Rental Income Not Taxable, Says IRS

Though only if certain conditions are met, IRS notes.

Church Finance Today

Rental Income Not Taxable, Says IRS

Though only if certain conditions are met, IRS notes.

A charity rented a portion of its premises to another charity with similar purposes. The IRS ruled that the rental income was not subject to the “unrelated business income tax” (UBIT), even though the property was “debt-financed,” since the rental arrangement was “substantially related” to the charity’s exempt purposes. The IRS noted that rental income received by a charity from “debt-financed” property generally is subject to UBIT. However, an exception applies to rental agreements that are substantially related to the charity’s exempt purposes. The IRS noted that “an organization’s leasing of its property to others may be substantially related to the performance of its exempt function.” This test was met, the IRS concluded, because the rental agreement “will contribute importantly to the accomplishment of [the charity’s] purposes” and will help further its “charitable goals.”

The IRS noted that a rental agreement will be “substantially related” to a charity’s exempt purposes if it meets any one or more of the following conditions:

(1) it has a “causal relationship to the achievement of exempt purposes (other than through the production of income)”

(2) it contributes importantly to the accomplishment of those purposes

(3) the entire property is devoted to the charity’s exempt purposes at least 85 percent of the time, or

(4) at least 85 percent of the property (in terms of physical area) is used for the charity’s exempt purposes. IRS Letter Ruling 9726005.

Key point. Church treasurers should apply these same considerations in evaluating whether or not rental income from debt-financed property is taxable.

Key point. Rental income from debt-free property is not subject to UBIT.

This article originally appeared in Church Treasurer Alert, September 1997.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.

This content is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. "From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations." Due to the nature of the U.S. legal system, laws and regulations constantly change. The editors encourage readers to carefully search the site for all content related to the topic of interest and consult qualified local counsel to verify the status of specific statutes, laws, regulations, and precedential court holdings.

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