When Does Your Nonprofit's Debt-Financed Income Trigger Taxes?

Nonprofits often generate income through investments like dividends, interest, rents, and annuities. Typically, these types of income are excluded from unrelated business income tax (UBIT) calculations. However, when the income comes from debt-financed property, it is usually taxable. To avoid triggering unwanted IRS scrutiny, it’s important to properly account for this type of income in your UBIT calculations.

What Qualifies as Unrelated Business Income (UBI)?

Income from debt-financed property is generally considered taxable unrelated business income (UBI) in proportion to the amount of debt on the property. For instance, if 75% of a property’s acquisition cost is financed with debt, 75% of the income generated from that property would typically be taxable UBI.

Real estate is the most common example of debt-financed property for nonprofits. For instance, renting out office space that isn’t related to your nonprofit’s mission could generate taxable income. Debt-financed property may also include stocks or other investments acquired with borrowed funds.

Any property that has outstanding “acquisition indebtedness” at any time during the tax year is considered debt-financed for UBIT purposes. This includes situations where your nonprofit took on debt before, during, or shortly after acquiring or improving the property.

What Doesn’t Count as UBI?

Not all debt-financed property results in taxable income. Here are some exceptions to consider:

• Property related to your exempt purpose: If at least 85% of the property’s use is tied directly to your nonprofit’s mission, it won’t be treated as debt-financed property. Keep in mind, using income from the property to support your programs doesn’t qualify the property itself as related to your exempt purpose. The property must actively be used in providing program services.
• Property used in certain excluded activities: Property used in trades or businesses that are excluded from the definition of “unrelated trade or business” also doesn’t count. This might include activities with a volunteer workforce, research activities, operations for the convenience of members, or selling donated merchandise.
• Real property under the neighborhood land rule: If your nonprofit acquires real estate with the intention of using it for exempt purposes within 10 years, it may qualify for this exemption. Generally, the property must be adjacent to other property already used for your exempt purposes. However, this exemption will no longer apply if you abandon your intent to use the land for exempt purposes.

Who Can Help?

There are additional circumstances in which investment income, such as dividends, interest, rents, or annuities, may be subject to UBIT — for example, if the income comes directly from a subsidiary your nonprofit controls. Determining when income is taxable can be complex, and the rules around UBIT are intricate.

To ensure compliance and avoid unexpected tax liabilities, reach out to us for guidance. We’re here to help you navigate these complex tax rules and keep your nonprofit in good standing with the IRS.

How HoganTaylor Can Help

The HoganTaylor Nonprofit team of business advisors and CPAs is comprised of former CFOs, controllers, and industry experts with extensive experience providing the guidance organizations need to lean forward again in their leadership. If you have any questions about this content, or if you would like more information about HoganTaylor’s Nonprofit practice, please contact Jack Murray, CPA, Nonprofit Practice Lead.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.