Department

of the

Treasury

Internal

Revenue

Service

Publication 598

(Rev. March 2021)

Cat. No. 46598X

Tax on

Unrelated

Business Income

of Exempt

Organizations

Contents

Introduction. . . . . . . . . . . . . . . . . . 2

Chapter 1. Organizations Subject

to the Tax . . . . . . . . . . . . . . . . . 2

Chapter 2. The Tax and Filing

Requirements . . . . . . . . . . . . . . 3

Chapter 3. Unrelated Trade

or Business. . . . . . . . . . . . . . . 4

Chapter 4. Unrelated Business

Taxable Income . . . . . . . . . . . . . 9

Chapter 5. How To Get Tax Help . . . . 21

Index. . . . . . . . . . . . . . . . . . . . . 22

Future Developments

The IRS has created a page on IRS.gov for information about Pub. 598, at IRS.gov/Pub598. Information about any future developments affecting Pub. 598 (such as legislation enacted after we release it) will be posted on that page.

Mar 22, 2021


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What's New

Mandatory electronic filing. Section 3101 of the Taxpayer First Act, (P.L. 116-25) requires tax-exempt organizations to electronically file information returns and related forms. This law affects tax-exempt organizations in tax years beginning after July 1, 2019. In 2020, the IRS continued to accept paper Forms 990-T pending conversion into electronic format. In 2021, the Form 990-T is being updated and e-filing is required for tax year 2020 filings. The IRS expects e-filing to be available beginning in February 2021. The IRS will announce the specific dates when the programming comes online. See the Instructions for Form 990-T, When, Where, and How To File, for more information.

Final regulations issued. Section 512(a)(6) requires a tax-exempt organization with more than one unrelated trade or business to compute unrelated business taxable income (UBTI), including any NOL deduction, separately for each trade or business. Final regulations were published in the Federal Register on December 2, 2020, that provide guidance on how an exempt organization determines if it has more than one unrelated trade or business, and, if so, how the exempt organization calculates unrelated business taxable income. T.D. 9933, 85 Fed. Reg. 77952 (Dec. 2, 2020). The final regulations are applicable to tax years beginning on or after December 2, 2020. In addition, an exempt organization may choose to apply the final regulations under section 512(a)

(6) to tax years beginning on or after January 1, 2018, and before December 2, 2020. Alternatively, an exempt

organization may rely on a reasonable, good-faith interpretation of section 512(a)

(6) for such tax years. For this purpose, a reasonable good faith interpretation includes the methods of aggregating or identifying separate trades or businesses provided in Notice 2018-67 or the proposed regulations published April 24, 2020 (85 Fed. Reg. 23172). See T.D. 9933 for more details.

Form 990-T has been redesigned for tax year 2020. Schedule M (Form 990-T) has been replaced with Schedule A. Each unrelated trade or business of an organization is reported on a separate Schedule A. At the organization’s discretion, each separate trade or business may be classified by a 2-digit North American Industrial Classification System (NAICS) code. See Regulations section 1.512(a)-6(b)(1). The Instructions for Form 990-T provide 6-digit Business Activity Codes for investment and other activities not represented in NAICS.

Organizations with more than one unrelated trade or business must compute unrelated business taxable income (UBTI), including for the purpose of determining any net operating loss deduction, separately with respect to each such trade or business. See Regulations section 1.512(a)-6 for more information.

Retroactive repeal of section 512(a)(7). P.L. 116-94 retroactively repealed the section 512(a)(7), which required exempt organizations to increase their unrelated business taxable income for expenses incurred to provide certain benefits, including qualified transportation fringes. If your organization reported and paid tax on such amounts included in unrelated business taxable income for tax years 2017 or 2018 and you want to claim a refund, file an amended Form 990-T.
Net operating loss (NOL) carryback. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) amended section 172 provides for carryback of any net operating loss arising in a tax year beginning after 2017 and before 2021 to each of the 5 tax years preceding the tax year of the NOL. Taxpayers may elect to waive the carryback period for NOLs arising in those years. To elect to waive the carryback period for an NOL arising in a tax year beginning in 2018 or 2019, attach a statement electing the carryback waiver to your return for the first tax year ending after March 27, 2020. For more information, see Rev. Proc. 2020-24. If you incurred an NOL in a tax year beginning in 2018 or 2019, you can file an amended return, Form 990-T, to carryback the NOL. See Pub. 536 for more information.

The maximum cost of a low-cost article, for organizations eligible to receive charitable contributions, was increased to $11.20 for 2020. See Distribution of low-cost articles, later.

The annual limit on associate member dues received by an agricultural or horticultural organization not treated as gross income was increased to $171 for 2020. See Exception under Dues of

Agricultural Organizations and Business Leagues, later.

Introduction

An exempt organization isn’t taxed on its in-come from an activity substantially related to the charitable, educational, or other purpose that is the basis for the organization's exemp-tion. Such income is exempt even if the activity is a trade or business.

However, if an exempt organization regu-larly carries on one or more trades or busi-nesses not substantially related to the organiza-tion's exempt purpose, except that conducting the trade or business provides funds to carry out the exempt purpose, the organization is subject to tax on its income from the unrelated trade(s) or business(es).

This publication covers the rules for the tax on unrelated business income of exempt organ-izations. It explains:

1. Which organizations are subject to the tax (chapter 1),

2. What the requirements are for filing a tax return (chapter 2),

3. What an unrelated trade or business is (chapter 3), and

4. How to figure unrelated business taxable income (chapter 4).

All section references in this publication are to the Internal Revenue Code.

Useful Items

You may want to see:

Publication

557 Tax-Exempt Status for Your

Organization

Form (and Instructions)

990-T Exempt Organization Business Income Tax Return

Schedule A (990-T) Unrelated Business Taxable Income From an Unrelated Trade or Business

Visit IRS.gov/FormsPubs to download forms and publications. Otherwise, you can go to IRS.gov/OrderForms to order current and prior-year forms and instructions. Your order should arrive within 10 business days.

Comments and suggestions. We welcome your comments about this publication and your suggestions for future editions.

Youcansenduscommentsthrough

IRS.gov/FormComments. Or you can write to:

Internal Revenue Service

Tax Forms and Publications

1111 Constitution Ave. NW, IR-6526

Washington, DC 20224

Although we can’t respond individually to each comment received, we do appreciate your feedback and will consider your comments as we revise our tax products.

Tax questions. If you have tax questions not answered by the publication, check IRS.gov

and How To Get Tax Help at the end of this publication.

1.

Organizations Subject to the Tax

The tax on unrelated business income applies to most organizations exempt from tax under section 501(a). These organizations include charitable, religious, scientific, and other organi-zations described in section 501(c), as well as employees' trusts forming part of pension, profit-sharing, and stock bonus plans described in section 401(a).

In addition, the following are subject to the tax on unrelated business income.

Individual retirement arrangements (IRAs), including traditional IRAs, Roth IRAs, sim-plified employee pensions (SEP-IRAs), and savings incentive match plans for em-ployees (SIMPLE IRAs).

State and municipal colleges and universi-ties.

Qualified state tuition programs described in section 529.

Qualified ABLE programs described in section 529A.

Medical savings accounts (MSAs) descri-bed in section 220(d).

Coverdell savings accounts described in section 530.

U.S. instrumentalities. A corporation that is a U.S. instrumentality described in section 501(c)

(1) isn’t subject to the tax on unrelated business income if the corporation is organized under an Act of Congress and, under the Act, is exempt from federal income taxes.

Colleges and universities. Colleges and uni-versities that are agencies or instrumentalities of any government or any political subdivision of a government, or that are owned or operated by a government or political subdivision of a government, are subject to the tax on unrelated business income. As used here, the word “gov-ernment” includes any foreign government (to the extent not contrary to a treaty) and all do-mestic governments (the United States and any of its possessions, any state, and the District of Columbia).

The tax is on the unrelated business income of both the universities and colleges themselves and on their wholly owned or controlled tax ex-empt subsidiary organizations. It is immaterial whether the business is conducted by the uni-versity or by a separately incorporated wholly owned or controlled subsidiary. If the business activity is unrelated, the income in both instan-ces will be subject to the tax. If the primary

Page 2Chapter 1Organizations Subject to the Tax

purpose of a wholly owned or controlled subsid-iary is to operate or conduct any unrelated trade or business (other than holding title to property and collecting income from it), the subsidiary isn’t an exempt organization, and this rule doesn’t apply.

Title-holding corporations. When an exempt title-holding corporation, described in section 501(c)(2), pays any of its net income to an or-ganization that itself is exempt from tax under section 501(a) (or would pay such an amount except that the expenses of collecting its in-come exceed the amount collected) and files a consolidated return with that organization, the title-holding corporation is treated, for unrelated business income tax purposes, as organized and operated for the same purposes as the ex-empt payee organization.

Thus, a title-holding corporation whose source of income is related to the exempt pur-poses of the payee organization isn’t subject to the unrelated business income tax if the holding corporation and the payee organization file a consolidated return. However, if the source of the income isn’t so related, the title-holding cor-poration is subject to unrelated business in-come tax.

