Our 501(c)(3) charity is expanding and looking for new office space. Our founder and current president owns an office building and is willing to lease us space for a good price if we make some serious tenant improvements. Should we do it? —From our Real Estate Planning webinar.
You have a couple of key tax questions to resolve at the outset. You say you are a 501(c)(3) charity, but don’t say whether you are a public charity or a private foundation. If you are a private foundation, a lease for any rent from the founder and president, who is by definition a “disqualified person,” would be a self-dealing transaction that could result in serious penalties for the founder and any foundation manager who approves it. Failure to correct the transaction could ultimately lead to the foundation’s loss of exemption. (See Ready Reference Page: “Private Foundations Must Avoid Self-Dealing”) The foundation would be required to report the transaction on its annual Form 990-PF and there could be additional penalties if not reported.
If you are a public charity, the founder-president is still a “disqualified person” with respect to the organization, but the excess benefit tax rules do not effectively prohibit the lease if the “good price” is reasonable. A tax would be imposed only if the rent exceeds the fair market value for a lease of the property. You will want an independent appraisal to assure that the rent is fair market value or less. Be sure that if you are providing significant tenant improvements, their benefit to the landlord does not make the total rent payment unreasonable, and that if the lease terminates early for any reason, the landlord has to pay you back for the value of the remaining life of the improvements.
If you get past the tax issues, there is still a question whether you really want to do it. What happens if the founder has a falling-out with the board and gets removed from office? The consequence for a business office may be more easily rectified than the consequence for the rental of a farm for an animal rescue, but the personal strain with your landlord is likely to continue long beyond the falling-out. This doesn’t mean you necessarily shouldn’t do it, but the likelihood and the possible consequences are additional things to consider.
You may want to include a provision in the lease that the charity has the option to terminate if the president ceases to be a member of the board. If you ask for such a provision, the president will probably ask to a similar one, so just make the right reciprocal on an acceptable reasonable notice.
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