- Publication 598 - Introductory Material
- Organizations Subject to the Tax
- The Tax and Filing Requirements
- Returns and Filing Requirements
- Payment of Tax
- Unrelated Trade or Business
- Trade or business.
- Regularly conducted.
- Not substantially related.
- Selling of products of exempt functions.
- Dual use of assets or facilities.
- Exploitation of exempt functions.
- Artists' facilities.
- Broadcasting rights.
- Business league's parking and bus services.
- Halfway house workshop.
- Health club program.
- Hospital facilities.
- Insurance programs.
- Magazine publishing.
- Membership list sales.
- Miniature golf course.
- Museum eating facilities.
- Museum greeting card sales.
- Museum shop.
- Nonpatient laboratory testing.
- Pet boarding and grooming services.
- Publishing legal notices.
- Directory of members.
- Sales of advertising space.
- Sales of cattle for commissions.
- Sales of hearing aids.
- School facilities.
- School handicraft shop.
- Selling endorsements.
- Services provided with lease.
- Sponsoring entertainment events.
- Travel tour programs.
- Yearbook advertising.
- Youth residence.
- Excluded Trade or Business Activities
- Bingo games.
- Gambling activities other than bingo.
- Legal definition.
- Legal where played.
- No for-profit games where played.
- Convenience of members.
- Convention or trade show activity.
- Distribution of low-cost articles.
- Employee association sales.
- Exchange or rental of member lists.
- Hospital services.
- Pole rentals.
- Public entertainment activity.
- Qualified sponsorship activities.
- Qualified sponsorship payment.
- Exception for contingent payments.
- Exception for conventions and trade shows.
- Exception for periodicals.
- Selling donated merchandise.
- Volunteer workforce.
- Unrelated Business Taxable Income
- Dividends, interest, annuities, and other investment income.
- Exception for insurance activity income of a controlled foreign corporation.
- Other exceptions.
- Income from lending securities.
- Mixed leases.
- Exception for rents based on net profit.
- Exception for income from personal services.
- Other exceptions.
- Income from research.
- Gains and losses from disposition of property.
- Lapse or termination of options.
- Gain or loss on disposition of certain brownfield property.
- Income from services provided under federal license.
- Member income of mutual or cooperative electric companies.
- Dues of Agricultural Organizations and Business Leagues
- Directly Connected
- Exploitation of Exempt ActivityAdvertising Sales
- Partnership Income or Loss
- S Corporation Income or Loss
- Special Rules for Foreign Organizations
- Special Rules for Social Clubs, VEBAs, and SUBs
- Special Rules for Veterans' Organizations
- Income From Controlled Organizations
- Income From Property Financed With Qualified 501(c)(3) Bonds
- Disposition of Property Received From Taxable Subsidiary and Used in Unrelated Business
- Income From Debt-Financed Property
- Debt-Financed Property
- Acquisition Indebtedness
- Change in use of property.
- Continued debt.
- Property acquired subject to mortgage or lien.
- Liens similar to a mortgage.
- Exception for property acquired by gift, bequest, or devise.
- Modifying existing debt.
- Extension or renewal.
- Debt increase.
- Debt That Isnt Acquisition Indebtedness
- Exceptions to Debt-Financed Property
- Property related to exempt purposes.
- Property used in an unrelated trade or business.
- Property used in research activities.
- Property used in certain excluded activities.
- Related exempt uses.
- Related organizations.
- Medical clinics.
- Life income contract.
- Neighborhood land rule.
- Actual use.
- Refund of taxes.
- Computation of Debt-Financed Income
- Gain or loss from sale or other disposition of property.
- Debt-financed property exchanged for subsidiary's stock.
- Gain or loss on disposition of certain brownfield property.
- Average acquisition indebtedness.
- Indeterminate price.
- Average adjusted basis.
- Basis for debt-financed property acquired in corporate liquidation.
- Computation of debt/basis percentage.
- Deductions for Debt-Financed Property
- Allocation Rules
- Acquisition Indebtedness
- How To Get Tax Help
- Tax reform.
- Preparing and filing your tax return.
- Getting tax forms and publications.
- Access your online account (individual taxpayers only).
- Using direct deposit.
- Delayed refund for returns claiming certain credits.
- Getting a transcript or copy of a return.
- Using online tools to help prepare your return.
- Resolving tax-related identity theft issues.
- Checking on the status of your refund.
- Making a tax payment.
- What if I cant pay now?
- Checking the status of an amended return.
- Understanding an IRS notice or letter.
- Contacting your local IRS office.
- Watching IRS videos.
- Getting tax information in other languages.
- Publication 598 - Additional Material
Publication 598 (02/2019), Tax on Unrelated Business Income of Exempt Organizations
Revised: February 2019
The IRS has created a page on IRS.gov for information about Pub. 598, at IRS.gov/Pub598. Information about any future developments affecting Pub. 598 (such as legislation enacted after we release it) will be posted on that page.
Organizations with more than one unrelated trade or business must compute unrelated business taxable income (UBTI), including for the purpose of determining any net operating loss deduction, separately with respect to each such trade or business. See Notice 2018-67 for more information.
