Q&A: Rental of Church Facilities

Does charging money for ministry space threaten our tax exempt status?

My wife has worked for a church-run preschool for 10 years. The church was going to close the program when the program director retired. My wife and another teacher asked the church if they could take over the program and make it private. The church said “yes,” and my wife formed an LLC. The church, which is separate from the preschool building, has allowed them to use the old school building, which is less than 1000 sq. ft in size. They are paying the church $140 per month for rent and water bill. All other utilities and expenses are paid by the LLC. There are a few members of the church who are now concerned that this could affect the church’s tax exempt status. Does this affect the churches tax exempt status since it is a nonprofit church collecting rent from a for profit business?

In any instance where a church rents or leases its facilities to a for profit entity careful consideration should be given to several areas of concern. The primary areas of concern are:

  • Determining a fair market rate of rental for the use of the facilities—Churches cannot allow their assets to be utilized in a for profit business without fair compensation for the use of the assets. Therefore, the rental rate for the property should be market rate for similar space in the area of the church. Below market rental can create an adverse consequence for the church.
  • Determining the income tax consequences of the payments received by the church for the rent received in light of all the rules surrounding unrelated business income tax. In some instances, rental income is not unrelated business income and in some instances, it is.
  • Reviewing the effects of the rental agreement on other areas; i.e., property tax exemptions and insurance coverage.

The potential issues can be vast and the resolutions can often depend on small factors that cannot be discerned when speaking in general circumstances. Therefore, this question should be considered by competent tax counsel who can review all the facts and circumstances of the specific instance and assist the church in evaluating all the above areas of concern.

The above information is current as of October 12, 2009.

Elaine L. Sommerville is licensed as a certified public accountant by the State of Texas. She has worked in public accounting since 1985.

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