I am a member of a Church Vestry in Virginia. The church is a 501(c)(3), and it owns a piece of retail property. If we lease the retail property to generate income, are we subject to an unrelated business income tax or would we fall within the exception for rental income?
This question is best answered by providing the rule-of-thumb regarding IRS tax consideration of non-profit activities: if the activity is designed to generate money that is not re-invested into the business, but rather creates a profit or loss for the owners (or "insiders"), then the organization engaging in the activity risks losing tax exempt status.
In the example above, the tax exempt organization should create a separate corporation apart from the church.
The risk here is that the IRS will determine that the profit you generate from the commercial enterprise represents a "for-profit" engagement designed to benefit the vestry of the church (insiders) -- and thereby revoke the tax exempt status for the entire 501(c)(3) organization. Generally, churches are fairly bullet proof (501(c)(3) organizations can engage in most conduct except most campaigning and legislative lobbying), but commercial real-estate is rarely ever a non-profit mission. As such, the proper recommendation in this instance -- create a separate corporation that handles for-profit aspects of the business, and leave the church and church activities as tax-exempt.
For more information on f 501(c)(3) organizations and permissible activities, see:
- IRS 501(c)(3) management and guidance summary
- Other forms of tax exempt organizations guidance and summary
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