For organizations that have employees, UBTI is increased by any amount for which a deduction is not allowable because of section 274 and which is paid or incurred by the organization after 2017 for any qualified transportation fringe, any parking facility used in connection with qualified parking, or any on-premises athletic facility (but only if the employer's provision of on-premises athletic facilities discriminates in favor of highly compensated employees). This rule does not apply to the extent the amount paid or incurred is directly connected with an unrelated trade or business which is regularly carried on by the organization.
The maximum cost of a low-cost article, for organizations eligible to receive charitable contributions, was increased to $11.10 for 2019. See Distribution of low-cost articles , later.
The annual limit on associate member dues received by an agricultural or horticultural organization not treated as gross income was increased to $169 for 2019. See Exception under Dues of Agricultural Organizations and Business Leagues, later.
The Tax Cuts and Jobs Act (P.L. 115-97) repealed the corporate alternative minimum tax (AMT), effective for tax years beginning after 2017. In addition to the AMT not applying to corporations for tax years beginning after 2017, corporations may treat a portion of their prior year AMT credit carryover as refundable. See Form 8827.
An exempt organization isn’t taxed on its income from an activity substantially related to the charitable, educational, or other purpose that is the basis for the organization's exemption. Such income is exempt even if the activity is a trade or business.
However, if an exempt organization regularly carries on one or more trades or businesses not substantially related to the organization's exempt purpose, except that conducting the trade or business provides funds to carry out the exempt purpose, the organization is subject to tax on its income from the unrelated trade(s) or business(es). In addition, for organizations that have employees, UBTI is increased by any amount for which a deduction is not allowable because of section 274 and which is paid or incurred by the organization after 2017 for any qualified transportation fringe, any parking facility used in connection with qualified parking, or any on-premises athletic facility (but only if the employer's provision of on-premises athletic facilities discriminates in favor of highly compensated employees). This rule does not apply to the extent the amount paid or incurred is directly connected with an unrelated trade or business which is regularly carried on by the organization.
This publication covers the rules for the tax on unrelated business income of exempt organizations. It explains:
Which organizations are subject to the tax (chapter 1),
What the requirements are for filing a tax return (chapter 2),
What an unrelated trade or business is (chapter 3), and
How to figure unrelated business taxable income (chapter 4).
All section references in this publication are to the Internal Revenue Code.
557 Tax-Exempt Status for Your Organization
Form (and Instructions)
990-T Exempt Organization Business Income Tax Return
Visit IRS.gov/FormsPubs to download forms and publications. Otherwise, you can go to IRS.gov/OrderForms to order current and prior-year forms and instructions. Your order should arrive within 10 business days.
The tax on unrelated business income applies to most organizations exempt from tax under section 501(a). These organizations include charitable, religious, scientific, and other organizations described in section 501(c), as well as employees' trusts forming part of pension, profit-sharing, and stock bonus plans described in section 401(a).
In addition, the following are subject to the tax on unrelated business income.
Individual retirement arrangements (IRAs), including traditional IRAs, Roth IRAs, simplified employee pensions (SEP-IRAs), and savings incentive match plans for employees (SIMPLE IRAs).
State and municipal colleges and universities.
Qualified state tuition programs described in section 529.
Qualified ABLE programs described in section 529A.
Medical savings accounts (MSAs) described in section 220(d).
Coverdell savings accounts described in section 530.
All organizations subject to the tax on unrelated business income, except the exempt trusts described in section 511(b)(2), are taxable at corporate rates on that income. All exempt trusts subject to the tax on unrelated business income that, if not exempt, would be taxable as trusts are taxable at trust rates on that income. However, an exempt trust may not claim the deduction for a personal exemption that is normally allowed to a trust.
The tax is imposed on the organization's UBTI (described in chapter 4). Under section 512(a)(6) an organization that conducts more than one unrelated trade or business calculates its UBTI as the sum of the UBTI calculated separately for each unrelated trade or business, and when calculating this sum, the UBTI from any of the separate trades or businesses can't be less than zero. The tax is reduced by any applicable tax credits, including the general business credits (such as the investment credit) and the foreign tax credit.
An exempt organization subject to the tax on unrelated business income must file Form 990-T and attach any required supporting schedules and forms. The obligation to file Form 990-T is in addition to the obligation to file any other required return or notice.
Form 990-T is required if the sum of the organization's gross income from all unrelated businesses and any addition to UBTI attributable to expenses for a qualified transportation fringe required by section 512(a)(7) is $1,000 or more. An exempt organization must report income from all its unrelated businesses on a single Form 990-T. Organizations that conduct more than one unrelated business report the income and expenses for each additional unrelated businesses on a separate Schedule M (Form 990-T). Each organization must file a separate Form 990-T, except section 501(c)(2) title-holding corporations and organizations receiving their earnings that file a consolidated return under section 1501.
The various provisions of tax law relating to accounting periods, accounting methods, at-risk limits (described in section 465), assessments, and collection penalties that apply to tax returns generally also apply to Form 990-T.
Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially related to the performance by the organization of its exempt purpose or function. Use by the organization, of the profits derived from this activity, does not, alone, make the activity substantially related to the performance by the organization of its exempt purpose or function.
Certain trade or business activities aren’t treated as an unrelated trade or business. See Excluded Trade or Business Activities , later.
The following are examples of activities that were determined to be (or not to be) unrelated trades or businesses using the definitions and principles just discussed.
A tax-exempt university alumni association provides a travel tour program for its members and their families. The organization works with various travel agencies and schedules approximately ten tours a year to various places around the world. It mails out promotional material and accepts reservations for fees paid by the travel agencies on a per-person basis.
The organization provides an employee for each tour as a tour leader. There is no formal educational program conducted with these tours, and they don’t differ from regular commercially operated tours (if there is a intent to make a profit).
By providing travel tours to its members, the organization is engaging in a regularly conducted trade or business. Even if the tours it offers support the university, financially and otherwise, and encourage alumni to do the same, the travel tours don’t contribute importantly to the organization's exempt purpose of promoting education. Therefore, the sale of the travel tours is an unrelated trade or business.
A tax-exempt organization formed for the purpose of educating individuals about the geography and the culture of the United States provides study tours to national parks and other locations within the United States. These tours are conducted by teachers and others certified by the state board of education. The tours are primarily designed for students enrolled in degree programs at state educational institutions but are open to all who agree to participate in the required study program associated with the tour taken. A tour's study program consists of instruction on subjects related to the location being visited on the tour. Each tour group brings along a library of material related to the subjects being studied on the tour. During the tour, 5 or 6 hours per day are devoted to organized study, preparation of reports, lectures, instruction, and recitation by the students. Examinations are given at the end of each tour. The state board of education awards academic credit for tour participation. Because these tours are substantially related to the organization's exempt purpose, they aren’t an unrelated trade or business.
The following activities are specifically excluded from the definition of unrelated trade or business.
Tax-exempt organizations X and Y are organized under the laws of state N, which has a law that permits exempt organizations to conduct bingo games. In addition, for-profit organizations are permitted to conduct bingo games in city S, a resort community located in county R. Several for-profit organizations conduct nightly games. Y conducts weekly bingo games in city S, while X conducts weekly games in county R. Since state law confines the for-profit organizations to city S, local jurisdiction controls. Y's bingo games conducted in city S are an unrelated trade or business. However, X's bingo games conducted in county R outside of city S aren’t an unrelated trade or business.
See Pub. 3079, Tax Exempt Organizations and Gaming, for more detailed information.
A retail store operated by an exempt orphanage where unpaid volunteers perform substantially all the work in carrying on the business isn’t an unrelated trade or business.
A volunteer fire company conducts weekly public dances. Holding public dances and charging admission on a regular basis may, given the facts and circumstances of a particular case, be considered an unrelated trade or business. However, because the work at the dances is performed by unpaid volunteers, the activity isn’t an unrelated trade or business.
The term "unrelated business taxable income" (UBTI) generally means the gross income derived from any unrelated trade or business regularly conducted by the exempt organization, less the deductions directly connected with carrying on the trade or business. Section 512(a)(6) requires an organization that regularly carries on two or more unrelated business activities to calculate its unrelated business taxable income, including for purposes of determining any net operating loss deduction, separately with respect to each such trade or business. The UBTI of the organization is the sum of the UBTI computed from each separate unrelated trade or business. For the purpose of this sum, the UBTI from any of the unrelated trades or businesses can't be less than zero. See Notice 2018-67 for more information.
For organizations that have employees, section 512(a)(7) requires UBTI to be increased by any amount for which a deduction is not allowable because of section 274 and which is paid or incurred by the organization after December 31, 2017 for any qualified transportation fringe (as defined in section 132(f)), any parking facility used in connection with qualified parking (as defined in section 132(f)(5)(C)), or any on-premises athletic facility (as defined in section 132(j)(4)(B)). This rule does not apply to the extent the amount paid or incurred is directly connected with an unrelated trade or business which is regularly carried on the by the organization.
A deduction for expenses paid or incurred for on-premises athletic facilities is disallowed due to application of section 274 only if it discriminates in favor of highly compensated employees.
In computing UBTI, gross income and deductions are subject to the modifications and special rules explained in this chapter. Whether a particular item of income or expense falls within any of these modifications or special rules must be determined by all the facts and circumstances in each specific case. For example, if the organization received a payment termed rent that is in fact a return of profits by a person operating the property for the benefit of the organization, or that is a share of the profits retained by the organization as a partner or joint venturer, the payment isn’t within the income exclusion for rents, discussed later under Exclusions .
Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income.
The following types of income (and deductions directly connected with the income) are generally excluded when figuring UBTI.
Dues received from associate members by organizations exempt under section 501(c)(5) or section 501(c)(6) may be treated as gross income from an unrelated trade or business if the associate member category exists for the principal purpose of producing unrelated business income. For example, if an organization creates an associate member category solely to allow associate members to purchase insurance through the organization, the associate member dues may be unrelated business income.
To qualify as allowable deductions in computing UBTI, the expenses, depreciation, and similar items generally must be allowable income tax deductions that are directly connected with carrying on the unrelated trade or business to which they relate. They can’t be directly connected with excluded income.
