Lancaster, NY asked in Tax Law for New York

Q: What does our church need have in line to legally rent to a for-profit daycare?

We (the church- 501c3) have been renting to a daycare for 30 years. It is a for-profit. The church has been renting for 1/2 market-value. There is no lease and they are paying via a "donation". It is my understanding that the IRS still considers that "rent". Is that accurate? I am also concerned about about "private benefit" for not charging market value. It is my understanding that we should give them a 1099 for the difference? Is it legal to label it as a donation instead of rent? Do we need to fix anything from the past?

What are the possible consequences of not repairing the situation?

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1 Lawyer Answer
Jeffrey Anton Collins
Jeffrey Anton Collins
  • Tax Law Lawyer
  • Naperville, IL

A: My experience with 501(c) exempt organizations is limited. But I can provide this:

The church should be concerned about what is called "Unrelated Business Income". The Internal Revenue Service defines the income generated from unrelated business activities as income from a trade or business regularly carried on, that is not substantially related to the purpose that is the basis of the organization's exemption from tax.

What that all means is if providing daycare services is not largely related to the church's non-profit mission or objectives, then it may have taxable income from that daycare or rental. Related to this point, categorizing the receipts as "donations" is merely superficial. It does not change the true nature of the payments.

Now, as a practical matter, most local church organizations fail to file the appropriate IRS Form 990 series, and report unrelated business income. Occasionally, they later become blind-sided with tax, interest and penalties resulting from IRS audits. I would hire an experienced certified public accountant to maintain a watch over the church's tax obligations. This will help ensure reporting compliance, transparency, and preparedness if there is a tax obligation.

J Anton Collins

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