PLR 1108037: Sale of an office building does not create unrelated business income

Plain-English summary

An IRC § 501(c)(3) organization planned to sell an office building that it partly used for its exempt activities and partly leased to unrelated tenants. The building was subject to refinanced debt, and the organization asked whether the sale would produce unrelated business income tax. The IRS ruled that the organization qualified for the real-property exception in IRC § 514(c)(9), so the debt was not acquisition indebtedness for this purpose and the building was not debt-financed property. As a result, gain from the sale would be excluded from unrelated business taxable income under IRC § 512(b)(5), assuming the facts did not materially change.

Ruling snapshot

• Question: Would the sale of the organization's office building create unrelated business income tax?
• Outcome: Approved.
• Key authorities: IRC §§ 501(c)(3), 509(a)(1), 170(b)(1)(A)(ii), 511, 512(b)(5), 514(c)(9), and 6110; Treas. Reg. § 1.514(c)-1(c)(1).

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201108037 Contact Person:
Release Date: 2/25/2011
Identification Number:
Date: November 29, 2010
Telephone Number:
UIL: 512.00-00; 514.07-00
Employer Identification Number:

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Dear

We have considered your ruling request dated March 14, 2008 (as supplemented by your letters
of May 10, 2010 and June 17, 2010), concerning the federal income tax consequences under
sections 511, 512, and 514 of the Internal Revenue Code (“Code”), relating to the proposed sale
of your principal place of operations located at_ Address (hereinafter referred to as “Building’).

FACTS

You are exempt from federal income tax under section 501(a) of the Code as an organization
described in section 501(c)(3). For foundation classification purposes, you were originally
classified as a publicly-supported charity under section 509(a)(2). In Year.2, you asked the
Internal Revenue Service (the “Service”) to reconsider your private foundation status.
Consequently, on Date 1, the Service modified your foundation status to reflect an organization
described in sections 509(a)(1) and 170(b)(1)(A)(ii).

You own the Building, which is an eight-story office building. You conduct activities in part of
the Building and lease the remainder of the Building to unrelated parties for purposes unrelated
to your exempt purposes. The Building is currently encumbered by a deed of trust securing a
promissory note evidencing a loan in the principal amount of approximately $x. The

note is a refinancing of earlier loans secured by the Building. You obtained the original loan in
Year 1 to acquire the land on which the Building was built. That loan has been refinanced

several times, with the amount borrowed increased at times to cover additional capital
expenditures and improvements to the Building and operational expenditures.

Your board of directors has determined that it is in your best interest to sell the Building and
move to a new location that would better serve your membership.

RULING REQUESTED
You have requested the following ruling:

The sale of Building will not result in the imposition of the unrelated business income tax
by reason of sections 512(b)(5) and 514(c)(9)(C) of the Code.

LAW

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

Section 512(a) of the Code defines “unrelated business taxable income” as the gross income
derived by any organization from any unrelated trade or business (as defined in section

513 of the Code) regularly carried on by the organization, less certain deductions allowed which
are directly connected with the carrying on of such trade or business, computed with the
modifications provided in 512(b) of the Code.

Section 512(b)(5) of the Code excludes from the definition of “unrelated business taxable
income” all gains or losses from the sale, exchange, or other disposition of property other than
(A) stock in trade or other property of a kind which would properly be includible in inventory if on
hand at the close of the taxable year, or (B) property held primarily for sale to customers in the
ordinary course of the trade or business.

Section 512(b)(4) of the Code provides that notwithstanding section 512(b)(5), in the case of
debt-financed property (as defined in section 514), there shall be included as an item of gross
income derived from an unrelated trade or business, the amount ascertained under section
514(a)(1), and there shall be allowed, as a deduction, the amount ascertained under section
514(a)(2).

Section 514(b)(1) of the Code defines the term "debt- financed property" as any property which
is held to produce income and with respect to which there is acquisition indebtedness (as
defined in section (c)) at any time during the taxable year (or, if the property was disposed of
during the taxable year, with respect to which there was acquisition indebtedness at any time
during the 12-month period ending with the date of such disposition.)