For an exception to the "directly connected" requirement, see Charitable contributions deduction. , under Modifications, later.
To be directly connected with the conduct of an unrelated trade or business, deductions must have a proximate and primary relationship to carrying on that trade or business. For an exception, see Expenses attributable to exploitation of exempt activities , later.
A school recognized as a tax-exempt organization contracts with an individual to conduct a summer tennis camp. The school provides the individual with tennis courts, housing, and dining facilities, and personnel to maintain and operate them. The contracted individual hires the instructors, recruits campers, and provides supervision of the tennis camp. The income the school receives from the individual under the contract from this activity for the use of its facilities and personnel is from a dual use of the facilities and personnel, not from conducting an educational activity. The school, in computing its UBTI, may deduct an allocable part of the expenses attributable to the facilities and personnel it makes available under the contract.
An exempt organization with gross income from an unrelated trade or business pays its president $90,000 a year. The president devotes approximately 10% of his time to the unrelated business. To figure the organization's UBTI, a deduction of $9,000 ($90,000 × 10%) is allowed for the salary paid to its president.
The sale of advertising in a periodical of an exempt organization that contains editorial material related to the accomplishment of the organization's exempt purpose is an unrelated business that exploits an exempt activity, the circulation and readership of the periodical. Therefore, in addition to direct advertising costs, exempt activity costs (expenses, depreciation, and similar expenses attributable to the production and distribution of the editorial or readership content) can be treated as directly connected with the conduct of the advertising activity. (See Expenses attributable to exploitation of exempt activities under Directly Connected, earlier.)
U is an exempt scientific organization with 10,000 members who pay annual dues of $15. One of U's activities is publishing a monthly periodical distributed to all of its members. U also distributes 5,000 additional copies of its periodical to nonmembers, who subscribe for $10 a year. Since the nonmember circulation of U's periodical represents one-third (more than 20%) of its total circulation, the subscription price charged to nonmembers is used to determine the part of U's membership receipts allocable to the periodical. Thus, U's allocable membership receipts are $100,000 ($10 times 10,000 members), and U's total circulation income for the periodical is $150,000 ($100,000 from members plus $50,000 from sales to nonmembers).
Assume the same facts except that U sells only 500 copies of its periodical to nonmembers, at a price of $10 a year. Assume also that U's members may elect not to receive the periodical, in which case their dues are reduced from $15 a year to $6 a year, and that only 3,000 members elect to receive the periodical and pay the full dues of $15 a year. U's stated subscription price of $9 to members consistently results in an excess of total income (including gross advertising income) attributable to the periodical over total costs of the periodical. Since the 500 copies of the periodical distributed to nonmembers represent only 14% of the 3,500 copies distributed, the $10 subscription price charged to nonmembers isn’t used to determine the part of membership receipts allocable to the periodical. Instead, since 70% of the members elect not to receive the periodical and pay $9 less per year in dues, the $9 price is used to determine the subscription price charged to members. Thus, the allocable membership receipts will be $9 a member, or $27,000 ($9 times 3,000 copies). U's total circulation income is $32,000 ($27,000 plus the $5,000 from nonmember subscriptions).
If an exempt organization publishes more than one periodical to produce income, it may treat all of them (but not less than all) as one in determining UBTI from selling advertising. It treats the gross income from all the periodicals, and the deductions directly connected with them, on a consolidated basis. Consolidated treatment, once adopted, must be followed consistently and is binding. This treatment can be changed only with the consent of the IRS.
An exempt organization's periodical is published to produce income if:
The periodical generates gross advertising income to the organization equal to at least 25% of its readership costs, and
Publishing the periodical is an activity engaged in for profit.
Whether the publication of a periodical is an activity engaged in for profit can be determined only by all the facts and circumstances in each case. The facts and circumstances must show that the organization carries on the activity for economic profit, although there may not be a profit in a particular year. For example, if an organization begins publishing a new periodical whose total costs exceed total income in the start-up years because of lack of advertising sales, that doesn’t mean that the organization didn’t have as its objective an economic profit. The organization may establish that it had this objective by showing it can reasonably expect advertising sales to increase, so that total income will exceed costs within a reasonable time.
Y, an exempt trade association, publishes three periodicals that it distributes to its members: a weekly newsletter, a monthly magazine, and a quarterly journal. Both the monthly magazine and the quarterly journal contain advertising that accounts for gross advertising income equal to more than 25% of their respective readership costs. Similarly, the total income attributable to each periodical has exceeded the total deductions attributable to each periodical for substantially all the years they have been published. The newsletter carries no advertising and its annual subscription price isn’t intended to cover the cost of publication. The newsletter is a service that Y distributes to all of its members in an effort to keep them informed of changes occurring in the business world. It is not engaged in for profit.
Under these circumstances, Y may consolidate the income and deductions from the monthly and quarterly journals in computing its UBTI. It may not consolidate the income and deductions from the newsletter with the income and deductions of its other periodicals, since the newsletter isn’t published for the production of income.
