Tax-exempt organizations are able to take advantage of the IRS’ Neighborhood Land Rule which offers protection from unrelated business income tax (UBIT) for debt-financed property when certain conditions apply. Here are the rules as they specifically apply to churches:
– A church may purchase property to use for tax-exempt purposes and has up to 15 years to develop the property.
– If the property is debt-financed and invokes the Neighborhood Land Rule, the church is not subject to unrelated business income tax on any rent or royalty income earned on the property. (The church may earn income from the existing structures or mineral rights without UBIT if the property will be used for tax-exempt purposes within 15 years of acquisition.)
– The property does not have to be in the same ‘neighborhood’ as the church. (For non-church tax-exempt organizations, the property must be within a mile of the present location.)
– The church must provide written intent for tax-exempt purposes to the IRS. Notification must happen at least 90 days prior to five years after acquisition of the property. A ruling must be requested from the IRS with regard to specific improvements and anticipated completion dates.
– The church must remove or demolish existing structures on the property if they are not suitable for church use prior to development. If structures are not removed or demolished for the furtherance of the church’s purpose, then the Neighborhood Land Rule does not apply.
– The Neighborhood Land Rule does not apply to structures erected on the land after acquisition. The intent is to ‘protect’ the church during the holding time between purchase and development.
– If the church purchases property for income purposes and later uses the property for exempt purposes, they can apply for a refund or tax credit for a prior tax year.
The key to tax-exemption is preventing the property from being considered debt-financed land. By being aware of the Neighborhood Land Rule criteria, churches can plan for future expansion and reduce tax burden at the same time.