Posted by Christina Bell, CPA
The IRS defines unrelated business income (UBI) as income from a trade or business regularly carried on by a nonprofit organization that is not substantially related to the performance by the organization of its exempt function. One source of UBI is rental income; however, not all rental income is subject to unrelated business income tax (UBIT). So how is a nonprofit to know if the rental income they receive is subject to UBIT? A few general rules are listed below. In addition, IRS publication 598 details all rules and regulations governing UBI, including income from rental property.
- Rental income from real property is excluded from UBI if there is no acquisition indebtedness on the property. Acquisition debt is defined as the unpaid debt incurred by an organization (1) when acquiring or improving property, (2) before acquiring or improving property if the debt would not have been incurred except for the acquisition or improvement, or (3) after acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement. Acquisition debt also includes liens similar to a mortgage. A lien is similar to a mortgage if titled to property encumbered by a lien for the creditor’s behalf such as a security interest under the Uniform Commercial Code.
- Rental income from real property that is subject to acquisition indebtedness is excluded from UBI if 85% or more of the use of the property is substantially related to the organization’s exempt purpose. The percent of usage can be determined by dividing the time the property is used for exempt purposes by the total time the property is used (hours) or by dividing the part of the property that is used for exempt purposes by the part used for all purposes (square footage).
- Rental income from real property that is subject to acquisition indebtedness is excluded from UBI if the lessee is a related organization. For this purpose an exempt organization is related to another exempt organization only if:
- One organization is an exempt holding company and the other receives profits derived by the exempt holding company.
- One organization controls the other
- More than 50% of the members of one organization are members of the other
- Each organization is a local organization directly affiliated with a common state, national, or international organization that is also exempt.
- Rental income from personal property is included as UBI and subject to UBIT.
- Mixed leases, meaning leases that include both real and personal property, are subject to a 10% rule. The rule states that if rents attributable to personal property are not more than 10% of all rents received under the lease, all rents are excluded from UBI. If rents attributable to personal property are greater than 50% of all rents received under the lease all rents are included in UBI. If rents attributable to personal property are greater than 10% but less than 50% of all rents received under the lease, only the rents received attributable to the real property are excluded from UBI.
Nonprofit organizations should seek appropriate counsel or expertise when engaging in business activities, including the rental of real and personal property, to understand their consequences on UBI and ensure the entity can optimally engage in such activities without triggering any income taxes.