An organization may have unrelated business income or loss as a member of a partnership, rather than through direct business dealings with the public. If so, it must treat its share of the partnership income or loss as if it had conducted the business activity in its own capacity as a corporation or trust. No distinction is made between limited and general partners. The organization is required to notify the partnership of its tax-exempt status. See Notice 2018-67, 2018-36 I.R.B. 409, for information and transition rules under section 512(a)(6) for aggregating income from partnerships and debt-financed income from partnerships.
Thus, if an organization is a member of a partnership regularly engaged in a trade or business that is an unrelated trade or business with respect to the organization, the organization must include in its UBTI its share of the partnership's gross income from the unrelated trade or business (whether or not distributed), and the deductions attributable to it. The partnership income and deductions to be included in the organization's UBTI are figured the same way as any income and deductions from an unrelated trade or business conducted directly by the organization. The partnership is required to provide the organization this information on Schedule K-1.
An exempt educational organization is a partner in a partnership that operates a factory. The partnership also holds stock in a corporation. The exempt organization must include its share of the gross income from operating the factory in its UBTI but may exclude its share of any dividends the partnership received from the corporation.
An organization that owns S corporation stock must take into account its share of the S corporation's income, deductions, and losses in figuring UBTI, regardless of the actual source or nature of the income, deductions, and losses. For example, the organization's share of the S corporation's interest and dividend income will be taxable, even though interest and dividends are normally excluded from UBTI. The organization must also take into account its gain or loss on the sale or other disposition of the S corporation stock in figuring UBTI.
The UBTI of a foreign organization exempt from tax under section 501(a) consists of the organization's:
Unrelated business taxable income derived from sources within the United States but not effectively connected with the conduct of a trade or business within the United States, and
Unrelated business taxable income effectively connected with the conduct of a trade or business within the United States, whether or not this income is derived from sources within the United States.
To determine whether income realized by a foreign organization is derived from sources within the United States or is effectively connected with the conduct of a trade or business within the United States, see sections 861 through 865 and the related regulations.
The following discussion applies to:
Social clubs described in section 501(c)(7),
Voluntary employees' beneficiary associations (VEBAs) described in section 501(c)(9), and
Supplemental unemployment compensation benefit trusts (SUBs) described in section 501(c)(17).
In general, these organizations are subject to section 512(a)(6). See Notice 2018-67, 2018-36 I.R.B. 409 for more information. However, they also must figure UBTI under special rules. Unlike other exempt organizations, they can’t exclude their investment income (dividends, interest, rents, etc.). (See Exclusions under Income, earlier.) Therefore, they are generally subject to unrelated business income tax on this income.
The UBTI of these organizations includes all gross income, less deductions directly connected with the production of that income, except that gross income for this purpose doesn’t include exempt function income. The deduction for dividends received by a corporation isn’t allowed in computing UBTI because it isn’t an expense incurred in the production of income.
Unrelated business taxable income of a veterans' organization that is exempt under section 501(c)(19) doesn’t include the net income from insurance business that is properly set aside. The organization may set aside income from payments received for life, sick, accident, or health insurance for the organization's members or their dependents for the payment of insurance benefits or reasonable costs of insurance administration, or for use exclusively for religious, charitable, scientific, literary, or educational purposes, or the prevention of cruelty to children or animals. For details, see section 512(a)(4) and the regulations under that section.
The exclusions for interest, annuities, royalties, and rents, explained earlier in this chapter under Income , may not apply to a payment of these items received by a controlling organization from its controlled organization. The payment is included in the controlling organization's UBTI to the extent it reduced the net unrelated income (or increased the net unrelated loss) of the controlled organization. All deductions of the controlling organization directly connected with the amount included in its UBTI are allowed.
If any part of a 501(c)(3) organization's property financed with qualified 501(c)(3) bonds is used in a trade or business of any person other than a section 501(c)(3) organization or a governmental unit, and such use isn’t consistent with the requirements for qualified 501(c)(3) bonds under section 145, the section 501(c)(3) organization is considered to have received unrelated business income in the amount of the greater of the actual rental income or the fair rental value of the property for the period it is used. No deduction is allowed for interest on the private activity bond. See sections 150(b)(3) and (c) for more information.
A taxable 80%-owned subsidiary corporation of one or more tax-exempt entities is generally subject to tax on a distribution in liquidation of its assets to its exempt parent (or parents). The assets are treated as if sold at fair market value.
Tax-exempt entities include organizations described in sections 501(a), 529, and 115, charitable remainder trusts, U.S. and foreign governments, Indian tribal governments, international organizations, and similar non-taxable organizations.
A taxable corporation that transfers substantially all of its assets to a tax-exempt entity in a transaction that otherwise qualifies for nonrecognition treatment must recognize gain on the transaction as if it sold the assets at fair market value. However, such a transfer isn’t taxable if it qualifies as a like-kind exchange under section 1031 or an involuntary conversion under section 1033. In such a case the built-in appreciation is preserved in the replacement property received in the transaction.