Example. X, a title -holding corporation, is required to distribute its net income to A, an ex-empt organization. During the tax year, X real-izes net income of $900,000 from source M, which is related to A's exempt function. X also receives $100,000 from source N, which isn’t related to A's exempt function. X and A file a consolidated return for the tax year. X has unre-lated business income of $100,000.

2.

The Tax and

Filing

Requirements

All organizations subject to the tax on unrelated business income, except the exempt trusts de-scribed in section 511(b)(2), are taxable at cor-porate rates on that income. All exempt trusts subject to the tax on unrelated business income that, if not exempt, would be taxable as trusts are taxable at trust rates on that income. How-ever, an exempt trust may not claim the deduc-tion for a personal exemption that is normally al-lowed to a trust.

The tax is imposed on the organization's unrela-ted business taxable income (UBTI) (described in chapter 4). Under section 512(a)(6), an or-ganization that conducts more than one unrela-ted trade or business calculates its UBTI as the sum of the UBTI calculated separately for each unrelated trade or business, and when calculat-ing this sum, the UBTI from any of the separate

trades or businesses can't be less than zero. The tax computed on the total UBTI can be re-duced by any applicable tax credits, including the general business credits (such as the in-vestment credit) and the foreign tax credit.

Returns and Filing Requirements

Mandatory electronic filing of Form 990-T star-ted in February 2021. Limited exceptions apply. See the Instructions for Form 990-T for more in-formation. The obligation to file Form 990-T is in addition to the obligation to file any other re-quired return or notice.

Form 990-T is required if the sum of the or-ganization's gross income from all unrelated businesses is $1,000 or more. An exempt or-ganization files a single Form 990 -T. The organ-ization reports the income and expenses for each of its unrelated businesses on a separate Schedule A (Form 990-T) attached to the Form 990-T. See Regulations section 1.512(a) -6 for information about how to identify separate unre-lated trades or businesses.

Each organization must file a separate Form 990-T, except section 501(c)(2) title-holding corporations and organizations receiving their earnings that file a consolidated return under section 1501.

The various provisions of tax law relating to accounting periods, accounting methods, at-risk limits (described in section 465), assess-ments, and collection penalties that apply to tax returns also generally apply to Form 990-T.

When to file. The Form 990-T of an employ-ees' trust described in section 401(a), an IRA (including a traditional, SEP, SIMPLE, Roth, or Coverdell IRA), or an MSA must be filed by the 15th day of the 4th month after the end of its tax year. The Form 990-T of any other exempt or-ganization must be filed by the 15th day of the 5th month after the end of its tax year. If the due date falls on a Saturday, Sunday, or legal holi-day, the return is due by the next business day.

Extension of time to file. Use Form 8868, Application for Automatic Extension of Time To File an Exempt Organization Return, to request an automatic 6-month extension of time to file Form 990-T.

Public Inspection Requirements of Section 501(c)(3) Organizations. Under section 6104(d), a section 501(c)(3) organization that has gross income from an unrelated trade or business of $1,000 or more must make its Form 990-T return (including amended returns) avail-able for public inspection. See the Instructions for Form 990-T for information about attach-ments and related forms that are disclosable as part of the return.

A section 501(c)(3) organization filing TIP the Form 990-T only to request a credit for certain federal excise taxes paid doesn’t have to make the Form 990-T available

for public inspection.

Chapter 2

Payment of Tax

Estimated tax. A tax-exempt organization must make estimated tax payments if it antici-pates its tax (unrelated business income tax af-ter certain adjustments) to be $500 or more. Es-timated tax payments are generally due by the 15th day of the 4th, 6th, 9th, and 12th months of the tax year. If any due date falls on a Saturday, Sunday, or legal holiday, the payment is due on the next business day.

Any organization that fails to pay the proper estimated tax when due may be charged an un-derpayment penalty for the period of underpay-ment. Generally, to avoid the estimated tax pen-alty, the organization must make estimated tax payments that total 100% of the organization's current tax year liability. However, an organiza-tion with taxable income less than $1 million for each of the 3 preceding tax years can base its required estimated tax payments on 100% of the tax shown on its return for the preceding year (unless no tax is shown). If an organiza-tion's taxable income for any of those years was $1 million or more, it can base only its first re-quired installment payment on its prior year's tax.

All tax-exempt organizations should use Form 990-W (Worksheet), to figure their estima-ted tax.

Tax due with Form 990-T. Any tax due with Form 990-T must be paid in full when the return is filed, but no later than the date the return is due (determined without extensions).

Federal Tax Deposits Must be Made by Electronic Funds Transfer

Electronic Deposit Requirement. The or-ganization must deposit all depository taxes (such as employment tax, excise tax, and cor-porate income tax) electronically. Generally, electronic fund transfers are made using the Electronic Federal Tax Payment System (EFTPS). For more information about EFTPS or to enroll in EFTPS, visit the EFTPS website at EFTPS.gov, or call 1-800-555-4477, 1-800-733-4829 (TDD), or 1-800-244 -4829 (Spanish). You can also get Pub. 966, Elec-tronic Federal Tax Payment System: A Guide to Getting Started.

Depositing on time. For EFTPS deposits to be made timely, the organization must initiate the deposit by 8 p.m. Eastern time the day be-fore the deposit is due.

Same-day wire payment option. If you fail to initiate a deposit transaction on EFTPS by 8 p.m. Eastern time the day before the date a de-posit is due, you can still make your deposit on time by using the Federal Tax Application (FTA), a same-day federal tax payment system that works in conjunction with EFTPS. Make ar-rangements with your financial institution ahead of time, noting the institution's availability, dead-lines, and costs, if you believe you would ever need the same-day wire payment option. To learn more, visit IRS.gov/SameDayWire and

The Tax and Filing RequirementsPage 3

also download the Same-Day Payment Work-sheet.

Timeliness of deposits. The IRS uses busi-ness days to determine the timeliness of depos-its. Business days are any day that isn't a Satur-day, Sunday, or legal holiday in the District of Columbia. See Pub. 583, Starting a Business and Keeping Records.

If the organization owes tax and is filing

a paper Form 990-T, don't include the CAUTION payment with the tax return. Instead, use EFTPS.

3.

Unrelated Trade or Business

Unrelated business income is the income from a trade or business regularly conducted by an exempt organization and not substantially rela-ted to the performance by the organization of its exempt purpose or function. Use by the organi-zation, of the profits derived from this activity, does not, alone, make the activity substantially related to the performance by the organization of its exempt purpose or function.

Certain trade or business activities aren’t trea-ted as an unrelated trade or business. See Ex-cluded Trade or Business Activities, later.

Trade or business. The term “trade or busi-ness” generally includes any activity conducted for the production of income from selling goods or performing services. An activity must be con-ducted with intent to make a profit to constitute a trade or business. An activity doesn’t lose its identity as a trade or business merely because it is conducted within a larger group of similar activities that may or may not be related to the exempt purposes of the organization.

For example, the regular sale of pharma-ceutical supplies to the general public by a hos-pital pharmacy doesn’t lose its identity as a trade or business, even though the pharmacy also furnishes supplies to the hospital and pa-tients of the hospital in accordance with its ex-empt purpose. Similarly, soliciting, selling, and publishing commercial advertising is a trade or business even though the advertising is pub-lished in an exempt organization's periodical that contains editorial matter related to the or-ganization's exempt purpose.

Regularly conducted. Business activities of an exempt organization ordinarily are consid-ered regularly conducted if they show a fre-quency and continuity, and are pursued in a manner similar to comparable commercial ac-tivities of nonexempt organizations.

For example, a hospital auxiliary's operation of a sandwich stand for 2 weeks at a state fair would not be the regular conduct of a trade or

business. The stand would not compete with similar facilities that a nonexempt organization would ordinarily operate year-round. However, operating a commercial parking lot every Satur-day, year -round, would be the regular conduct of a trade or business.

Not substantially related. A business activity isn’t substantially related to an organization's exempt purpose if it doesn’t contribute impor-tantly to accomplishing that purpose (other than through the production of funds). Whether an activity contributes importantly depends in each case on the facts involved.

In determining whether activities contribute importantly to the accomplishment of an ex-empt purpose, the size and extent of the activi-ties involved must be considered in relation to the nature and extent of the exempt function that they intend to serve. For example, to the extent an activity is conducted on a scale larger than is reasonably necessary to perform an ex-empt purpose, it doesn’t contribute importantly to the accomplishment of the exempt purpose. The part of the activity that is more than needed to accomplish the exempt purpose is an unrela-ted trade or business.

Also in determining whether activities con-tribute importantly to the accomplishment of an exempt purpose, the following principles apply.

Selling of products of exempt functions. Ordinarily, selling products that result from the performance of exempt functions isn’t an unre-lated trade or business if the product is sold in substantially the same state it is in when the ex-empt functions are completed. Thus, for an ex-empt organization engaged in rehabilitating handicapped persons (its exempt function), selling articles made by these persons as part of their rehabilitation training is not an unrelated trade or business.