Section 514(c)(1) of the Code provides that the term "acquisition indebtedness" means, with
respect to any debt-financed property, the unpaid amount of (A) the indebtedness incurred by
the organization in acquiring or improving such property; (B) the indebtedness incurred before
the acquisition or improvement of such property if such indebtedness would not have been
incurred but for such acquisition or improvement; or (C) the indebtedness incurred after the

acquisition or improvement of such property if such indebtedness would not have been incurred
but for such acquisition or improvement and the incurrence of such indebtedness was
reasonably foreseeable at the time of such acquisition or improvement.

Section 514(c)(3) of the Code provides that an extension, renewal, or refinancing of an
obligation evidencing a preexisting indebtedness shall not be treated as the creation of new
indebtedness.

With certain exceptions not applicable in this case, section 514(c)(9)(A) of the Code provides
that except as provided in section 514(c)(9)(B), the term "acquisition indebtedness" does not
include indebtedness incurred by a qualified organization in acquiring or improving any real
property.

Section 514(c)(9)(C)(i) of the Code defines the term "qualified organization" to include an
organization described in section 170(b)(1)(A)(ii).

Section 1.514(c)-1(c)(1) of the regulations provides that an extension, renewal, or refinancing of
an obligation evidencing a preexisting indebtedness is considered as a continuation of the old
indebtedness to the extent the outstanding principal amount thereof is not increased. Where
the principal amount of the modified obligation exceeds the outstanding principal amount of the
preexisting indebtedness, the excess shall be treated as a separate indebtedness for purposes
of section 514 and the regulations thereunder.

ANALYSIS

You plan to sell the Building, your principal place of operations. The promissory note secured
by the deed of trust that currently encumbers the Building manifests the refinancing of an
obligation evidencing a preexisting indebtedness. Under section 514(c)(3) of the Code and
section 1.514(c)-1(c)(1) of the regulations, the note is considered a continuation of the old
indebtedness to the extent the outstanding principal amount thereof is not increased, and is
considered a separate indebtedness to the extent the principal amount of the modified
obligation exceeds the outstanding principal amount of the preexisting indebtedness.
Nevertheless, under section 514(c)(9) of the Code, such indebtedness is not “acquisition
indebtedness’ within the meaning of section 514(c)(1) because it was incurred by you — an
organization described in section 170(b)(1)(A)(ii) and, hence, a “qualified organization” within
the meaning of section 514(c)(9)(C) —to acquire or improve real property. Consequently, the
Building is not considered debt-financed property within the meaning of section 514(b)(1), and
any gain or loss from the sale of the Building would be excluded from unrelated business
taxable income by operation of section 512(b)(5).

RULING
Based on the information submitted, we rule as follows:

The sale of Building would not result in the imposition of unrelated business income tax
under section 511 of the Code because the Building is not debt-financed property within

the meaning of section 514, and, thus, any gain on the sale of the Building would be
excluded from unrelated business taxable income by reason of section 512(b)(5).

This ruling will be made available for public inspection under section 6110 of the Code after
certain deletions of identifying information are made. For details, see enclosed Notice 437,
Notice of Intention to Disclose. A copy of this ruling with deletions that we intend to make
available for public inspection is attached to Notice 437. If you disagree with our proposed
deletions, you should follow the instructions in Notice 437.

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 by others as precedent.

This ruling is based on the understanding there will be no material changes in the facts upon
which it is based. Any changes that may have a bearing upon your tax status should be
reported to the Service. This ruling does not address the applicability of any section of the Code
or regulations to the facts submitted other than with respect to the sections described.

Because this letter could help resolve any future questions about tax consequences of your
activities, you should keep a copy of this ruling in your permanent records.

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

In accordance with the Power of Attorney and Declaration of Representative currently on file
with the Service, we are sending a copy of this letter to your authorized representative.

Sincerely,

Steven Grodnitzky
Manager, Exempt Organizations
Technical Group 1

Enclosure:
Notice 437