A corporation that changes status from taxable to tax-exempt is treated generally as if it transferred all of its assets to a tax-exempt entity immediately before the change in status (thus subjecting it to the tax on a deemed sale for fair market value). This rule doesn’t apply where the taxable corporation becomes exempt within 3 years of formation, or had previously been exempt and within several years (generally a period of 3 years) regains exemption, unless the principal purpose of the transactions is to avoid the tax on the change in status.
In the transactions described above, the taxable event is deferred for property that the tax-exempt entity immediately uses in an unrelated business. If the parent later disposes of the property, then any gain (not in excess of the amount not recognized) is included in the parent's UBTI. If there is partial use of the assets in unrelated business, then there is partial recognition of gain or loss. Property is treated as disposed if the tax-exempt entity no longer uses it in an unrelated business.
Losses on the transfer of assets to a tax-exempt entity are disallowed if part of a plan with a principal purpose of recognizing losses.
Investment income that would otherwise be excluded from an exempt organization's UBTI (see Exclusions under Income, earlier) must be included to the extent it is derived from debt-financed property. The amount of income included is proportionate to the debt on the property.
In general, the term "debt-financed property" means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). It includes rental real estate, tangible personal property, and corporate stock.
For any debt-financed property, acquisition indebtedness is the unpaid amount of debt incurred by an organization:
When acquiring or improving the property,
Before acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement, and
After acquiring or improving the property if:
The debt would not have been incurred except for the acquisition or improvement, and
Incurring the debt was reasonably foreseeable when the property was acquired or improved.
The facts and circumstances of each situation determine whether incurring a debt was reasonably foreseeable. That an organization may not have foreseen the need to incur a debt before acquiring or improving the property doesn’t necessarily mean that incurring the debt later wasn’t reasonably foreseeable.
Y, an exempt scientific organization, mortgages its laboratory to replace working capital used in remodeling an office building that Y rents to an insurance company for nonexempt purposes. The debt is acquisition indebtedness since the debt, though incurred after the improvement of the office building, would not have been incurred without the improvement, and the debt was reasonably foreseeable when, to make the improvement, Y reduced its working capital below the amount necessary to continue current operations.
X, an exempt organization, forms a partnership with A and B. The partnership agreement provides that all three partners will share equally in the profits of the partnership, each will invest $3 million, and X will be a limited partner. X invests $1 million of its own funds in the partnership and $2 million of borrowed funds.
The partnership buys as its sole asset an office building that it leases to the public for nonexempt purposes. The office building costs the partnership $24 million, of which $15 million is borrowed from Y bank. The loan is secured by a mortgage on the entire office building. By agreement with Y bank, X isn’t personally liable for payment of the mortgage.
X has acquisition indebtedness of $7 million. This amount is the $2 million debt X incurred in acquiring the partnership interest, plus the $5 million that is X's allocable part of the partnership's debt incurred to buy the office building (one-third of $15 million).
A labor union advanced funds, from existing resources and without any borrowing, to its tax-exempt subsidiary title-holding company. The subsidiary used the funds to pay a debt owed to a third party that was previously incurred in acquiring two income-producing office buildings. Neither the union nor the subsidiary has incurred any further debt in acquiring or improving the property. The union has no outstanding debt on the property. The subsidiary's debt to the union is represented by a demand note on which the subsidiary makes payments whenever it has the available cash. The books of the union and the subsidiary list the outstanding debt as inter-organizational indebtedness.
Although the subsidiary's books show a debt to the union, it isn’t the type subject to the debt-financed property rules. In this situation, the very nature of the title-holding company and the parent-subsidiary relationship shows this debt to be merely a matter of accounting between the two organizations. Accordingly, the debt isn’t acquisition indebtedness.
Certain debt and obligations aren’t acquisition indebtedness. These include the following.
Debts incurred in performing an exempt purpose.
Real property debts of qualified organizations.
Certain Federal financing.
In addition, acquisition indebtedness doesn’t include indebtedness incurred by a small business investment company licensed under the Small Business Investment Act of 1958 after October 22, 2004, if such indebtedness is evidenced by a debenture issued by such company and held or guaranteed by the Small Business Administration. However, this provision doesn’t apply to any small business investment company during any period that any organization which is exempt from tax (other than a governmental unit) owns more than 25% of the capital or profits interest in such company, or organizations which are exempt from tax (including governmental agencies other than any agency or instrumentality of the United States) own, in the aggregate, 50% or more of the capital or profits interest in such company.
For each debt-financed property, the unrelated debt-financed income is a percentage (not over 100%) of the total gross income derived during a tax year from the property. This percentage is the same percentage as the average acquisition indebtedness with respect to the property for the tax year of the property's average adjusted basis for the year (the debt/basis percentage). Thus, the formula for deriving unrelated debt-financed income is:
|average adjusted basis|
X, an exempt trade association, owns an office building that is debt-financed property. The building produced $10,000 of gross rental income last year. The average adjusted basis of the building during that year was $100,000, and the average acquisition indebtedness with respect to the building was $50,000. Accordingly, the debt/basis percentage was 50% (the ratio of $50,000 to $100,000). Therefore, the unrelated debt-financed income with respect to the building was $5,000 (50% of $10,000).