However, if a completed product resulting from an exempt function is used or exploited in further business activity beyond what is reason-ably appropriate or necessary to dispose of it as is, the activity is an unrelated trade or business. For example, if an exempt organization main-tains an experimental dairy herd for scientific purposes, the sale of milk and cream produced in the ordinary course of operation of the project isn’t an unrelated trade or business. But if the organization uses the milk and cream in the fur-ther manufacture of food items such as ice cream, pastries, etc., the sale of these products is an unrelated trade or business unless the manufacturing activities themselves contribute importantly to the accomplishment of an ex-empt purpose of the organization.

Dual use of assets or facilities. If an as-set or facility necessary to the conduct of ex-empt functions is also used in commercial activ-ities, its use for exempt functions doesn’t, by itself, make the commercial activities a related trade or business. The test, as discussed ear-lier, is whether the activities contribute impor-tantly to the accomplishment of exempt purpo-ses.

For example, a museum has a theater audi-torium designed for showing educational films in connection with its program of public educa-tion in the arts and sciences. The theater is a principal feature of the museum and operates continuously while the museum is open to the

public. If the organization also operates the the-ater as a motion picture theater for the public when the museum is closed, the activity is an unrelated trade or business.

For information on allocating expenses for the dual use of assets or facilities, see Deduc-tions in chapter 4.

Exploitation of exempt functions. Ex-empt activities sometimes create goodwill or other intangibles that can be exploited in a com-mercial way. When an organization exploits such an intangible in commercial activities, the fact that the income depends in part upon an exempt function of the organization doesn’t make the commercial activities a related trade or business. Unless the commercial exploitation contributes importantly to the accomplishment of the exempt purpose, the commercial activi-ties are an unrelated trade or business.

For the treatment of expenses attributable to the exploitation of exempt activities, see Deduc-tions in chapter 4.

Examples

The following are examples of activities that were determined to be (or not to be) unrelated trades or businesses using the definitions and principles just discussed.

Artists' facilities. An organization whose ex-empt purpose is to stimulate and foster public interest in the fine arts by promoting art exhibits, sponsoring cultural events, and furnishing infor-mation about fine arts leases studio apartments to artist tenants and operates a dining hall pri-marily for these tenants. These two activities don’t contribute importantly to accomplishing the organization's exempt purpose. Therefore, they are unrelated trades or businesses.

Broadcasting rights. An exempt collegiate athletic conference conducts an annual com-petitive athletic game between its conference champion and another collegiate team. Income is derived from admission charges and the sale of exclusive broadcasting rights to a national ra-dio and television network. An athletic program is considered an integral part of the educational process of a university.

The educational purposes served by inter-collegiate athletics are identical whether con-ducted directly by individual universities or by their regional athletic conference. Also, the edu-cational purposes served by exhibiting a game before an audience that is physically present and exhibiting the game on television or radio before a much larger audience are substantially similar. Therefore, the sale of the broadcasting rights contributes importantly to the accomplish-ment of the organization's exempt purpose and isn’t an unrelated trade or business.

In a similar situation, an exempt organization was created as a national governing body for amateur athletes to foster interest in amateur sports and to encourage widespread public par-ticipation. The organization receives income each year from the sale of exclusive broadcast-ing rights to an independent producer, who con-tracts with a commercial network to broadcast many of the athletic events sponsored, super-vised, and regulated by the organization.

Page 4Chapter 3Unrelated Trade or Business

The broadcasting of these events promotes the various amateur sports, fosters widespread public interest in the benefits of the organiza-tion's nationwide amateur program, and encour-ages public participation. The sale of the rights and the broadcasting of the events contribute importantly to the organization's exempt pur-pose. Therefore, the sale of the exclusive broadcasting rights isn’t an unrelated trade or business.

Business league's parking and bus serv-ices. The exempt purpose of a business lea-gue is to retain and stimulate trade in a down-town area that has inadequate parking facilities. The organization operates, as an insubstantial part of its activities, a park-and-shop plan.

The park-and-shop plan allows customers of particular merchants to park free at certain parking lots in the area. Merchants participating in this plan buy parking stamps, which they dis-tribute to their customers to use to pay for park-ing.

The park-and-shop plan encourages cus-tomers to use a limited number of participating member merchants in order to obtain free park-ing. This provides a particular service to individ-ual members of the organization and doesn’t further its exempt purpose. Therefore, operating the park-and-shop plan is an unrelated trade or business.

Halfway house workshop. A halfway house organized to provide room, board, therapy, and counseling for persons discharged from alco-holic treatment centers also operates a furniture shop to provide full-time employment for its res-idents. The profits are applied to the operating costs of the halfway house. The income from this venture isn’t unrelated trade or business in-come because the furniture shop contributes importantly to the organization's purpose of aid-ing its residents' transition from treatment to a normal and productive life.

tic and therapeutic procedures to the hospital's		more time viewing the museum's exhibits with-
patients and operates the hospital's emergency		out having to seek outside restaurants at meal-
room on a 24-hour basis. The leasing activity is		time. The eating facilities also allow the mu-
substantially related to the hospital's exempt		seum staff and employees to remain in the
purpose and isn’t an unrelated trade or busi-		museum throughout the day. Thus, the mu-
ness.		seum's operation of the eating facilities contrib-
The hospital also operates a gift shop		utes importantly to the accomplishment of its
patronized by patients, visitors making purcha-		exempt purposes and isn’t an unrelated trade or
ses for patients, and employees; a cafeteria		business.
and coffee shop primarily for employees and		Museum greeting card sales. An art mu-
medical staff; and a parking lot for patients and
visitors only. These activities are substantially		seum that exhibits modern art sells greeting
related to the hospital's exempt purpose and		cards that display printed reproductions of se-
don’t constitute unrelated trades or businesses.		lected works from other art collections. Each
Insurance programs. An organization that		card is imprinted with the name of the artist, the
		title or subject matter of the work, the date or
acts as a group insurance policyholder for its		period of its creation, if known, and the mu-
members and collects a fee for performing ad-		seum's name. The cards contain appropriate
ministrative services is normally carrying on an		greetings and are personalized on request.
unrelated trade or business.		The organization sells the cards in the shop
*Exceptions.*	Administrative services provi-	it operates in the museum and sells them at
		quantity discounts to retail stores. The museum
ded by an organization whose exempt activities		also sells greeting cards by mail order through a
may include the provision of insurance benefits,		catalog that is advertised in magazines and
such as fraternal beneficiary societies, volun-		other publications throughout the year. As a re-
tary employees beneficiary associations, and		sult, a large number of cards are sold at a sig-
labor organizations, are generally not an unrela-		nificant profit.
ted trade or business.		The museum is exempt as an educational
Magazine publishing. An association of credit		organization on the basis of its ownership,
		maintenance, and exhibition for public viewing
unions with tax-exempt status as a business
		of works of art. The sale of greeting cards with
league publishes a consumer-oriented maga-
		printed reproductions of artworks contributes
zine four times a year and makes it available to
		importantly to the achievement of the museum's
member credit unions for purchase.
		exempt educational purposes by enhancing
By selling a magazine to its members as a
		public awareness, interest, and appreciation of
promotional device, the organization furnishes
		art. The cards may encourage more people to
its members with a regular commercial service
		visit the museum itself to share in its educa-
they can use in their own operations. This serv-
		tional programs. The fact that the cards are pro-
ice doesn’t promote the improvement of busi-
		moted and sold in a commercial manner at a
ness conditions of one or more lines of busi-
		profit and in competition with commercial greet-
ness, which is	the exempt purpose of a
		ing card publishers doesn’t alter the fact that the
business league.
		activity is related to the museum's exempt pur-
Since the activity doesn’t contribute impor-
		pose. Therefore, these sales activities aren’t an
tantly to the organization's exempt function, it is		unrelated trade or business.
an unrelated trade or business.

Health club program. An exempt charitable organization's purpose is to provide for the wel-fare of young people. The organization con-ducts charitable activities and maintains facili-ties that will contribute to the physical, social, mental, and spiritual health of young people at minimum or no cost to them. Nominal annual dues are charged for membership in the organi-zation and use of the facilities.

In addition, the organization organized a health club program that its members could join for an annual fee in addition to the annual dues. The annual fee is comparable to fees charged by similar local commercial health clubs and is sufficiently high to restrict participation in the program to a limited number of members of the community.

The health club program is in addition to the general physical fitness program of the organi-zation. Operating this program does not contrib-ute importantly to the organization's accom-plishing its exempt purpose and, therefore, is an unrelated trade or business if there is a in-tent to make a profit.

Membership list sales. An exempt educa-tional organization regularly sells membership mailing lists to business firms. This activity doesn’t contribute importantly to the accom-plishment of the organization's exempt purpose and therefore is an unrelated trade or business. Also see Exchange or rental of member lists un-der Excluded Trade or Business Activities, later.

Miniature golf course. An exempt youth wel-fare organization operates a miniature golf course that is open to the general public. The course, which is managed by salaried employ-ees, is substantially similar to commercial cour-ses. The admission fees charged are compara-ble to fees of commercial facilities and are designed to return a profit.

The operation of the miniature golf course in a commercial manner doesn’t contribute impor-tantly to the accomplishment of the organiza-tion's exempt purpose and, therefore, is an un-related trade or business.

