Can a 501(c)(3) nonprofit buy remodeling work tax-free for a building it leases out to for-profit tenants?

Plain-English summary

A 501(c)(3) organization, whose exempt purpose is providing pension annuities to nonprofit colleges, universities, and research institutions (and their teachers and staff) without profit to itself, was remodeling a building it owns. About 75% of the work was tenant improvements (benefiting the organization's for-profit lessees) and 25% was base-building improvements. The organization's rental income from leasing the space is treated as related (not unrelated business) income under IRS guidelines, because it's tied to its exempt purpose.

The Comptroller ruled the organization could purchase the entire remodeling project sales-tax-free by giving the contractor an exemption certificate — one that includes a statement confirming the leased-space income counts as related income under IRS guidelines. The result doesn't depend on the fact that most of the physical work benefits nonexempt tenants; what matters is that the rental income itself is tied to the organization's own tax-exempt purpose.

What this means for you

501(c)(3) organizations that lease out space

If your organization's rental income from leased space qualifies as "related" (not unrelated business) income under IRS guidelines because it supports your exempt purpose, you can buy remodeling of that space -- including tenant improvements for nonexempt lessees -- entirely tax-free with an exemption certificate that documents the related-income status.

Contractors working for nonprofit building owners

If your nonprofit client's rental income is related income under IRS guidelines, you can accept an exemption certificate covering the whole remodeling job, even for portions that specifically improve space rented out to for-profit tenants.

Common questions

Q: Does it matter that most of the remodel work benefits for-profit tenants, not the nonprofit itself?
A: Not in this ruling -- the exemption turned on whether the leasing income is related to the organization's exempt purpose under IRS guidelines, not on which portion of the building directly serves the nonprofit's own operations.

Q: What does the exemption certificate need to say?
A: Per this letter, it should include a statement that the income derived from the remodeled, leased-out area constitutes related income under IRS guidelines.

Q: Would this exemption apply if the rental income were unrelated business income instead?
A: This letter's answer is premised specifically on the income being related (tax-exempt) income; it doesn't address the outcome if the income were instead unrelated business income.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9806580L

Original ruling text

June 15, 1998

Dear Mr. **:

Thank you for your recent letter regarding the tax treatment of a contract to
remodel a building for the ** an organization exempted under
Section 501(c)(3) of the Internal Revenue Code.

Approximately 75% of the work will be for tenant improvements and the remaining
25% pertains to base building improvements.

The ** states that its primary (exempt) purpose is provide
non-proprietary and non-profit colleges, universities and other institutions
engaged primarily in education or research with pension annuities suited to the
needs of such institutions and of the teachers and other persons employed by
them without profit to **. The income derived from the lease of
** in **, Texas is related to its primary purpose and
would be treated under Internal Revenue Service guidelines as related (tax
exempt) income.

Response: The ** may purchase the entire remodeling project sales
tax free by issuing your firm an exemption certificate including a statement
that the income derived from the remodeled area constitutes related income
under Internal Revenue Service guidelines.

This opinion is rendered based on the facts presented. If there are additional
or different facts, the opinion may change.

You may call me toll free at 1-800-531-5441, ext. 3-4680. The direct line is
512/463-4680. You may also write to Tax Policy, Comptroller of Public
Accounts. The email address is .

Sincerely,

Al Van Allen
Tax Policy Division