5 Ways Your Nonprofit’s Rental Real Estate Income Could Be Taxable

Not-for-profit organizations, recognized under Section 501(c) of the Internal Revenue Code, are generally exempt from federal income tax. However, not-for-profits with annual gross income above $1,000 stemming from activities unrelated to their exempt purposes — known as unrelated business taxable income (UBTI) — can in fact be subject to tax. One common source of UBTI is rental real estate. If your not-for-profit has rental real estate income, it’s important to understand the specific exceptions that may apply.

What is Unrelated Business Taxable Income (UBTI)?

UBTI is income generated from a trade or business that is regularly carried on and not substantially related to the organization's exempt purpose. See the definition of each component below:

• Trade or Business: Any activity conducted to produce income from selling goods or services.
• Regularly Carried On: Activities that show frequency and continuity.
• Not Substantially Related: Activities that do not significantly contribute to the accomplishment of the organization's exempt purposes, e.g., its mission or goals.

How Your Rental Real Estate Income Could Be Included in Your UBTI

Generally, rents from real property are excluded from UBTI if income is derived solely from renting real property and meets certain conditions. However, there are some exceptions. In fact, several circumstances can cause rental income to be included in your organization’s UBTI and potentially taxed:

1. Provision of Substantial Services to Lessees
   • If your organization provides services beyond those typically offered by a landlord, such as maid services or catering, the rental income may be considered UBTI. Routine services like maintenance and trash collection would not cause your rental income to be included in UBTI.
2. Personal Property Leased with Real Property (Mixed Leases)
   • When a lease includes both real and personal property, the tax treatment depends on the proportion of rent attributable to each:
     • If rents attributable to personal property are 10% or less of the total rents, all income is excluded from UBTI.
     • If more than 10%, but not more than 50%, is attributable to personal property, then the portion attributable to personal property is included in UBTI.
     • If more than 50% is attributable to personal property, all the income is included in UBTI.
3. Debt-Financed Property
   • Income from property acquired or improved with borrowed funds may be subject to UBTI. The portion of income treated as UBTI is proportional to the property's average acquisition indebtedness relative to its average adjusted basis.
4. Rent Based on Net Profits
   • If rent is based on a percentage of the lessee's net profits, it does not qualify for exclusion and, therefore, will be included in your UBTI.
5. Rent from Controlled Entities
   • Special rules apply to rents received from controlled entities. Under certain conditions, such rents may be included in UBTI.

While rental income from real property is generally excluded from UBTI, your not-for-profit must carefully assess its rental arrangements to ensure compliance with IRS regulations. Factors such as the provision of services, mixed leases, debt-financing, profit-based rent and relationships with lessees can significantly affect the tax treatment of rental income. Work with your tax advisers to stay informed and proactive so you can maintain your tax-exempt status while effectively managing rental income.

Contact Pargat Singh or a member of your service team to discuss this topic further.

In this blog Cohen & Co is not rendering legal, accounting, investment, tax or other professional advice. Rather, the information contained in this blog is for general informational purposes only. Any decisions or actions based on the general information contained in this blog should be made or taken only after a detailed review of the specific facts, circumstances and current law with your professional advisers.