How Can a 501(c)(3) Rent Property?

By Larissa Bodniowycz, J.D.

How Can a 501(c)(3) Rent Property?

By Larissa Bodniowycz, J.D.

A nonprofit organization can usually rent property from a third party without issue, just like any other entity. However, there are some restrictions on a nonprofit's ability to rent out real property to a third party.

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Renting Property to a Third Party

A nonprofit organization is usually tax exempt under Section 501(c)(3) of the United States Internal Revenue Code and may accept tax-free donations. A nonprofit must utilize all revenue to operate the organization.

The organization itself cannot generate a profit, but it can rent out real property it owns (for example, physical buildings and structures), receive rental income, and utilize that income in operating the nonprofit. While rental income from real property is generally tax exempt, this rental income may become taxable depending on factors, such as the tenant's activities and whether the nonprofit provides services to the tenant.

Types of Activities and Investments

The best way to understand the key issues related to nonprofits' ownership of a rental property is by example. Let's say a religious organization owns a church building. The organization may rent out the church to a third party for events whether that third party is nonprofit or for-profit. However, the church could be taxed on the rental income from the rental arrangement. The question is whether the tenant's activities are “related" to the church's purpose.

If the activities contribute substantially to the organization's purpose, the rental income will not be taxed. For this reason, it is important for the organization to use its property for activities that further the church's purpose as a religious organization. If the activities are unrelated to the church's mission, the rental income may be subject to federal taxes as “Unrelated Business Taxable Income" (UBTI).

There is also a question of whether the rental investment is active or passive. Renting out real estate is generally considered a passive investment, and is thus tax exempt, as the church is merely operating as a landlord. However, providing personal services beyond the rental of space would likely generate taxable income. If the church were to provide resources or staff to the tenant, the rental may be considered an “active" investment because the church would be providing substantial personal services for unrelated activities.

Other Considerations

Additionally, the rental agreement cannot involve terms that provide for rental income based on the tenant's profits from the property. Any rental income tied to the success of the tenant is not tax exempt, as this arrangement could be considered a joint business venture.

Even if the church is taxed on rental income as unrelated business taxable income, the church will not lose its 501(c)(3) tax-exempt status unless the church substantially engages in for-profit activities unrelated to the church's purpose.

Other restrictions apply that may subject a nonprofit's rental income to the unrelated business income tax, including considerations of whether the property is debt-financed and whether the tenant is a controlled organization. Due to the complexity of the issue, it is best to consult with a nonprofit attorney or tax professional to determine whether the rental income is tax exempt.

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