for commercial purposes, the entire facility is subject to tax.
Case study. The education wing of a parish center used for Sunday school on Sunday but as a commercial child care center during the week was not used primarily for public worship and was denied exemption. Summit United Methodist Church v. Kinney, 455 N.E.2d 669 (Ohio 1983).
(2) rental of church property to another charity
Many churches operate preschool programs, and some allow outside contractors to create and staff a nonprofit program on church premises for a monthly rental fee. Some courts have ruled that the exemption is not affected if the contractor is a nonprofit corporation, since in such a case the property continues to be used for exempt purposes.
(3) use of rental income for exempt purposes
Some church leaders assume that church property retains its exempt status, even when rented to an outside group, so long as the rental income is used by the church for its exempt purposes. This is incorrect. Several courts have ruled that it is the nature of the rental activity, and not the use of rental income, that determines the tax status of church property.
2. Property under construction
Unfortunately, few property tax exemption statutes directly address whether a church building under construction is exempt from property taxes. One statute specifies that “all grounds and buildings used or under construction by … religious institutions and societies” (emphasis added) are exempt from tax. Iowa Code § 421.1 (2011). Another statute specifies:
[Church property] from which no revenue is derived shall be exempt though not in actual use therefore by reason of the absence of suitable buildings or improvements thereon if (a) the construction of such buildings or improvements is in progress or is in good faith contemplated by such corporation or association or (b) such real property is held by such corporation or association upon condition that the title thereto shall revert in case any building not intended and suitable for one or more such purposes shall be erected upon such premises or some part thereof. N.Y. Real Prop. Tax Law § 420-a (2010).
Not all states favor churches, though:
Case study. A church purchased property that it was renovating for church use. The Nebraska Supreme Court ruled that the property was not entitled to exemption. St. Monica’s v. Lancaster County Board of Equalization, 751 N.W.2d 604 (Nebr. 2008).
3. Leased property
Some churches lease the property they use for worship services and other activities. Most property tax exemption statutes only apply to property that is owned by a church or other specified charity. The fact that a church leases property does not ordinarily render the property exempt from tax.
Some statutes refer to property that is used for religious purposes. Property leased by a church for religious purposes may qualify for exemption under such a statute.
Case study. An Illinois appeals court concluded that a building leased by a church for use as a sanctuary by its parishioners was exempt from property taxation under Illinois law based on its use. Faith Christian Fellowship v. Department of Revenue, 589 N.E.2d 796 (Ill. App. 1992).
A parsonage is a church-owned property used as a residence by a minister. Many states exempt such properties from taxation. Some states impose restrictions on the exemption. For example, a few states exempt parsonages only up to a specified dollar value, exempt only one parsonage for each church, or exempt the grounds surrounding a parsonage only up to a specified area. The exemption does not extend to residences owned by ministers themselves.
Generally, the courts have concluded that a church is not limited to one parsonage. As a result, unless the state property tax law specifies otherwise, a church having two or more full-time ministers may provide a tax-free parsonage to each. See, e.g., Congregation B’Nai Jacob v. City of Oak Park, 302 N.W.2d 296 (Mich. 1981); In re Marlow, 237 S.E.2d 57 (S.C. 1977); Cudlipp v. City of Richmond, 180 S.E. 525 (Va. 1971).
5. Vacant land
Churches often acquire vacant, unencumbered land for future expansion. The tax status of such property has presented a difficult, but common, problem for the courts (see “The IRS Addresses the Neighborhood Land Rule” in the May 2012 edition of Church Finance Today). Several courts have affirmed the exemption of such property.
Case study. The Kentucky Supreme Court ruled that a 10-acre tract of largely vacant property that a church had acquired for future expansion was exempt from property taxation due to its occasional use for church purposes. Freeman v. St. Andrew Orthodox Church, Inc., 294 S.W.3d 425 (Ky. 2009).
A number of courts have held that vacant land ordinarily is not used exclusively for religious purposes and does not qualify for exemption. This almost always will be the result if the land is used for commercial purposes (such as farming) or if no religious or charitable activities occur on the land or such uses are insignificant.
Case study. The Minnesota Tax Court ruled that there was insufficient support for the exemption of three church-owned wooded lots from property taxation to grant the church’s motion for summary judgment in its favor. The church claimed that the lots were devoted to, and reasonably necessary to, the accomplishment of church purposes, such as prayer, reflection, and Christian education, including a Vacation Bible School. Advent Evangelical Lutheran Church v. County of Ramsey, 2008 WL 3892374 (Minn. Tax Court 2008).
6. Application for exemption
The fact that a religious organization has received a determination letter from the IRS acknowledging that it is exempt from federal income taxation as an organization described in section 501(c)(3) of the tax code does not necessarily entitle the organization to a property tax exemption. In most states, an exemption application must be filed with local tax authorities. Failure to do so will result in loss of exemption, at least for the current year.
The Minnesota Supreme Court ruled that a church’s property was not exempt from property taxes since it had not been “acquired” by the assessment date of July 1 as required by state law. The court rejected the church’s arguments that an oral understanding to acquire the property, plus the signing of a letter of intent with the seller, satisfied the “acquisition” requirement. Crossroads Church v. County of Dakota, 800 N.W.2d 608 (Minn. 2011).
Case study. The Nebraska Supreme Court ruled that a church can be denied exemption from real estate taxes as a result of its failure to file an application for exemption. The court relied on the United States Supreme Court ruling that those “claiming the benefits of the religious-organization exemption should not automatically enjoy those benefits. Rather, in order to receive them, [they] may be required by the state to provide that [they] are a religious organization within the meaning of the act.” Indian Hills Church v. County Board of Equalization, 412 N.W.2d 459 (Neb. 1987).
In most states, property acquired by a church after the tax assessment date is not entitled to exemption for the current year, even though it is used exclusively for religious purposes. A few courts have reached the opposite conclusion based on the wording of the exemption statute.
7. Fees and special assessments
Does a state or local government have the authority to assess a fee or special assessment against church property in lieu of a direct tax? A few courts have addressed this question, with conflicting results.
Case study. A Florida appeals court ruled that churches can be required to pay special assessments only if their property is directly benefited. The court concluded that fees imposed on churches for fire and rescue services met the definition of a special assessment and therefore could be assessed against a church consistently with the church’s exemption from property tax. Sarasota County v. Sarasota Church of Christ, 641 So.2d 900 (Fla. App. 2 Dist. 1994).
Case study. A Wisconsin court ruled that a city could assess a fee against all utility customers, including churches, to pay for the cost of providing water in the event of a fire. It concluded that the additional charge added to utility customers’ bills was a fee rather than a tax. River Falls v. St. Bridget’s Catholic Church, 513 N.W.2d 673 (Wis. App. 1994).
Need more information? Property taxes are addressed in Richard Hammar’s Church & Clergy Tax Guide.