The Neighborhood Land Rule lets tax-exempt organizations acquire and hold real estate in the same neighborhood as the primary organization without taxation if the property meets certain criteria. Typically, income-producing properties are subject to unrelated business income tax (UBIT) for debt-financed property. The Neighborhood Land Rule negates the UBIT. Here are the criteria that must be met to qualify:
– The organization must intend to use the property for tax-exempt purposes.
– Development must occur within 10 years.
– The property must be within a mile of the present location.
– The Neighborhood Land Rule only applies after the first five years if the organization provides written intentions to the IRS that detail the improvement plan and anticipated completion date. The organization must provide information about plans to the IRS at least 90 days prior to the end of the fifth year after acquisition.
– After 10 years, the Neighborhood Land Rule no longer applies.
– If the property is debt-financed and invokes the Neighborhood Land Rule, the organization is not subject to unrelated business income tax on any rent or royalty income earned on the property within 10 years of acquisition.
– The organization must remove or demolish existing structures on the property if they are not suitable for use prior to development. If structures are not removed or demolished for the furtherance of the organization’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 tax-exempt organization during the holding time between purchase and development.
– If the organization 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 rules for churches regarding the Neighborhood Land Rule are somewhat different than nonprofit organizations. See an explanation of rules for churches on the Faithful Steward blog.