The deductions allowed for each debt-financed property are determined by applying the debt/basis percentage to the sum of allowable deductions.
The allowable deductions are those directly connected with the debt-financed property or with the income from it (including the dividends-received deduction), except that:
The allowable deductions are subject to the modifications for computation of the UBTI (discussed earlier in this chapter), and
The depreciation deduction, if allowable, is computed only by use of the straight-line method.
To be directly connected with debt-financed property or with the income from it, a deductible item must have proximate and primary relationship to the property or income. Expenses, depreciation, and similar items attributable solely to the property qualify for deduction, to the extent they meet the requirements of an allowable deduction.
For example, if the straight-line depreciation allowance for an office building is $10,000 a year, an organization can deduct depreciation of $10,000 if the entire building is debt-financed property. However, if only half of the building is debt-financed property, the depreciation allowed as a deduction is $5,000.
When only part of the property is debt-financed property, proper allocation of the basis, debt, income, and deductions with respect to the property must be made to determine how much income or gain derived from the property to treat as unrelated debt-financed income.
X, an exempt college, owns a four-story office building that it bought with borrowed funds (assumed to be acquisition indebtedness). During the year, the lower two stories of the building were used to house computers that X uses for administrative purposes. The two upper stories were rented to the public and used for nonexempt purposes.
The gross income X derived from the building was $6,000, all of which was attributable to the rents paid by tenants. The expenses were $2,000 and were equally allocable to each use of the building. The average adjusted basis of the building for the year was $100,000 and the average acquisition indebtedness for the year was $60,000.
Since the two lower stories were used for exempt purposes, only the upper half of the building is debt-financed property. Consequently, only the rental income and the deductions directly connected with this income are taken into account in computing UBTI. The part taken into account is determined by multiplying the $6,000 of rental income and $1,000 of deductions directly connected with the rental income by the debt/basis percentage.
The debt/basis percentage is the ratio of the allocable part of the average acquisition indebtedness to the allocable part of the property's average adjusted basis: that is, in this case, the ratio of $30,000 (one-half of $60,000) to $50,000 (one-half of $100,000). Thus, the debt/basis percentage for the year is 60% (the ratio of $30,000 to $50,000).
Under these circumstances, X must include net rental income of $3,000 in its UBTI for the year, computed as follows:
|Rental income treated as gross income
from an unrelated trade or business (60% of $6,000)
|Less the allowable portion of
deductions directly connected with that income (60% of $1,000)
|Net rental income included by X in
computing its UBTI from debt-financed property.
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The Taxpayer Bill of Rights describes 10 basic rights that all taxpayers have when dealing with the IRS. Go to TaxpayerAdvocate.IRS.gov to help you understand what these rights mean to you and how they apply. These are your rights. Know them. Use them.
TAS can help you resolve problems that you can’t resolve with the IRS. And their service is free. If you qualify for their assistance, you will be assigned to one advocate who will work with you throughout the process and will do everything possible to resolve your issue. TAS can help you if:
Your problem is causing financial difficulty for you, your family, or your business;
You face (or your business is facing) an immediate threat of adverse action; or
You’ve tried repeatedly to contact the IRS but no one has responded, or the IRS hasn’t responded by the date promised.
TAS has offices in every state, the District of Columbia, and Puerto Rico. Your local advocate’s number is in your local directory and at TaxpayerAdvocate.IRS.gov/Contact-Us. You can also call them at 877-777-4778.
TAS works to resolve large-scale problems that affect many taxpayers. If you know of one of these broad issues, please report it to them at IRS.gov/SAMS.
TAS also has a website, Tax Reform Changes, which shows you how the new tax law may change your future tax filings and helps you plan for these changes. The information is categorized by tax topic in the order of the IRS Form 1040. Go to TaxChanges.us for more information.
Low Income Taxpayer Clinics (LITCs) are independent from the IRS. LITCs represent individuals whose income is below a certain level and need to resolve tax problems with the IRS, such as audits, appeals, and tax collection disputes. In addition, clinics can provide information about taxpayer rights and responsibilities in different languages for individuals who speak English as a second language. Services are offered for free or a small fee. To find a clinic near you, visit TaxpayerAdvocate.IRS.gov/LITCmap or see IRS Pub. 4134, Low Income Taxpayer Clinic List.
- Acquisition indebtedness, Average acquisition indebtedness.
- Annuity obligations, Annuity obligation.
- By gift or bequest of mortgaged property, Exception for property acquired by gift, bequest, or devise.
- Change in property use, Change in use of property.
- Continued debt, Continued debt.
- Debt modifying existing, Modifying existing debt.
- Federal financing, Certain federal financing.
- For performing exempt purpose, Debt incurred in performing exempt purpose.
- Obligation to return collateral, Securities loans.
- Property subject to mortgage or lien, Property acquired subject to mortgage or lien.
- Real property, Real property debts of qualified organizations.
- Advertising income, Exploitation of Exempt Activity—Advertising Sales
- Agricultural organization dues, Dues of Agricultural Organizations and Business Leagues
- Business league dues, Dues of Agricultural Organizations and Business Leagues
- Debt-financed property, Income From Debt-Financed Property
- Acquired in liquidation, Basis for debt-financed property acquired in corporate liquidation.