Museum shop. An art museum maintained and operated for the exhibition of American folk art operates a shop in the museum that sells:

1. Reproductions of works in the museum's own collection and reproductions of artis-tic works from the collections of other art museums (prints suitable for framing, postcards, greeting cards, and slides);

2. Metal, wood, and ceramic copies of Amer-ican folk art objects from its own collection and similar copies of art objects from other collections of artworks;

3. Instructional literature and scientific books and souvenir items concerning the history and development of art and, in particular, of American folk art; and

4. Scientific books and souvenir items of the city in which the museum is located.

The shop also rents originals or reproduc-tions of paintings contained in its collection. All of its reproductions are imprinted with the name

Hospital facilities. An exempt hospital leases its adjacent office building and furnishes certain office services to a hospital-based medical group for a fee. The group provides all diagnos-

Museum eating facilities. An exempt art mu-	of the artist, the title or subject matter of the
seum operates a dining room, a cafeteria, and a	work from which it is reproduced, and the mu-
snack bar for use by the museum staff, employ-	seum's name.
ees, and visitors. Eating facilities in the museum
help to attract visitors and allow them to spend
Chapter 3 Unrelated Trade or Business		Page 5

Each line of merchandise must be consid-ered separately to determine if sales are related to the exempt purpose.

The sale and rental of reproductions and copies of works from the museum's own collec-tion and reproductions of artistic works not owned by the museum contribute importantly to the achievement of the museum's exempt edu-cational purpose by making works of art familiar to a broader segment of the public, thereby en-hancing the public's understanding and appre-ciation of art. The same is true for the sale of lit-erature relating to art. Therefore, these sales activities aren’t an unrelated trade or business.

On the other hand, the sale (if they intend to make a profit) of scientific books and souvenir items of the city where the museum is located has no causal relationship to art or to artistic en-deavor and, therefore, doesn’t contribute impor-tantly to the accomplishment of the museum's exempt educational purposes. Even though selling some of these items could, in a different context, be related to the exempt educational purpose of a different exempt educational or-ganization doesn’t change this conclusion. Ad-ditionally, the sale of these items doesn’t lose its character as an unrelated trade or business merely because the museum also sells articles that contribute importantly to the accomplish-ment of its exempt function. Therefore, these sales by the museum in this example are an un-related trade or business.

Nonpatient laboratory testing. Nonpatient laboratory testing performed by a tax-exempt teaching hospital on specimens needed for the conduct of its teaching activities isn’t an unrela-ted trade or business. However, laboratory test-ing performed by a tax-exempt non-teaching hospital on referred specimens from private of-fice patients of staff physicians is an unrelated trade or business if these services are other-wise available in the community.

Pet boarding and grooming services. An exempt organization, organized and operated for the prevention of cruelty to animals, receives unrelated business income from providing pet boarding and grooming services for the general public. These activities don’t contribute impor-tantly to its purpose of preventing cruelty to ani-mals.

Publishing legal notices. A bar association publishes a legal journal containing opinions of the county court, articles of professional interest to lawyers, advertisements for products and services used by the legal profession, and legal notices. The legal notices are published to sat-isfy state laws requiring publication of notices in connection with legal proceedings, such as the administration of estates and actions to quiet ti-tle to real property. The state designated the bar association's journal as the place to publish the required notices.

The publication of ordinary commercial ad-vertising doesn’t advance the exempt purposes of the association even when published in a pe-riodical that contains material related to exempt purposes. Although the advertising is directed specifically to members of the legal profession, it is still commercial in nature and doesn’t con-tribute importantly to the exempt purposes of

the association. Therefore, the advertising in-come is unrelated trade or business income.

On the other hand, the publication of legal notices is distinguishable from ordinary com-mercial advertising in that its purpose is to in-form the general public of significant legal events rather than to stimulate demand for the products or services of an advertiser. This pro-motes the common interests of the legal profes-sion and contributes importantly to the associa-tion's exempt purposes. Therefore, the publishing of legal notices doesn’t constitute an unrelated trade or business.

Directory of members. A business league publishes an annual directory that contains a list of all its members, their addresses, and their area of expertise. Each member has the same amount of space in the directory, and its format doesn’t emphasize the relative importance or reputation of any member. The directory con-tains no commercial advertisement and is sold only to the organization's members.

The directory facilitates communication among the members and encourages the ex-change of ideas and expertise. Because the di-rectory lists the members in a similar noncom-mercial format without advertising and isn’t distributed to the public, its sale doesn’t confer private commercial benefits on the members. The sale of the directory does contribute impor-tantly to the organization's exempt purpose and isn’t an unrelated trade or business. This direc-tory differs from the publication discussed next because of its noncommercial characteristics.

Sales of advertising space. A national asso-ciation of law enforcement officials publishes a monthly journal that contains articles and other editorial material of professional interest to its members. The journal is distributed without charge, mainly to the organization's members.

The organization sells advertising space in the journal either for conventional advertising or to merely identify the purchaser without a com-mercial message. Some of the noncommercial advertising identifies the purchaser in a sepa-rate space, and some consists of listings of 60 or more purchasers per page. A business firm identified in a separate space is further identi-fied in an Index of Advertisers.

The organization solicits advertising by per-sonal contacts. Advertising from large firms is solicited by contacting their chief executive offi-cer or community relations officer rather than their advertising manager. The organization also solicits advertising in form letters appealing for corporate and personal contributions.

An exempt organization's sale of advertising placed for the purchaser's commercial benefit is a commercial activity. Goodwill derived by the purchaser from being identified as a patron of the organization is usually considered a form of commercial benefit. Therefore, advertising in an exempt organization's publication is generally presumed to be placed for the purchaser's com-mercial benefit, even if it has no commercial message. However, this presumption isn’t con-clusive if the purchaser's patronage would be difficult to justify commercially in view of the facts and circumstances. In that case, other fac-tors should also be considered in determining whether a commercial benefit can be expected. Those other factors include:

1. The normal manner in which the publica-tion is circulated;

2. The territorial scope of the circulation;

3. The extent to which its readers, promot-ers, or the like could reasonably be expec-ted to further, either directly or indirectly, the commercial interest of the advertisers;

4. The eligibility of the publishing organiza-tion to receive tax-deductible contribu-tions; and

5. The commercial or noncommercial meth-ods used to solicit the advertisers.

In this situation, the purchaser of a separate advertising space without a commercial mes-sage can nevertheless expect a commercial benefit from the goodwill derived from being identified in that manner as a patron of the or-ganization. However, the purchaser of a listing can’t expect more than an inconsequential ben-efit. Therefore, the sale of separate spaces, but not the listings, is an unrelated trade or busi-ness.

Sales of cattle for commissions. An agricul-tural organization, whose exempt purposes are to promote better conditions for cattle breeders and to improve the breed generally, engages in an unrelated trade or business when it regularly sells cattle for its members on a commission basis.

Sales of hearing aids. A tax-exempt hospital, whose primary activity is rehabilitation, sells hearing aids to patients. This activity is an es-sential part of the hospital's program to test and evaluate patients with hearing deficiencies and contributes importantly to its exempt purpose. The hearing aid sales aren't an unrelated trade or business.

School facilities. An exempt school has ten-nis courts and dressing rooms that it uses dur-ing the regular school year in its educational program. During the summer, the school oper-ates a tennis club open to the general public. Employees of the school run the club, including collecting membership fees and scheduling court time.

Another exempt school leases the same type of facilities to an unrelated individual who runs a tennis club for the summer. The lease is for a fixed fee that doesn’t depend on the in-come or profits derived from the leased prop-erty.

In both situations, the organization’s exempt purpose is the advancement of education. Fur-nishing tennis facilities in the manner described doesn't further that exempt purpose. These ac-tivities are unrelated trades or businesses. However, in the second situation the income derived from the leasing of the property may be excluded from UBTI as rent from real property. See Rents under Exclusions in chapter 4.

School handicraft shop. An exempt voca-tional school operates a handicraft shop that sells articles made by students in their regular courses of instruction. The students are paid a percentage of the sales price. In addition, the shop sells products made by local residents who make articles at home according to the

Page 6Chapter 3Unrelated Trade or Business

shop's specifications. The shop manager peri-odically inspects the articles during their manu-facture to ensure that they meet desired stand-ards of style and quality. Although many local participants are former students of the school, any qualified person may participate in the pro-gram. The sale of articles made by students doesn’t constitute an unrelated trade or busi-ness, but the sale of products made by local residents is an unrelated trade or business and is subject to unrelated business income tax.

Selling endorsements. An exempt scientific organization enjoys an excellent reputation in the field of biological research. It exploits this reputation regularly by selling endorsements of laboratory equipment to manufacturers. En-dorsing laboratory equipment doesn’t contribute importantly to the accomplishment of any pur-pose for which exemption is granted to the or-ganization. Accordingly, the sale of endorse-ments is an unrelated trade or business.

Services provided with lease. An exempt university leases its football stadium during sev-eral months of the year to a professional foot-ball team for a fixed fee. Under the lease agree-ment, the university furnishes heat, light, and water and is responsible for all ground mainte-nance. It also provides dressing room, linen, and stadium security services for the professio-nal team.

