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Legal
Counsel > For Congregations >
Tax Exemptions > Rental Income
Since 1969, churches have been
subject to the Unrelated Business Income Tax (UBIT) for federal
income tax purposes, to the same extent as other 501(c)(3)
tax-exempt organizations. A church that is liable for UBIT must file
an IRS Form 990-T by the 15th day of the 5th month following the end
of its fiscal year.
Section 511 of the Internal Revenue
Code of 1986 (Code), as amended, imposes the corporate tax rate on
Unrelated Business Taxable Income (UBTI). UBTI is defined in Code
Section 512. Rental income is excluded from taxation under Code
Section 512(b), unless the rental income is derived from
Debt-Financed Property (DFP) (as defined in Code Section 514) that
is subject to outstanding Acquisition Indebtedness (AI) incurred in
acquiring or improving the property. If a congregation is debt free,
none of its rental income could be derived from DFP subject to AI,
since there obviously is no outstanding debt. Therefore, a
congregation that is debt free will not incur any liability for UBIT
with respect to its rental income.
There are exceptions that may remove
rental income from taxation, even when the church has outstanding
AI. These exceptions are complicated and may be difficult to apply
in specific situations. Only two are mentioned here. One is where
more than 85 percent of the use of the DFP is devoted to the
church's exempt purposes (see Income Tax Regulation
§1.514(b)-1(b)(1)). A second exception is where the rent is
received from a related organization for an exempt purpose use (see ITR §1.514(b)-1(c)(2)). An example of a related organization is a
separately incorporated school whose board of directors is elected
by the congregation.
Where the church does have
outstanding AI, and none of the exceptions apply, some or all of the
"net" rental income will be subject to taxation.
"Net" rental income is the gross rents less allowable
deductions, including depreciation, attributable to the rented
space. The percentage (never more than 100 percent) of
"net" rental income that will be subject to taxation is
determined by the following fraction: Average outstanding AI Average
adjusted basis
Average adjusted basis is the cost of
the property including improvements reduced by accumulated
depreciation allowable.
It is strongly recommended that a
congregation secure the services of a competent tax professional if
it has or believes it may have exposure for UBIT.
This explanation on federal income
tax consequences of a congregation leasing its property was prepared
in February 1998, by Mr. David J. Hardy, senior attorney, in the
Office of the Secretary of the Evangelical Lutheran Church in
America, 8765 West Higgins Road, Chicago, IL 60631. It is
informational only and may not be considered legal advice.
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