PLR 200032050: charitable use of a debt-financed facility keeps rent outside UBIT

Plain-English summary

A charity bought a facility with borrowed funds to support job training and other services in an area with high poverty and unemployment. It planned to lease part of the building to an organization offering related welfare and employment services, which would sublet space to a child care provider. The IRS ruled that this use was substantially related to the charity's purposes. The rent would therefore not be treated as income from debt financed property under section 514 or as unrelated business income under section 512. The ruling depends on the described facts remaining materially unchanged.

Ruling snapshot

• Question: Will rent from leasing part of the borrowed funds facility for related services be subject to unrelated business income tax?
• Outcome: Approved. The described rent is outside the debt financed property and unrelated business income rules.
• Key authorities: IRC §§ 501(c)(3), 511, 512(b)(3) and (4), 513, and 514(b)(1)(A); Treas. Reg. §§ 1.514(b)-1(b)(1) and 1.513-1(d)(2).

Full text (IRS public release)

200032050

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

Date: MAY 16 2000
Contact Person:
ID Number:
Uniform Issue List: 514.06-00
Telephone Number:
[illegible]
Legend:
A =
B =
C=
D =
E =

Dear Applicant:

This letter is in reply to your request for a ruling
regarding the effect of a proposed transaction in which you will
lease a portion of a facility you purchased with borrowed funds
to B.

You are an organization described in sections 501(c) (3) and
509(a) (1) /170 (b) (1) (A) (vi) of the Internal Revenue Code. Your
Articles of Incorporation state that you were organized to
stabilize urban districts by developing and implementing human
service programs. Your goals are to improve the quality of life
of residents of inner city D by fostering employment and
alleviating poverty. You will accomplish this by providing
social services related to job training.

In specific, you seek to hold economic summits and job
fairs. You will promote the creation of small businesses in D by
sponsoring seminars and inviting financial institutions and
potential small business owners. You seek to encourage community
based banking and home-ownership through seminars. You seek to



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establish day care centers which provide second and third shift
care as well as care for the mentally challenged.

Your facility is situated in an area of D where there are
high rates of unemployment and poverty. You intend to lease a
portion of this property to B and in turn B will sublet some of
the property to C. B will use the facility to provide “one stop
shopping” so that the recipients of your services will be able to
take advantage of B’s services in the same location. C, which is
organized under section 501(c) (3), will use the facility to
provide child care services to persons seeking to make use of B's
and your services; this will do away with the parent’s need to
travel throughout the city with their children. The ultimate
goal of this “joint venture” is to better enable your clients to
make use of B’s services as well as your own.

You perform several activities at your facility. You plan
activities to be held at an adjacent recreational facility for
people who are finishing school and preparing to work. You work
to connect your target population with job opportunities and
public transportation. You help to create a support network for
extended families that simultaneously care for their elders and
children. Lastly, you have established a support network to
provide information on transportation, child care, elder care,
affordable housing, money management, home ownership, and health
care. Your programs are intended to increase the participation
and the effectiveness of B's programs.

B will use your facility to bring support services directly
to the residents of inner city D who are lacking job training,
employment counseling, life education skills, and child care.
Specifically, B will offer welfare counseling, job training, and
assistance for unemployed and underemployed individuals at your
facility. Together you and B intend to combat poverty and social
deprivation in D.

You request the following ruling:

The lease of a portion of the property you own to B is
substantially related to your charitable purposes so that rents
received will not be treated as income from debt-financed
property within the meaning of section 514 of the Code or
otherwise as unrelated business income within the meaning of
section 512 of the Code.

Section 501(c) (3) of the Code exempts from federal income
tax organizations organized and operated exclusively for
charitable, educational, scientific, or certain other purposes.



200032050

Section 511(a)(1) of the Code imposes a tax on the unrelated
business income of organizations described in section 501(c) (3).

Section 512(b) (3) (A) (i) of the Code excludes rents from real
property from the definition of unrelated business income.
However, section 512(b) (4) eliminates this exclusion in the case
of debt-financed property.

Section 514(b) (1) of the Code defines debt-financed property
as “any property which is held to produce income and with respect
to which there is an acquisition indebtedness.”