Leasing of the stadium is an unrelated trade or business. In addition, the substantial services furnished for the convenience of the lessee go beyond those usually provided with the rental of space for occupancy only. Therefore, the in-come from this lease is rent from real property and unrelated business taxable income.

Sponsoring entertainment events. An ex-empt university has a regular faculty and a reg-ularly enrolled student body. During the school year, the university sponsors the appearance of professional theater companies and symphony orchestras that present drama and musical per-formances for the students and faculty mem-bers. Members of the general public also are admitted. The university advertises these per-formances and supervises advance ticket sales at various places, including such university fa-cilities as the cafeteria and the university book-store. Although the presentation of the perform-ances makes use of an intangible generated by the university's exempt educational func-tions—the presence of the student body and faculty—such drama and music events contrib-ute importantly to the overall educational and cultural functions of the university. Therefore, the activity isn’t an unrelated trade or business.

Travel tour programs. Travel tour activities that are a trade or business are an unrelated trade or business if the activities aren’t substan-tially related to the purpose for which tax ex-emption was granted to the organization.

Example 1. A tax-exempt university alumni association provides a travel tour program for its members and their families. The organization works with various travel agencies and sched-ules approximately ten tours a year to various places around the world. It mails out promo-tional material and accepts reservations for fees

paid by the travel agencies on a per-person ba-sis.

The organization provides an employee for each tour as a tour leader. There is no formal educational program conducted with these tours, and they don’t differ from regular com-mercially operated tours (if there is a intent to make a profit).

By providing travel tours to its members, the organization is engaging in a regularly conduc-ted trade or business. Even if the tours it offers support the university, financially and otherwise, and encourage alumni to do the same, the travel tours don’t contribute importantly to the organization's exempt purpose of promoting ed-ucation. Therefore, the sale of the travel tours is an unrelated trade or business.

Example 2. A tax-exempt organization formed for the purpose of educating individuals about the geography and the culture of the Uni-ted States provides study tours to national parks and other locations within the United States. These tours are conducted by teachers and others certified by the state board of educa-tion. The tours are primarily designed for stu-dents enrolled in degree programs at state edu-cational institutions but are open to all who agree to participate in the required study pro-gram associated with the tour taken. A tour's study program consists of instruction on sub-jects related to the location being visited on the tour. Each tour group brings along a library of material related to the subjects being studied on the tour. During the tour, 5 or 6 hours per day are devoted to organized study, preparation of reports, lectures, instruction, and recitation by the students. Examinations are given at the end of each tour. The state board of education awards academic credit for tour participation. Because these tours are substantially related to the organization's exempt purpose, they aren’t an unrelated trade or business.

Yearbook advertising. An exempt organiza-tion receives income from the sale of advertis-ing in its annual yearbook. The organization hires an independent commercial firm, under a contract covering a full calendar year, to con-duct an intensive advertising solicitation cam-paign in the organization's name. This firm is paid a percentage of the gross advertising re-ceipts for selling the advertising, collecting from advertisers, and printing the yearbook. This ad-vertising activity is an unrelated trade or busi-ness.

Youth residence. An exempt organization, whose purpose is to provide for the welfare of young people, rents rooms primarily to people under age 25. The residence units are operated on, and as a part of, the premises in which the organization carries on the social, recreational, and guidance programs for which it was recog-nized as exempt. The facilities are under the management and supervision of trained career professionals who provide residents with per-sonal counseling, physical education programs, and group recreational activities. The rentals aren’t an unrelated trade or business because renting the rooms is substantially related to the organization's exempt purpose.

Excluded Trade or Business Activities

The following activities are specifically excluded from the definition of unrelated trade or busi-ness.

Gaming. In general, games of chance do not further an exempt purpose. An exempt organi-zation that generates revenue from the conduct of activities will be operating an unrelated trade or business, unless a exception applies. The exceptions to the general rule (that gaming does not usually further an exempt purpose) in-clude organizations whose exempt purposes in-clude social or recreational activities. For these organizations, gaming itself may further an ex-empt purpose.

More information about gaming activities by exempt organizations can be found in Publica-tion 3079, Tax-Exempt Organizations and Gam-ing.

Bingo games. Bingo games may qualify for a specific exclusion from the definition of unrela-ted trade or business. To qualify for this exclu-sion, the bingo game must meet the following requirements.

1. It meets the legal definition of bingo.

2. It is legal where it is played.

3. It is played in a jurisdiction where bingo games aren’t regularly conducted by for-profit organizations.

Gambling activities other than bingo. Games of chance conducted by an exempt or-ganization may avoid being treated as an unre-lated trade or business if they are:

Conducted with substantially all volunteer labor,

Qualified public entertainment activities, and

Games of chance conducted in North Da-kota.

Legal definition. For a game to meet the legal definition of bingo, wagers must be placed, winners must be determined, and pri-zes or other property must be distributed in the presence of all persons placing wagers in that game.

A wagering game that doesn’t meet the le-gal definition of bingo doesn’t qualify for the ex-clusion, regardless of its name. For example, “instant bingo,” in which a player buys a pre-packaged bingo card with pull-tabs that the player removes to determine if he or she is a winner, doesn’t qualify.

Legal where played. This exclusion ap-plies only if bingo is legal under the laws of the jurisdiction where it is conducted. The fact that a jurisdiction's law that prohibits bingo is rarely enforced or is widely disregarded doesn’t make the conduct of bingo legal for the exception and is therefore an unrelated trade or business.

No for-profit games where played. This exclusion applies only if for-profit organizations can’t regularly conduct bingo games in any part of the same jurisdiction. Jurisdiction is normally

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the entire state; however, in certain situations, local jurisdiction will control.

Example. Tax-exempt organizations X and Y are organized under the laws of state N, which has a law that permits exempt organiza-tions to conduct bingo games. In addition, for-profit organizations are permitted to conduct bingo games in city S, a resort community loca-ted in county R. Several for-profit organizations conduct nightly games. Y conducts weekly bingo games in city S, while X conducts weekly games in county R. Since state law confines the for-profit organizations to city S, local jurisdic-tion controls. Y's bingo games conducted in city S are an unrelated trade or business. However, X's bingo games conducted in county R outside of city S aren’t an unrelated trade or business.

See Pub. 3079, for more detailed informa-tion.

Convenience of members. A trade or busi-ness conducted by a 501(c)(3) organization or by a state college or university primarily for the convenience of its members, students, patients, officers, or employees isn’t an unrelated trade or business. For example, a laundry operated by a college for the purpose of laundering dor-mitory linens and students' clothing isn’t an un-related trade or business.

Convention or trade show activity. An unre-lated trade or business doesn’t include qualified convention or trade show activities conducted at a convention, annual meeting, or trade show.

A qualified convention or trade show activity is any activity of a kind traditionally conducted by a qualifying organization in conjunction with an international, national, state, regional, or lo-cal convention, annual meeting, or show if:

1. One of the purposes of the organization in sponsoring the activity is promoting and stimulating interest in, and demand for, the products and services of that industry or educating the persons in attendance re-garding new products and services or new rules and regulations affecting the indus-try; and

2. The show is designed to achieve its pur-pose through the character of the exhibits and the extent of the industry products that are displayed.

For these purposes, a qualifying organiza-tion is one described in section 501(c)(3), 501(c)(4), 501(c)(5), or 501(c)(6). The organiza-tion must regularly conduct, as one of its sub-stantial exempt purposes, a qualified conven-tion or trade show activity.

The rental of display space to exhibitors (in-cluding exhibitors who are suppliers) at a quali-fied convention or trade show isn’t an unrelated trade or business even if the exhibitors who rent the space are permitted to sell or solicit orders. For this purpose, a supplier's exhibit is one in which the exhibitor displays goods or services that are supplied to, rather than by, members of the qualifying organization in the conduct of these members' own trades or businesses.

Certain Internet activities conducted by a trade association described in section 501(c)(6) will be considered qualified convention and trade show activity if conducted on a special

supplementary section of the association's website in conjunction with a trade show con-ducted by the association. The trade show itself must be a qualified convention and trade show activity. The supplementary section of the web-site must be ancillary to, and serve to augment and enhance, the trade show, as when it makes available the same information available at the trade show and is available only during a time period that coincides with the time period that the trade show is in operation. Conversely, In-ternet activities that aren’t conducted in con-junction with a qualified convention and trade show activity and that don’t augment and en-hance the trade show can’t themselves be qualified convention and trade show activity.

Distribution of low-cost articles. The term “unrelated trade or business” doesn’t include activities relating to the distribution of low-cost articles incidental to soliciting charitable contri-butions. This applies to organizations described in section 501 that are eligible to receive chari-table income tax deductible contributions.

A distribution is considered incidental to the solicitation of a charitable contribution if:

1. The recipient didn’t request the distribu-tion,

2. The distribution is made without the ex-press consent of the recipient, and

3. The article is accompanied by a request for a charitable contribution to the organi-zation and a statement that the recipient may keep the low-cost article regardless of whether a contribution is made.

An article is considered low cost if the cost of an item (or the aggregate costs if more than one item) distributed to a single recipient in a tax year isn’t more than $11.20 (in 2020), in-dexed annually for inflation. The cost of an arti-cle is the cost to the organization that distrib-utes the item or on whose behalf it is distributed.