- Dues, agricultural organizations and business leagues, Dues of Agricultural Organizations and Business Leagues
- Exchange or rental of member lists, Exchange or rental of member lists.
- Excluded trade or business activities, Excluded Trade or Business Activities
- Exclusions, Volunteer workforce.
- Sponsorship, Qualified sponsorship activities.
- Exempt function income, Exempt function income.
- Exploitation of exempt activity
- Advertising income, Exploitation of Exempt Activity—Advertising Sales
- Exploitation of exempt functions, Exploitation of exempt functions.
- Form 990-T, Returns and Filing Requirements
- Limits, Limits.
- Specific deduction, Specific deduction.
- Tax, Organizations Subject to the Tax
- Colleges and universities, Colleges and universities.
- Deposits, Federal Tax Deposits Must be Made by Electronic Funds Transfer
- Estimated, Payment of Tax
- Organizations affected, Organizations Subject to the Tax
- Payment, Public Inspection Requirements of Section 501(c)(3) Organizations.
- Rates, The Tax and Filing Requirements
- Return, Returns and Filing Requirements
- Title-holding corporations, Title-holding corporations.
- U.S. instrumentalities, U.S. instrumentalities.
- Title-holding corporations, Title-holding corporations.
- Unrelated business
- Hospital laboratory, Nonpatient laboratory testing.
- Unrelated business income, Unrelated Business Taxable Income, Income
- Advertising income, Exploitation of Exempt Activity—Advertising Sales
- Certain trusts, Special Rules for Social Clubs, VEBAs, and SUBs
- Controlled organizations, Income From Controlled Organizations
- Debt-financed property, Income From Debt-Financed Property
- Deductions, Deductions
- Employees beneficiary associations, Special Rules for Social Clubs, VEBAs, and SUBs
- Exclusions, Exclusions
- Foreign organizations, Special Rules for Foreign Organizations
- Income from gambling activities, Legal definition.
- Income from lending securities, Income from lending securities.
- Modifications, Modifications
- Partnership income or loss, Partnership Income or Loss
- Products of exempt functions, Selling of products of exempt functions.
- S corporation income, S Corporation Income or Loss
- S corporation income or loss, S Corporation Income or Loss
- Social clubs, Special Rules for Social Clubs, VEBAs, and SUBs
- Veterans organizations, Special Rules for Veterans' Organizations
- Unrelated debt-financed income, Certain federal financing.
- Average acquisition indebtedness, Average acquisition indebtedness.
- Average adjusted basis, Average adjusted basis.
- Computation, Computation of Debt-Financed Income
- Debt/basis percentage, Computation of debt/basis percentage.
- Deductions, Deductions for Debt-Financed Property
- Gains from dispositions, Gain or loss from sale or other disposition of property.
- Indeterminate property price, Indeterminate price.
- Unrelated trade or business, Unrelated Trade or Business
- Artists facilities, Artists' facilities.
- Broadcasting rights, Broadcasting rights.
- Business league's parking and bus services, Business league's parking and bus services.
- Convenience of members, Convenience of members.
- Convention or trade show, Convention or trade show activity.
- Directory of members, Directory of members.
- Distribution of low-cost articles, Distribution of low-cost articles.
- Dual use facilities, etc., Dual use of assets or facilities.
- Employees association sales, Employee association sales.
- Exclusions, Excluded Trade or Business Activities
- Exploitation of exempt functions, Exploitation of exempt functions.
- Gambling activities other than bingo, Gambling activities other than bingo.
- Halfway house, Halfway house workshop.
- Health club program, Health club program.
- Hearing aid sales, Sales of hearing aids.
- Hospital facilities, Hospital facilities.
- Hospital services, Hospital services.
- Insurance programs, Insurance programs.
- Magazine publishing, Magazine publishing.
- Member lists rentals, etc., Exchange or rental of member lists.
- Membership list sales, Membership list sales.
- Miniature golf course, Miniature golf course.
- Museum eating facilities, Museum eating facilities.
- Museum greeting card sales, Museum greeting card sales.
- Pet boarding and grooming services, Pet boarding and grooming services.
- Pole rentals, Pole rentals.
- Public entertainment activity, Public entertainment activity.
- Publishing legal notices, Publishing legal notices.
- Regularly conducted, Regularly conducted.
- Sales commissions, Sales of cattle for commissions.
- Sales of advertising space, Sales of advertising space.
- School facilities, School facilities.
- School handicraft shop, School handicraft shop.
- Selling donated merchandise, Selling donated merchandise.
- Selling endorsements, Selling endorsements.
- Sponsoring entertainment events, Sponsoring entertainment events.
- Substantially related, Not substantially related.
- Trade or business defined, Trade or business.
- Travel tour programs, Travel tour programs.
- Volunteer workforce, Volunteer workforce.
- Yearbook advertising, Yearbook advertising.
- Youth residence, Youth residence.
- Unstated trade or business
- Bingo games, Bingo games.
- Volunteer fire company, Excluded Trade or Business Activities
- When to file, When to file.