Unrelated Business Income (UBI): The Nonprofit Curse Word
By Corey Pless, Tax Senior
If you took a poll of 100 people, my guess is very few (if any) would volunteer to give a portion of their earnings back to the government. Now imagine those earnings were going to help children in need, educate the next generation or feed homeless families. We would be even less willing to volunteer to give the government these earnings. As nonprofit organizations attempt to find additional avenues for revenue, we should always be aware of those streams of revenue that could potentially lead to Unrelated Business Income (UBI). But, there are sources of revenue that are excluded from UBI:
- Gains on Dispositions of Property
With the IRS, there are always exceptions to and exemptions from the rules. I want to focus on a few exceptions to the rental exclusion that could catch an organization in a UBI trap.
Debt Financed Property
Debt finance property occurs when an exempt organization uses debt to acquire or improve property held to produce income. This acquisition debt can be incurred at three different times in the acquisition or improvement of the property:
- During the acquisition or improvement of the property;
- Before acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement; and,
- After acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement and incurring the debt was reasonably foreseeable when the property was acquired or improved.
The debt incurred does not have to be secured by the property. For example, you can pay cash for a property but if you had to take out a line of credit to pay other bills and debts, the property would qualify as debt financed property. Schools, as defined in Section 170(b)(1)(A)(ii), are exempted from the debt financed property exception along with their affiliated support organizations. If an organization acquires real property with the intention of using the land for exempt purposes within 10 years, it will not be treated as debt financed property if it is in the neighborhood of other property the organization uses for exempt purposes. To calculate the debt financed income, take the average acquisition indebtedness divided by the average adjusted basis multiplied by the gross income from the debt financed property.
Example: Not for Profit, Inc. owns an office building that is debt financed property. The gross rental income last year was $10,000. The average adjusted basis of the property was $100,000 and the average acquisition indebtedness of the building was $30,000. The debt/basis percentage was 30% (the ratio of $30,000 to $100,000). Therefore, the unrelated debt financed income from the rental of the building was $3,000.
Dual Use Facilities
When using facilities for both exempt and nonexempt purposes, an organization could run into UBI issues. When an organization has dual use of facilities, expenses must be allocated between exempt and unrelated. These expenses must be applied on a reasonable basis and must be consistent. Each expense must have a proximate and primary relationship to the unrelated business. There are three ways to allocate expenses for the unrelated portion: Space Based, Time Based and Unit Based.
- Space Based – Using the square footage of the area used
- Time Based – Using the amount of time spent for exempt purposes compared to unrelated purposes
- Unit Based – Using exempt purpose units compared to nonexempt purpose units
- Example: Student/Faculty golf rounds (exempt) compared to public golf rounds (nonexempt) at a university golf course
While rents of real property (other than what is described above) is excluded from UBI, there is no exclusion for rentals of personal property. This could become confusing and unclear when there is a rental of both real and personal property. The IRS has outlined how to handle the mixed lease of renting personal property with real property.
- If the rents associated to the personal property are not more than 10% of the total rents, the personal property rents are considered de minimis and all rents are excluded from UBI.
- If the rents associated to the personal property are more than 10% but not more than 50% of the total rents, only the rents attributable to the personal property are subject to UBI tax.
- If the rents associated to the personal property are more than 50%, all rents, real and personal property, will be subject to UBI tax.
If you have any questions about unrelated business income, don’t hesitate to contact us at HoganTaylor.