Are Certain Church Activities Subject to Taxes?

Making sense of Unrelated Business Income Taxes (UBIT) in regard to churches.

At StartCHURCH, we encourage pastors and ministry leaders to expand their horizons when they think about how to fund their organization. Often, we see churches and ministries find alternative ways to generate income instead of solely relying on donations. In fact, a common question we are asked at StartCHURCH is, “Can my ministry rent out space in our building to generate additional income?”

Many churches purchase a building to conduct their activities and services and then realize that some of the space in the building isn’t always being used. A great way for the church to generate additional income is to rent out that extra space for use by community members and other organizations.

While this is common, the income from this activity may be considered unrelated business income by the IRS, and thus subject to unrelated business income tax (UBIT).

Before we get into the specifics on renting out property, let’s take a look at what unrelated business income tax is.

IRS Publication 598 defines unrelated business income as “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.”

Now let’s take a look at how the IRS views income derived from renting out church property.

Debt-Financed Property

When it comes to income derived from property being rented out, the way that income is viewed by the IRS greatly depends on whether the church owns the property outright or if the property is debt-financed.

Debt-financed property is defined by the IRS as, “Any property held to produce income for which there is an acquisition indebtedness at any time during the tax year. It includes rental real estate, tangible personal property, and corporate stock.”

In other words, if your organization’s building is mortgaged and you rent a portion of it out to another organization, then the rental income you receive from that activity is subject to unrelated business income tax.

However, there is an exception to this rule. Certain property, even though debt-financed, will be exempt from treatment as debt-financed property.

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“If substantially all (85% or more) of the use of any property is substantially related to an organization’s exempt purposes, the property isn’t treated as debt-financed property.” —IRS Publication 598

Real Property vs. Personal Property

We have discussed what happens when a ministry rents out mortgaged property, but what about whenever the ministry owns the building or property outright?

IRS Publication 598 states: “The rules for debt-financed property don’t apply to rents from personal property, certain passive income from controlled organizations, and other amounts that are required by other rules to be included in computing UBTI.”

If the church owns it’s own building outright, then it is considered real property to the church.

Real property includes land and permanent structures, as well as their structural components.

Any income derived from real property is considered passive income. This type of income is excluded when computing UBIT and therefore, is not taxable to the church.

However, there is a difference between real property and personal property.

Personal property is any property other than real estate. The distinguishing factor between real property and personal property is that personal property is movable/not fixed permanently to one location.

Some examples of rentable personal property may include items like instruments, sound equipment, chairs and tables. Any income derived from the rent of personal property is considered UBI, and therefore is taxable to the church.

If your church’s unrelated trade or business constitutes more than an “insubstantial” part of its activities, then your church’s tax-exempt status will be in jeopardy of being revoked.

Rather than taking this risk, the best answer to this potential problem for your church is to start a for-profit arm. In short, a for-profit arm is a business venture of which your church is a majority shareholder. In return, the for-profit arm pays the church profits in the form of tax-free dividends.

We advocate the concept of ecclesiastical entrepreneurism as a necessary component of church life and its impact on the community. To start and run a ministry-owned business is to break out of the traditional methods used in times past and to begin carving a new way of doing church business. The days of churches depending solely on giving are over.

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So, what do you do whenever the income your church is generating is considered UBI?

Filing Form 990-T

When any tax-exempt organization derives income from an unrelated trade or business, including the renting out of its facilities, then it must file an income tax return using Form 990-T. Keep in mind that filing Form 990-T is only required if your church receives $1,000 or more in gross income from an unrelated trade or business.

Like other Form 990s, Form 990-T must be filed no later than the fifteenth day of the fifth month of your church’s fiscal year. In most instances, this date will be May 15. However, if, for example, your church’s fiscal year happens to begin on July 1 and end on June 30, then your Form 990-T would be due no later than November 15.

If you expect your church’s unrelated business income tax liability for the year to be $500 or more, then you will need to use Form 990-W to calculate estimated taxes. You can pay these taxes in quarterly installments.

If your church’s fiscal year is the same as the calendar year, then your quarterly estimated payments should be made by April 15, June 15, Sept. 15 and Dec. 15.

According to the instructions of Form 990-W, failure to pay the estimated tax on time may result in an underpayment penalty for the period of the underpayment. If your church ends up overpaying its estimated unrelated business income tax, then you may apply for a “quick refund” using Form 4466. Generally, you can do this if your overpayment is a least 10% of your estimated income tax liability for the year, and it is at least $500.

This article was first published on StartChurch.com. Used by permission.