UBIT - Renting Facilities to a Christian School

Q: A private Christian school wants to rent some classroom space in our church facility. Will our church be subject to taxes for unrelated business income?

A: Even though churches are recognized as tax-exempt organizations, they may be liable for tax on unrelated business income. If a church has $1,000 or more in gross income from an unrelated business, it must file Form 990-T, Exempt Organization Business Income Tax Return. And if the church expects its tax to be $500 or more, it must estimate that tax and pay it quarterly.

There are several criteria to determine if income is subject to the unrelated business income tax (UBIT). According to the IRS, an activity will be considered an unrelated business (and subject to unrelated business income tax) if it meets three requirements:

1. It is a trade or business,
2. It is regularly carried on, and
3. It is not substantially related to the exempt purposes of the organization.

There are a few exclusions, like dividends, interest, and gains or losses from selling property. Rental income from real property is also excluded (but rental income from personal property is not). However, if the income is derived from debt-financed property, meaning the property is subject to “acquisition indebtedness,” such as a mortgage, then the income could be subject to UBIT, unless a specific exception exists. Some of these exceptions include:

• The property is used at least 85% of the time for exempt purposes.
• The business is operated for the convenience of the organization’s members or employees.
• The business is performed substantially by volunteers.

Therefore, income from a cafeteria would be excluded from UBIT, as would income from a volunteer-operated bake sale. With respect to the original question that was posed, the church may not be subject to UBIT for several reasons. If the church has a mission of providing Christian discipleship or education opportunities to the community, then renting the facility to a private Christian school may align with the exempt purposes of the church.

Further, the IRS excludes rental income on real property from UBIT, as long as the property is not debt-financed. However, if the church property has a mortgage, we must determine if any other exceptions apply, such as the property is used at least 85% of the time for religious purposes.

Due to the IRS’s complex rules and the unique circumstances that each scenario presents, it may be beneficial to seek guidance from a local CPA or lawyer. Further, besides UBIT, there may be other issues to consider, such as zoning, property tax exemption, and legal liability. A local expert, familiar in nonprofit and legal issues, can help navigate all of these issues.

Additional Resource

The IRS has a page dedicated to unrelated business income tax found here, including several publications and instructions for filling out Form 990-T.

Chapter 12 in Richard Hammar’s annual Church and Clergy Tax Guide also discusses UBIT and provides further guidance.