Getting Educated on Rental Income for Educational Organizations

While the uncertainty of these times has affected exempt organizations across the board, educational institutions have uniquely felt its impact. Between the need to shift to virtual services, whether in-part or full-time, or reimagine the in-person learning experience, these organizations have had to reevaluate how they operate and how they utilize their space.

What Is Considered an Educational Organization?

Under the regulations, an educational organization is described in §170(b)(1)(A)(ii) if:

  1. Its primary function is the presentation of formal instruction;
  2. It normally maintains a regular faculty and curriculum, and
  3. Normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on.

Thus, if an organization meets these requirements, rental income generated by property that was acquired using debt would remain nontaxable.

When Does the Exception Not Apply?

  1. It is important to note, however, that even for these types of educational organizations this exception from acquisition indebtedness does not apply in the following situations:
    The acquisition price is not a fixed amount determined as of the date of the acquisition or the completion of the improvement.
  2. Any debt or other amount payable for the debt, or the time for making any payment, depends, in whole or in part, upon any revenue, income, or profits derived from the real property.
  3. The real property is leased back to the seller of the property or to a person related to the seller.
  4. The seller, a person related to the seller, or a person related to a qualified retirement plan provides financing for the transaction on other than commercially reasonable terms.

Ultimately, the use of debt financing to acquire or improve real property can be a valuable revenue generation tool for qualified exempt educational organizations, however, care must be taken to make sure that the transaction is structured to avoid any resultant UBIT.

Withum’s Not-for-Profit and Education Service Group is well versed in these complex tax laws and can expertly assist with structuring transactions in the most tax efficient manner. For questions or further assistance, please
contact a member of our team.

Not-for-Profit and Education Services

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