Employee association sales. The sale of cer-tain items by a local association of employees described in section 501(c)(4), organized be-fore May 17, 1969, isn’t an unrelated trade or business if the items are sold for the conven-ience of the association's members at their usual place of employment. This exclusion ap-plies only to the sale of work-related clothes and equipment and items normally sold through vending machines, food dispensing facilities, or by snack bars.

Exchange or rental of member lists. The ex-change or rental of member or donor lists be-tween organizations described in section 501 that are eligible to receive charitable contribu-tions isn’t included in the term unrelated trade or business.

Hospital services. The providing of certain services at or below cost by an exempt hospital to other exempt hospitals that have facilities for 100 or fewer inpatients isn’t an unrelated trade or business. This exclusion applies only to serv-ices described in section 501(e)(1)(A).

Pole rentals. The term unrelated trade or busi-ness doesn’t include qualified pole rentals by a

mutual or cooperative telephone or electric company described in section 501(c)(12). A qualified pole rental is the rental of a pole (or other structure used to support wires) if the pole (or other structure) is used:

1. By the telephone or electric company to support one or more wires that the com-pany uses in providing telephone or elec-tric services to its members, and

2. According to the rental, to support one or more wires (in addition to the wires descri-bed in 1) for use in connection with the transmission by wire of electricity or of tel-ephone or other communications.

For this purpose, the term rental includes any sale of the right to use the pole (or other struc-ture).

Public entertainment activity. An unrelated trade or business doesn’t include a qualified public entertainment activity. A public entertain-ment activity is one traditionally conducted at a fair or exposition promoting agriculture and edu-cation, including any activity whose purpose is designed to attract the public to fairs or exposi-tions or to promote the breeding of animals or the development of products or equipment.

A qualified public entertainment activity is one conducted by a qualifying organization:

1. In conjunction with an international, na-tional, state, regional, or local fair or expo-sition;

2. In accordance with state law that permits the activity to be operated or conducted solely by such an organization or by an agency, instrumentality, or political subdi-vision of the state; or

3. In accordance with state law that permits an organization to be granted a license to conduct an activity for not more than 20 days on paying the state a lower percent-age of the revenue from the activity than the state charges nonqualifying organiza-tions that hold similar activities.

For these purposes, a qualifying organiza-tion is an organization described in section 501(c)(3), 501(c)(4), or 501(c)(5) that regularly conducts an agricultural and educational fair or exposition as one of its substantial exempt pur-poses. Its conducting qualified public entertain-ment activities will not affect determination of its exempt status.

Qualified sponsorship activities. Receiving qualified sponsorship payments isn’t an unrela-ted trade or business, and the payments aren’t subject to unrelated business income tax.

Qualified sponsorship payment. This is any payment made by a person engaged in a trade or business for which the person will re-ceive no substantial benefit other than the use or acknowledgment of the business name, logo, or product lines in connection with the organiza-tion's activities. “Use or acknowledgment” doesn’t include advertising the sponsor's prod-ucts or services. The organization's activities in-clude all its activities, whether or not related to its exempt purposes.

For example, if, in return for receiving a sponsorship payment, an organization

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promises to use the sponsor's name or logo in acknowledging the sponsor's support for an ed-ucational or fundraising event, the payment is a qualified sponsorship payment and isn’t subject to the unrelated business income tax.

Providing facilities, services, or other privi-leges (for example, complimentary tickets, pro-am playing spots in golf tournaments, or re-ceptions for major donors) to a sponsor or the sponsor's designees in connection with a spon-sorship payment does not affect whether the payment is a qualified sponsorship payment. In-stead, providing these goods or services is trea-ted as a separate transaction in determining whether the organization has unrelated busi-ness income from the event. Generally, if the services or facilities aren’t a substantial benefit or if providing them is a related business activ-ity, the payments will not be subject to the unre-lated business income tax.

Similarly, the sponsor's receipt of a license to use an intangible asset (for example, a trade-mark, logo, or designation) of the organization is treated as separate from the qualified spon-sorship transaction in determining whether the organization has UBTI.

If part of a payment would be a qualified sponsorship payment if paid separately, that part is treated as a separate payment. For ex-ample, if a sponsorship payment entitles the sponsor to both product advertising and the use or acknowledgment of the sponsor's name or logo by the organization, then the unrelated business income tax doesn’t apply to the part of the payment that is more than the fair market value of the product advertising.

Advertising. A payment isn’t a qualified sponsorship payment if, in return, the organiza-tion advertises the sponsor's products or serv-ices. For information on the treatment of pay-ments for advertising, see Exploitation of Exempt Activity—Advertising Sales in chap-ter 4.

Advertising includes:

1. Messages containing qualitative or com-parative language, price information, or other indications of savings or value;

2. Endorsements; and

3. Inducements to purchase, sell, or use the products or services.

The use of promotional logos or slogans that are an established part of the sponsor's identity isn’t, by itself, advertising. In addition, mere dis-tribution or display of a sponsor's product by the organization to the public at a sponsored event, whether for free or for remuneration, is consid-ered use or acknowledgment of the product rather than advertising.

Exception for contingent payments. A payment isn’t a qualified sponsorship payment if its amount is contingent, by contract or other-wise, upon the level of attendance at one or more events, broadcast ratings, or other factors indicating the degree of public exposure to one or more events. However, the fact that a spon-sorship payment is contingent upon an event actually taking place or being broadcast doesn’t, by itself, affect whether a payment qualifies.

Exception for conventions and trade shows. A payment isn’t a qualified sponsor-ship payment if it is made in connection with any qualified convention or trade show activity. The exclusion of qualified convention or trade show activities from the definition of unrelated trade or business is explained earlier under Convention or trade show activity.

Exception for periodicals. A payment isn’t a qualified sponsorship payment if it enti-tles the payer to the use or acknowledgment of the business name, logo, or product lines in the organization's periodical. For this purpose, a periodical is any regularly scheduled and prin-ted material (for example, a monthly journal) published by or on behalf of the organization. It doesn’t include material that is related to and primarily distributed in connection with a spe-cific event conducted by the organization (for example, a program or brochure distributed at a sponsored event).

The treatment of payments that entitle the payer to the depiction of the payer's name, logo, or product lines in an organization's peri-odical is determined under the rules that apply to advertising activities. See Sales of advertis-ing space under Examples, earlier in this chap-ter. Also see Exploitation of Exempt Activ-ity—Advertising Sales in chapter 4.

Selling donated merchandise. A trade or business that consists of selling merchandise, substantially all of which the organization re-ceived as gifts or contributions, isn’t an unrela-ted trade or business. For example, a thrift shop operated by a tax-exempt organization that sells donated clothes and books to the general public, with the proceeds going to the exempt organization, isn’t an unrelated trade or busi-ness.

Volunteer workforce. Any trade or business in which substantially all the work is performed for the organization without compensation isn’t an unrelated trade or business.

Example 1. A retail store operated by an exempt orphanage where unpaid volunteers perform substantially all the work in carrying on the business isn’t an unrelated trade or busi-ness.

Example 2. A volunteer fire company con-ducts weekly public dances. Holding public dances and charging admission on a regular basis may, given the facts and circumstances of a particular case, be considered an unrelated trade or business. However, because the work at the dances is performed by unpaid volun-teers, the activity isn’t an unrelated trade or business.

4.

Unrelated Business Taxable Income

The term “unrelated business taxable income” (UBTI) generally means the gross income de-rived from any unrelated trade or business reg-ularly conducted by the exempt organization, less the deductions directly connected with car-rying on the trade or business. Section 512(a)

(6) requires an organization that regularly car-ries on two or more unrelated business activi-ties to calculate its unrelated business taxable income, including for purposes of determining any net operating loss deduction, separately with respect to each such trade or business. The UBTI of the organization is the sum of the UBTI computed from each separate unrelated trade or business. For the purpose of this sum, the UBTI from any of the unrelated trades or businesses can't be less than zero. See Regu-lations section 1.512(a)-6 for more information.

In computing UBTI, gross income and deduc-tions are subject to the modifications and spe-cial rules explained in this chapter. Whether a particular item of income or expense falls within any of these modifications or special rules must be determined by all the facts and circumstan-ces in each specific case. For example, if the organization received a payment termed rent that is in fact a return of profits by a person op-erating the property for the benefit of the organi-zation, or that is a share of the profits retained by the organization as a partner or joint ven-turer, the payment isn’t within the income exclu-sion for rents, discussed later under Exclusions.

Income

Generally, unrelated business income is taxa-ble, but there are exclusions and special rules that must be considered when figuring the in-come.

Exclusions

The following types of income (and deductions directly connected with the income) are gener-ally excluded when figuring UBTI.

Dividends, interest, annuities, and other in-vestment income. All dividends, interest, an-nuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organiza-tion's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in comput-ing UBTI.

Exception for insurance activity income of a controlled foreign corporation. This

Chapter 4Unrelated Business Taxable IncomePage 9

exclusion doesn’t apply to income from certain insurance activities of an exempt organization's controlled foreign corporation. The income isn’t excludable dividend income, but instead is UBTI to the extent it would be so treated if the exempt organization had earned it directly. Cer-tain exceptions to this rule apply. For more in-formation, see section 512(b)(17).

