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Will we lose exemption for lease?

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Will we lose exemption for lease?

Our 501(c)(3) child care facility wants to allow another 501(c)(3) agency to take over management of the child care program. We have a mortgage on the building and will "lease" it to the other agency to continue our mission. Is this legal? Will we have to pay real estate taxes or lose our (c)(3) status?

It would certainly be legal to lease your facility to another to carry out your mission. The tax question would be how to characterize the income from the rental. Ordinarily, rental income is not unrelated business taxable income and not subject to unrelated business income tax (UBIT) if the rental is related to the charitable purpose of the landlord or, even if unrelated, if the property is not mortgaged. Since it is arguably within your charitable purpose, it may be program service revenue, although I don’t have enough information to be sure of that. Whether related or unrelated, you would probably need to carry out additional programming and have other income to avoid being classified as a private foundation. (See Ready Reference Pages: “Nonprofits Often Worry About UBIT” and “Calculating Public Support Percentage”)
Whether you would lose your local real estate exemption is a matter of state law. Some states require that the owner and charitable user be the same entity; others permit exemption only if both are charities; others permit exemption if the property is used for charitable activity without regard to ownership. You may want to check with your local assessor about the consequences of a lease.
You might avoid all of these issues by contracting with the other agency to manage your program. You would be ultimately responsible for the operation and would have to oversee the management, but if you are trying to get rid of the day-to-day headaches, it might be a way to go.
Tuesday, March 9, 2010

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