Section 514(c)(1) of the Code states “for purposes of this
section, the term ‘acquisition indebtedness’ means, with respect
to any debt-financed property, the unpaid amount of the
indebtedness incurred by the organization in acquiring or
improving such property.”

Section 514(c)(2) of the Code states that when property is
acquired subject to a mortgage or other similar lien, the amount
of the indebtedness secured by such mortgage or lien shall be
considered as an indebtedness of the organization incurred in
acquiring such property.

Section 514(b) (1) (A) of the Code states that “any property
substantially all the use of which is substantially related
(aside from the need of the organization for income or funds) to
the exercise or performance by such organization of its
charitable, educational, or other purpose or function
constituting the basis for its exemption under section 501” is
not debt-financed property.

Section 1.514(b)-1(b) (1) of the Regulations states that in
making the determination of whether the exclusion set forth in
section 514(b) (1) (A) (i) is applicable, the principles established
in section 1.513-1 of the Regulations are applicable.

Section 1.513-1(d) (2) of the Regulations states that trade or
business is related to exempt purposes only where the conduct of the
business activities has a causal relationship to the achievement of
exempt purposes (other than through the production of income); and
it is substantially related for purposes of section 513, only if the
causal relationship is a substantial one.

Rev. Rul. 69-572, 1969-2 C.B. 119 deals with an organization
which was created to construct and maintain a building to house
member agencies of a community chest, so as to facilitate


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coordination among the agencies and to make more efficient use of
the agencies' volunteer labor. The organization leases the
building it owns to agencies for substantially less than the
going rate for comparable commercial facilities. The
organization demonstrated that its operations materially aided
its tenants in the performance of their respective charitable
functions. In addition, the proximity of different agencies
enabled them to make frequent use of volunteer labor on an
efficient basis and to promote the common interests of the
agencies through the effective coordination of operations and
services. Because of the close connection between this
organization and the charitable functions of the tenant-
organizations, the rental of the organization's facilities at
rates substantially below their fair rental value, and the
operation by the organization with the intention of realizing an
amount sufficient only to meet their annual operating costs, the
organization did not generate unrelated business income.

Rev. Rul. 77-47, 1977-1 C.B. 157 involved an exempt
organization which acquired historically or architecturally
significant buildings and promoted the appreciation of history
and architecture by opening the buildings to the public. The
organization leased the building to another entity and the public
was neither accommodated nor encouraged to view the premises.

The organization also leased some the buildings to generate
income for itself and not for purposes that related to the
building's historical or architectural importance. This activity
generated unrelated business income.

Your mission is to improve the quality of life of
individuals and families in inner city D by fostering employment
and alleviating poverty. You will accomplish this by providing
social services related to job training. You will use the
facility you purchased with borrowed funds to provide social
services related to employment and establish a support network to
provide information on transportation, child care, elder care,
affordable housing, money management, homeownership, and health
care. You will lease a portion of the facility to B which will
use the facility to provide services such as welfare counseling,
job training, and assistance for unemployed and underemployed
individuals. B will sublet a portion of the facility to C and C
will use the facility to provide child care services. C’s child
care services will do away with the need of parents to travel
throughout the city with children to make use of your and B’s
services. The services which B and you provide address similar
problems and provide services to the same population. The
services to be provided appear to be substantially related to the



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performance of the charitable purpose constituting the basis for
your exemption under section 501 of the Code.

Accordingly, we rule as follows:

The lease of a portion of the property you own to B is
substantially related to your charitable purposes so that rents
received will not be treated as income from debt-financed
property within the meaning of section 514 of the Code and will
not be unrelated business income within the meaning of section
512 of the Code.

This ruling is based on the understanding that there will be
no material changes in the facts upon which they are based. Any
such change should be reported to the Ohio Tax Exempt and
Government Entities (TE/GE) Customer Service office. Because it
could help resolve questions concerning your federal income tax
status, this ruling should be kept in your permanent records. A
copy of this ruling is being forwarded to the Ohio TE/GE Customer
Service office.

This ruling is directed only to the organization that
requested it. Section 6110(k) (3) of the Code provides that it
may not be used or cited as precedent.

If you have any questions, please contact the person whose
name and telephone number are shown in the heading of this
letter.

Sincerely Yours,

(signed) Garland A. Carter

Garland A. Carter
Manager, Exempt Organizations
Technical Group 2