Q: A home school wants to rent a portion of our church. It’s a for-profit organization. We have the space and are considering the offer. However, we do not want to risk our tax-exempt status with either the IRS or the county.
We read an earlier On Nonprofits, “Renting Space to a For-Profit Company,” which covered a lot of valuable ground. While it touched on the circumstances under which an organization that rents its space would have to pay unrelated business income tax (UBIT) on its income, it doesn’t specify the rate of rent we can safely charge to avoid payment of UBIT. Is there some sort of guide? Also, we are curious if there are any lease conditions we should be sure to consider. Finally, we are concerned that “rent” is not normally listed as a “related service” in the not-for-profits exemption application, which focuses instead on products and services. Can you fill in some of the blanks?
A: I can try, but I must begin with a disclosure that I’m not an attorney. Even if I was, information shared in a column like this cannot be taken as a legal advice, especially since laws differ in different locales. That being said, let me wade into the water using the IRS Publication 598, “Tax on Unrelated Business Income of Exempt Organizations,” as a guide. (You might want to check it out as well.)
As I indicated in the previous article you reference, you don’t have to worry about your tax-exempt status on the federal level. In some states it might jeopardize your real estate tax exemption.The biggest issue is whether you would pay UBIT. Three factors will determine whether you would owe any UBIT: whether you have a mortgage or other debt financing on the church; whether the school helps you fulfill your mission in some way; and whether you are charging fair market value for the space.
If you owe no debt on the property you would owe no taxes on any rental income you receive. But, assuming you do have a mortgage, you can still receive an exemption as long as you don’t rent out any more than 15 percent of your space.
There is no UBIT if the for-profit activity helps you meet your mission. For example, nonprofit organizations offering job training often open for-profit businesses in which their clients can work to gain the necessary skills to make them marketable in the greater community. Profits from the for-profit businesses are then typically fed back to the nonprofits to provide yet additional training for others. Conceivably, the school looking to rent space from you could offer such a synergistic relationship.
As a final means of avoiding a tax liability, be sure that you are charging rents that are equivalent to others in the area. Consider not only the price per square foot, but also any amenities you are offering, such as utilities and parking. In the earlier article I warned you away from providing any furniture, equipment, or even janitorial services. Today there are many office spaces that do provide these necessities. If you opt to include any of this, be sure you can demonstrate that the rent comparisons you come up with are apples to apples. This means you will have to do some research. Ultimately, the board is responsible for setting the rent, remembering its duty of care – that all its decisions are made in the best interest of the church.
One comment I made about UBIT in the previous article is worth repeating here… It’s not the worst thing in the world to have to pay. It means you have made money, and that’s a good thing! However, it can be tricky to determine what to report and how much you would owe. You will find instructions on Form 990T, but you probably should get some professional help to be sure you have calculated everything correctly and are reporting everything on the proper schedules.
As to the question about any lease conditions, I’d get help from a real estate attorney. There are a few things that come to my mind that I would specifically ask the attorney about. The first is requiring the for-profit to pay any local real estate or personal property taxes that are incurred directly as a result of this rental arrangement. Second is being held harmless if someone is physically injured at the school, or a teacher or an administrator at the school sexually harasses someone. (You might still want to beef up your own liability insurance.) The third is what might be deemed “common property” and how to share that space equitably. For instance will the school be allowed to use the church’s kitchen? If so, how will the liability for that be shared? Which entity gets use of the kitchen if both require it at the same time? How will you handle disputes about cleanliness or the disappearance of one party’s paper goods or staples? Fourth, how will you deal with policies or actions of the school that may go against your religious principles?
Lastly, you raised the issue of rent not being ‘listed as a “related service” in the not-for-profits exemption application, which focuses instead on products and services.’ I’m not sure that’s relevant in this case, since I assume you already have your designation as a religious institution. That application is only for those who are first applying for nonprofit status. Rest assured, the IRS is seeing a lot of nonprofits looking to raise additional income through the rental of extra space. They have a specific line on the 990 – Line 6, Section VIII – on which to report it.