It’s common for nonprofits to compare their activities to other nonprofits in hopes of determining whether or not the activity is appropriate. While it can be a good place to start, you can’t necessarily rely on what other organizations are doing to guide decisions for your organization since nonprofit rules are dependent on so many factors. Consider rental income, for example.
Let’s say your organization purchased a van to make deliveries to needy people in your community. However, the van is only used Monday – Friday and sits idle on the weekends. As a way to earn some much-needed additional income, your organization decides to rent out the van to moving companies on the weekends for $100/day. You’re aware that certain income may be taxable to nonprofits, but the nonprofit across the street recently mentioned that they rent office space to a for-profit business and were advised that rental income is not taxable. You feel confident about the decision until one of your board members asks whether this income is taxable since it meets all three of the factors for unrelated business taxable income: it’s not part of the exempt purpose of the organization, is regularly carried-on and is intended to make a profit. So who is right? Is rental income taxable to a nonprofit or not? The answer is much more complicated than you might initially think.
The first step is determining whether the property being rented is tangible personal property or real property. Tangible property is generally taxable while real property (ie. land and buildings) are generally not taxable. However, if the real property is mortgaged, rental income from that property will typically be taxable unless you’re renting out less than 15% of the space or the time the area is rented is less than 15% of the total time the space is available. A common misconception is that renting debt-financed space to another nonprofit is not taxable. Unless that nonprofit is related to your nonprofit or has purpose that contributes importantly to exempt purpose of your organization, the fact that they are a nonprofit does not matter. Renting debt-financed space to anyone is taxable income if the rental does not further your exempt purpose. Keep in mind that the rental activity itself must further the exempt purpose; simply using the proceeds for your mission will not satisfy this requirement.
Even if your building is not debt-financed, rental income may be taxable if your organization is providing a substantial amount of services in addition to the space. This includes cleaning, event management, accounting, etc. Parking lot rental may be taxable if the land is debt-financed or if your organization is renting parking spaces instead of the lot. Rental of a parking space to a neighbor will generally be taxable since it is considered a bailment arrangement instead of a rental of land. Rental of an entire parking lot after business hours may not be taxable if your organization is not providing services, the renter accepts full liability and the lot is not mortgaged.
Rental of tangible property, including furniture, equipment, vehicles and other movable items is generally taxable if the rental is not directly accomplishing the exempt purpose of the organization. Rental income will not jeopardize the exempt status of your nonprofit unless it appears that your organization exists for the rental purpose instead of the exempt purpose. Factors to consider include how much staff time, building space and/or money is devoted to the rental activity. The amount of money earned from the activity is not as important to the IRS as the amount of exempt purpose resources used for the activity. It’s also a good idea to protect the nonprofit by establishing criteria about how the property can be used and who may use it; bad publicity tied to the use of a nonprofit vehicle for unlawful activity could damage the organization’s reputation.
In general, rental income can be a great source of unrestricted revenues for a nonprofit. However, don’t forget to consider the potential tax consequences of certain activities and track any related expenses in order to minimize the tax burden.
