Unrelated Business Income and Internal Revenue Code §514

Unrelated Business Income and Internal Revenue Code §514

4th in a Series

Business IncomeThis tax tip is the fourth and final tip in a series addressing unrelated business income (“UBI”). Under Internal Revenue Code (“IRC”) §514, amounts of income and expenses that would otherwise not be considered UBI are required to be included in the UBI computation. The amounts to be included are required in the case of income derived from debt-financed property. In a tax-exempt organization’s computation of UBI for any taxable year, the proportionate share of income and expenses derived from debt-financed property, including, but not limited to, any gain upon disposition or rental income, must be included in the UBI computation. The term “debt-financed property” refers to any property held to produce income for which there is acquisition indebtedness at any time during the year. Debt-financed property includes rental real estate, tangible personal property, and corporate stock.

BACKGROUND

Acquisition indebtedness plays a significant role in the determination of whether or not debt-financed property constitutes UBI. Acquisition indebtedness is defined, in Internal Revenue Service (“IRS”) Publication 598, Tax on Unrelated Business Income of Exempt Organizations, (“IRS Publication 598”) as the unpaid amount of debt incurred by an organization when:

  • Acquiring or improving the property,
  • Before acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement, and
  • After acquiring or improving the property if (a) the debt would not have been incurred except for the acquisition or improvement, and (b) incurring the debt was reasonably foreseeable when the property was acquired or improved.

When considering the inclusion of income and deductions associated with debt-financed property in an organization’s UBI calculation, it is important to note that the following, although not all inclusive, is a list of items that are generally not includible as debt-financed property:

  • Any indebtedness incurred by the tax-exempt organization which is inherent in the performance or exercise of the tax-exempt organization’s exempt purpose or function.
  • If substantially all (85% or more) of the use of any property is substantially related to an organization’s exempt purposes.
  • Property used in an unrelated trade or business.
  • Property used in research activities.
  • Property used in activities which are excluded from the definition of UBI, as defined by IRC §512.
  • Related exempt uses. Property owned by a tax-exempt organization and used by a related exempt organization, or an organization related to the related organization, in furtherance by either organization of its exempt purposes.

Under IRC §514, a certain percentage of gross income generated from debt-financed property must be included in UBI for an exempt organization. According to IRS Publication 598, “when only part of the property is debt-financed property, proper allocation of the basis, debt, income and deductions with respect to the property must be made to determine how much income or gain derived from the property to treat as unrelated debt-financed income”. It is imperative that the tax-exempt organization maintain detailed records when determining if there is any underlying acquisition indebtedness and whether or not income needs to be included for tax liability purposes. Proper documentation enables proper exclusions and inclusions to determine the correct amounts necessary for tax purposes.

UBI TAX RATE AND REPORTING

As outlined in our May 29, 2013 tax tip, “Unrelated Business Income”, all activities that generate UBI are required to be reported, on an activity by activity basis, on Form 990-T, Exempt Organization Business Income Tax Return. Any tax-exempt organization with gross income of $1,000 or more for any year from the conduct of an unrelated trade or business must prepare and file a Form 990-T. Any net UBI, or UBTI, reported on a Form 990-T is subject to Federal income tax at regular corporation rates as prescribed by the IRS.

CONCLUSION

As noted in our previous tax tips, continued IRS interest and scrutiny in this area will continue to subject organizations to questions and examinations with respect to UBI reporting and activities. All organizations should carefully consider reviewing their existing business activities to determine if any may constitute UBI and any new business ventures for UBI reporting.

A complete copy of the 2012 IRS Form 990-T, 2012 Form 990-T instructions and IRS Publication 598 can be accessed at the healthcare services section of our firm’s website.

For more information on the topics discussed or services we can provide, please contact:
Scott Mariani, JD, Partner
Practice Leader
973.898.9494 ? [email protected]

Questions or comments?
E-mail us at [email protected]

To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

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