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Are sale-leaseback arrangements legal/ethical for nonprofits?

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Are sale-leaseback arrangements legal/ethical for nonprofits?

I am on the Board of a 501(c)(3) private school that has nine buildings on its campus. Many are in need of modernization and the finances of the school do not allow that at the moment. The Chair wishes to 'sell' the main administration building to a contractor/consultant for $1 and then let the contractor get the financing to upgrade the building. The contractor will then 'lease' the building back to the school until the cost is paid. I do not think it would be legal or ethical and would harm the nonprofit status of the school as donors would donate to a capital campaign to improve the building in question but the building would not be owned by the school. Would donors still be able to take a tax deduction? What are your thoughts on this scheme?

I am generally not a proponent of the sale-leaseback approach for charities, especially those that are identified with a specific location and integrated with other buildings at that location, like a private school, college or medical center.  There are a lot of negatives.  First, to make the deal work for tax purposes for the developer, you have to buy the building back at fair market value at the time of the sale back, not the cost of the improvements.  That will probably make it more expensive, perhaps considerably so. Second, you are probably converting property that is exempt from real estate tax because it is owned and operated by a charity into property that is subject to real estate tax because it is owned by a for-profit business.  That makes the monthly rent more expensive.  Third, if your developer defaults on the mortgage or goes bankrupt, which could happen for reasons totally unrelated to your paying the rent, you might lose Old Main in the center of your campus to a purchaser at the foreclosure or bankruptcy sale who would use it for a totally unrelated — and offensive — purpose.  I could go on, but these would be enough to scare me away.

If you go the sale-leaseback route, and some do, it is not likely that you will lose your exempt status (unless the deal is so good for the developer that it is considered private inurement).  And you can structure a capital campaign to raise funds for capital improvements to your leasehold interest so that donors will get a legitimate deduction.  But look at the numbers and the risks carefully before you proceed.  There are probably better alternatives.

Wednesday, August 27, 2014

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