Other exceptions. This exclusion doesn’t apply to unrelated debt-financed income (dis-cussed under Income From Debt-Financed Property, later), or to certain rents, royalties, in-terest or annuities received from a controlled corporation (discussed under Income From Controlled Organizations, later).

Income from lending securities. Pay-ments received with respect to a security loan are excluded in computing UBTI only if the loan is made under an agreement that:

1. Provides for the return to the exempt or-ganization of securities identical to the se-curities loaned,

2. Requires payments to the organization of amounts equivalent to all interest, divi-dends, and other distributions that the owner of the securities is entitled to re-ceive during the period of the loan,

3. Doesn’t reduce the organization's risk of loss or opportunity for gain on the securi-ties,

4. Contains reasonable procedures to imple-ment the obligation of the borrower to fur-nish collateral to the organization with a fair market value each business day dur-ing the period of the loan in an amount not less than the fair market value of the se-curities at the close of the preceding busi-ness day, and

5. Permits the organization to terminate the loan upon notice of not more than 5 busi-ness days.

Payments with respect to securities loans in-clude:

1. Amounts in respect of dividends, interest, and other distributions,

2. Fees based on the period of time the loan is in effect and the fair market value of the security during that period,

3. Income from collateral security for the loan, and

4. Income from the investment of collateral security.

The payments are considered to be from the securities loaned and not from collateral secur-ity or the investment of collateral security from the loans. Any deductions that are directly con-nected with collateral security for the loan, or with the investment of collateral security, are considered deductions that are directly connec-ted with the securities loaned.

Royalties. Royalties, including overriding roy-alties, are excluded in computing UBTI.

To be considered a royalty, a payment must relate to the use of a valuable right. Payments for trademarks, trade names, or copyrights are ordinarily considered royalties. Similarly,

payments for the use of a professional athlete's name, photograph, likeness, or facsimile signa-ture are ordinarily considered royalties. How-ever, royalties don’t include payments for per-sonal services. Therefore, payments for personal appearances and interviews aren’t ex-cluded as royalties and must be included in fig-uring UBTI.

Unrelated business taxable income doesn’t include royalty income received from licensees by an exempt organization that is the legal and beneficial owner of patents assigned to it by in-ventors for specified percentages of future roy-alties.

Mineral royalties are excluded whether measured by production or by gross or taxable income from the mineral property. However, the exclusion doesn’t apply to royalties that stem from an arrangement whereby the organization owns a working interest in a mineral property and is liable for its share of the development and operating costs under the terms of its agreement with the operator of the property. To the extent they aren’t treated as loans under section 636 (relating to income tax treatment of mineral production payments), payments for mineral production are treated in the same manner as royalty payments for the purpose of computing UBTI. To the extent they are treated as loans, any payments for production that are the equivalent of interest are treated as interest and are excluded.

Exceptions. This exclusion doesn’t apply to debt-financed income (discussed under In-come From Debt-Financed Property, later) or to royalties received from a controlled corporation (discussed under Income From Controlled Or-ganizations, later).

Rents. Rents from real property, including ele-vators and escalators, are excluded in comput-ing UBTI. Rents from personal property aren’t excluded. However, special rules apply to “mixed leases” of both real and personal prop-erty.

Mixed leases. In a mixed lease, all of the rents are excluded if the rents attributable to the personal property aren’t more than 10% of the total rents under the lease, as determined when the personal property is first placed in service by the lessee. If the rents attributable to per-sonal property are more than 10% but not more than 50% of the total rents, only the rents attrib-utable to the real property are excluded. If the rents attributable to the personal property are more than 50% of the total rents, none of the rents are excludable.

Property is placed in service when the les-see first may use it under the terms of a lease. For example, property subject to a lease en-tered into on November 1, for a term starting on January 1 of the next year, is considered placed in service on January 1, regardless of when the lessee first actually uses it.

If separate leases are entered into for real and personal property and the properties have an integrated use (for example, one or more leases for real property and another lease or leases for personal property to be used on the real property), all the leases will be considered as one lease.

The rent attributable to the personal prop-erty must be recomputed, and the treatment of the rents must be redetermined, if:

1. The rent attributable to all the leased per-sonal property increases by 100% or more because additional or substitute personal property is placed in service, or

2. The lease is modified to change the rent charged (whether or not the amount of rented personal property changes).

Any change in the treatment of rents resulting from the recomputation is effective only for the period beginning with the event that caused the recomputation.

Exception for rents based on net profit. The exclusion for rents doesn’t apply if the amount of the rent depends on the income or profits derived by any person from the leased property, other than an amount based on a fixed percentage of the gross receipts or sales.

Exception for income from personal services. Payment for occupying space when personal services are also rendered to the oc-cupant doesn’t constitute rent from real prop-erty. Therefore, the exclusion doesn’t apply to transactions such as renting hotel rooms, rooms in boarding houses or tourist homes, and space in parking lots or warehouses.

Other exceptions. This exclusion doesn’t apply to unrelated debt-financed income (dis-cussed under Income From Debt-Financed Property , later), or to interest, annuities, royal-ties and rents received from a controlled corpo-ration (discussed under Income From Control-led Organizations, later), or investment income (dividends, interest, rents, etc.) received by or-ganizations described in sections 501(c)(7), 501(c)(9), and 501(c)(17). See Special Rules for Social Clubs, VEBAs, and SUBs, discussed later, for more information.

Income from research. A tax-exempt organi-zation may exclude income from research grants or contracts from UBTI. However, the ex-tent of the exclusion depends on the nature of the organization and the type of research.

Income from research for the United States, any of its agencies or instrumentalities, or a state or any of its political subdivisions is exclu-ded when computing UBTI.

For a college, university, or hospital, all in-come from research, whether fundamental or applied, is excluded in computing UBTI.

When an organization is operated primarily to conduct fundamental research (as distin-guished from applied research) and the results are freely available to the general public, all in-come from research performed for any person is excluded in computing UBTI.

The term research, for this purpose, doesn’t include activities of a type normally conducted as an incident to commercial or industrial oper-ations, such as testing or inspecting materials or products, or designing or constructing equip-ment, buildings, etc. In addition, the term funda-mental research doesn’t include research con-ducted for the primary purpose of commercial or industrial application.

Page 10Chapter 4Unrelated Business Taxable Income

Gains and losses from disposition of prop-

competitive if they are neither materially

erty. Also excluded from UBTI are gains or

higher nor materially lower than the rates

losses from the sale, exchange, or other dispo-

charged by similar businesses operating

sition of property other than:

in the same general area.

1. Stock in trade or other property of a kind

Exception. This exclusion doesn’t apply to

that would properly be includible in inven-

unrelated debt-financed income (discussed un-

tory if on hand at the close of the tax year,

der Income From Debt-Financed Property,

2. Property held primarily for sale to custom-

later)

.

ers in the ordinary course of a trade or

Member income of mutual or cooperative

business, or

electric companies. Income of a mutual or

3. Cutting of timber that an organization has

cooperative electric company described in sec-

elected to consider as a sale or exchange

tion 501(c)(12) that is treated as member in-

of the timber.

come under subparagraph (H) of that section is

It should be noted that the last exception re-

excluded from UBTI.

lates only to cut timber. The sale, exchange, or

Dues of Agricultural

other disposition of standing timber is excluded

from the computation of unrelated business in-

Organizations and Business

come, unless it constitutes property held for

Leagues

sale to customers in the ordinary course of busi-

ness.

Dues received from associate members by or-

Lapse or termination of options. Any

ganizations exempt under section 501(c)(5) or

gain from the lapse or termination of options to

section 501(c)(6) may be treated as gross in-

buy or sell securities is excluded from UBTI.

come from an unrelated trade or business if the

The exclusion applies only if the option is writ-

associate member category exists for the prin-

ten in connection with the exempt organiza-

cipal purpose of producing unrelated business

tion's investment activities. Therefore, this ex-

income. For example, if an organization creates

clusion isn’t available if the organization is

an associate member category solely to allow

engaged in the trade or business of writing op-

associate members to purchase insurance

tions or the options are held by the organization

through the organization, the associate member

as inventory or for sale to customers in the ordi-

dues may be unrelated business income.

nary course of a trade or business.

Exception. Associate member dues re-

Exception. This exclusion doesn’t apply to

ceived by an agricultural or horticultural organi-

unrelated debt-financed income, discussed

zation aren’t treated as gross income from an

later under Income From Debt-Financed Prop-

unrelated trade or business, regardless of their

erty.

purpose, provided the associate member dues

do not exceed an annual limit, which is indexed

Gain or loss on disposition of certain

for inflation. The limit on dues paid by an asso-

brownfield property. Gain or loss from the

ciate member is $171 in 2020.

qualifying sale, exchange, or other disposition

If the required annual dues are more than

of a qualifying brownfield property (as defined in

the limit, the entire amount is treated as income

section 512(b)(19)(C)), which was acquired by

from an unrelated business unless the asso-

the organization after December 31, 2005 and

ciate member category was formed or availed

before January 1, 2011, is excluded from UBTI

of for the principal purpose of furthering the or-

and is excepted from the debt-financed rules.

ganization's exempt purposes.

