Q: My wife has worked for a church-run preschool for 10 years. The church planned to close the program when the director retired. My wife and another teacher asked the church if they could take over the program privately. The church agreed, and my wife formed an LLC. They now rent the old school building—less than 1,000 square feet—from the church for $140 per month, including water. Other utilities and expenses are paid by the LLC. However, some church members are concerned this arrangement might affect the church’s tax-exempt status. How is rental income taxed, and does this arrangement pose any risks to the church’s nonprofit status?
Can Churches Rent to For-Profit Entities?
Churches can rent facilities to for-profit entities, but doing so requires careful consideration of potential legal and tax implications. The key areas to address include:
1. Fair Market Rental Rate
The rental rate must reflect fair market value for comparable spaces in the area. Allowing below-market rent to a for-profit business could lead to complications, including questions about whether church assets are being used appropriately. Fair compensation ensures compliance with nonprofit regulations.
2. Unrelated Business Income Tax (UBIT)
Rental income may trigger UBIT, depending on the nature of the agreement. Typically, rental income from real property is exempt from UBIT unless the property is debt-financed or includes services beyond basic maintenance. Consulting a tax professional is crucial to determine whether this income qualifies as unrelated business income.
3. Property Tax Exemptions and Insurance
Renting church facilities for commercial purposes could impact property tax exemptions, depending on state and local laws. Additionally, insurance coverage may need to be reviewed and updated to account for the new use of the property. A thorough review ensures continued compliance and protection.
Steps Churches Should Take
To avoid potential risks, churches should:
- Consult Tax Counsel: Engage a tax professional to evaluate the arrangement and ensure compliance with all relevant tax laws.
- Set Market-Rate Rent: Research comparable rental rates in the area to ensure the agreement reflects fair market value.
- Review Property Tax Rules: Confirm that the rental agreement does not jeopardize property tax exemptions under local laws.
- Update Insurance Policies: Ensure the church’s insurance covers potential liabilities arising from the rental agreement.
FAQs: How Is Rental Income Taxed for Churches?
1. Does rental income always trigger unrelated business income tax?
No, rental income from real property is typically exempt from UBIT unless the property is debt-financed or additional services are provided.
2. Can renting to a for-profit entity jeopardize tax-exempt status?
Not necessarily. However, below-market rent or activities inconsistent with the church’s mission could raise concerns with the IRS.
3. How does property tax exemption come into play?
Renting church property for non-religious purposes may affect property tax exemptions, depending on state and local laws.
4. Why is fair market rent important?
Charging below-market rent could be seen as an improper use of church resources, leading to potential legal and tax consequences.
In conclusion, understanding how rental income is taxed and its implications is vital when churches rent to for-profit entities. Seeking professional advice ensures compliance with tax laws and protects the church’s tax-exempt status.
The above information is current as of October 12, 2009.