See sections 512(b)(19) and 514(b)(1)(E).

Income from services provided under fed-

Deductions

eral license. There is a further exclusion from

UBTI of income from a trade or business con-

To qualify as allowable deductions in computing

ducted by a religious order or by an educational

UBTI, the expenses, depreciation, and similar

organization maintained by the order.

items must generally be allowable income tax

This exclusion applies only if the following

deductions that are directly connected with car-

requirements are met.

rying on the unrelated trade or business to

1. The trade or business must have been op-

which they relate. They can’t be directly con-

erated by the order or by the institution be-

nected with excluded income.

fore May 27, 1959.

For an exception to the “directly connected”

2. The trade or business must provide serv-

requirement, see

Charitable contributions de-

ices under a license issued by a federal

duction

, under Modifications, later.

regulatory agency.

Directly Connected

3. More than 90% of the net income from the

business for the tax year must be devoted

To be directly connected with the conduct of an

to religious, charitable, or educational pur-

poses that constitute the basis for the reli-

unrelated trade or business, deductions must

gious order's exemption.

have a proximate and primary relationship to

4. The rates or other charges for these serv-

carrying on that trade or business. For an ex-

ception, see Expenses attributable to exploita-

ices must be fully competitive with the

tion of exempt

activities, later.

rates or other charges of similar taxable

businesses. Rates or other charges for

Expenses attributable solely to unrelated

these services will be considered as fully

business. Expenses, depreciation, and simi-

lar items attributable solely to the conduct of an unrelated business are proximately and primar-ily related to that business and qualify for de-duction to the extent that they are otherwise al-lowable income tax deductions.

For example, salaries of personnel em-ployed full-time to conduct the unrelated busi-ness and depreciation of a building used en-tirely in the conduct of that business are deductible to the extent otherwise allowable.

Expenses attributable to dual use of facili-ties or personnel. When facilities or person-nel are used both to conduct exempt functions and to conduct an unrelated trade or business, expenses, depreciation, and similar items attrib-utable to the facilities or personnel must be allo-cated between the two uses on a reasonable basis. The part of an item allocated to the unre-lated trade or business is proximately and pri-marily related to that business and is allowable as a deduction in computing UBTI if the ex-pense is otherwise an allowable income tax de-duction.

An exempt organization with more than one unrelated trade or business likewise allocates deductions between separate unrelated trades or businesses using the reasonable basis standard.

Example 1. A school recognized as a tax-exempt organization contracts with an indi-vidual to conduct a summer tennis camp. The school provides the individual with tennis courts, housing, and dining facilities, and per-sonnel to maintain and operate them. The con-tracted individual hires the instructors, recruits campers, and provides supervision of the tennis camp. The income the school receives from the individual under the contract from this activity for the use of its facilities and personnel is from a dual use of the facilities and personnel, not from conducting an educational activity. The school, in computing its UBTI, may deduct an allocable part of the expenses attributable to the facilities and personnel it makes available under the contract.

Example 2. An exempt organization with gross income from an unrelated trade or busi-ness pays its president $90,000 a year. The president devotes approximately 10% of his time to the unrelated business. To figure the or-ganization's UBTI, a deduction of $9,000 ($90,000 × 10%) is allowed for the salary paid to its president.

Expenses attributable to exploitation of ex-empt activities. Generally, expenses, depre-ciation, and similar items attributable to the con-duct of an exempt activity aren’t deductible in computing UBTI from an unrelated trade or business that exploits the exempt activity. (See Exploitation of exempt functions under Not sub-stantially related in chapter 3.) This is because they don’t have a proximate and primary rela-tionship to the unrelated trade or business, and therefore, they don’t qualify as directly connec-ted with that business.

Exception. Expenses, depreciation, and similar items may be treated as directly connec-ted with the conduct of the unrelated business if all the following conditions are met.

Chapter 4Unrelated Business Taxable IncomePage 11

1. The unrelated business exploits the ex-empt activity.

2. The unrelated business is a type normally conducted for profit by taxable organiza-tions.

3. The exempt activity is a type normally con-ducted by taxable organizations in carry-ing on that type of business.

The amount treated as directly connected is the smaller of:

1. The excess of these expenses, deprecia-tion, and similar items over the income from, or attributable to, the exempt activity; or

2. The gross unrelated business income re-duced by all other expenses, depreciation, and other items that are actually directly connected.

The application of these rules to an advertis-ing activity that exploits an exempt publishing activity is explained next.

Exploitation of Exempt Activity—Advertising Sales

The sale of advertising in a periodical of an ex-empt organization that contains editorial mate-rial related to the accomplishment of the organi-zation's exempt purpose is an unrelated business that exploits an exempt activity, the circulation, and readership of the periodical. Therefore, in addition to direct advertising costs, exempt activity costs (expenses, depre-ciation, and similar expenses attributable to the production and distribution of the editorial or readership content) can be treated as directly connected with the conduct of the advertising activity. (See Expenses attributable to exploita-tion of exempt activities under Directly Connec-ted, earlier.)

Figuring UBTI. The UBTI of an advertising activity is the amount shown in the following chart.

IF gross advertising	THEN UBTI is . . .
income is . . .
more than direct	the excess advertising income,
advertising costs	reduced (but not below zero)
	by the excess, if any, of
	readership costs over
	circulation income.
equal to or less than	zero.
direct advertising	Circulation income and
costs
	readership costs aren’t taken
	into account.

The terms used in the chart are explained in the following discussions.

Periodical Income

Gross advertising income. This is all the in-come from the unrelated advertising activities of an exempt organization periodical.

Circulation income. This is all the income from the production, distribution, or circulation of an exempt organization's periodical (other

than gross advertising income). It includes all amounts from the sale or distribution of the readership content of the periodical, such as in-come from subscriptions. It also includes allo-cable membership receipts if the right to receive the periodical is associated with a membership or similar status in the organization.

Allocable membership receipts. This is the part of membership receipts (dues, fees, or other charges associated with membership) equal to the amount that would have been charged and paid for the periodical if:

1. The periodical was published by a taxable organization,

2. The periodical was published for profit, and

3. The member was an unrelated party deal-ing with the taxable organization at arm's length.

The amount used to allocate membership receipts is the amount shown in the following chart.

For this purpose, the total periodical costs are the sum of the direct advertising costs and the readership costs, explained under Periodi-cal Costs, later. The cost of other exempt activi-ties means the total expenses incurred by the organization in connection with its other exempt activities, not offset by any income earned by the organization from those activities.

	THEN the amount used to
IF...	allocate membership
	receipts is . . .
20% or more of the	the subscription price charged
total circulation	nonmembers.
consists of sales to
nonmembers
the above condition	the reduction in dues for a
doesn’t apply, and	member not receiving the
20% or more of the	periodical.
members pay
reduced dues
because they do not
receive the periodical
neither of the above	the membership receipts
conditions applies	multiplied by this fraction:
		Total periodical costs
		Total periodical costs
		Plus
	Cost of other exempt activities

Example 1. U is an exempt scientific or-ganization with 10,000 members who pay an-nual dues of $15. One of U's activities is pub-lishing a monthly periodical distributed to all of its members. U also distributes 5,000 additional copies of its periodical to nonmembers, who subscribe for $10 a year. Since the nonmember circulation of U's periodical represents one-third (more than 20%) of its total circulation, the sub-scription price charged to nonmembers is used to determine the part of U's membership re-ceipts allocable to the periodical. Thus, U's allo-cable membership receipts are $100,000 ($10 times 10,000 members), and U's total circula-tion income for the periodical is $150,000 ($100,000 from members plus $50,000 from sales to nonmembers).

Example 2. Assume the same facts ex-cept that U sells only 500 copies of its periodi-cal to nonmembers, at a price of $10 a year. As-sume also that U's members may elect not to receive the periodical, in which case their dues are reduced from $15 a year to $6 a year, and that only 3,000 members elect to receive the periodical and pay the full dues of $15 a year. U's stated subscription price of $9 to members consistently results in an excess of total income (including gross advertising income) attributa-ble to the periodical over total costs of the peri-odical. Since the 500 copies of the periodical distributed to nonmembers represent only 14% of the 3,500 copies distributed, the $10 sub-scription price charged to nonmembers isn’t used to determine the part of membership re-ceipts allocable to the periodical. Instead, since 70% of the members elect not to receive the pe-riodical and pay $9 less per year in dues, the $9 price is used to determine the subscription price charged to members. Thus, the allocable mem-bership receipts will be $9 per member, or $27,000 ($9 times 3,000 copies). U's total circu-lation income is $32,000 ($27,000 plus the $5,000 from nonmember subscriptions).

Periodical Costs

Direct advertising costs. These are expen-ses, depreciation, and similar items of deduc-tion directly connected with selling and publish-ing advertising in the periodical.

Examples of allowable deductions under this classification include agency commissions and other direct selling costs, such as transpor-tation and travel expenses, office salaries, pro-motion and research expenses, and office over-head directly connected with the sale of advertising lineage in the periodical. Also inclu-ded are other deductions commonly classified as advertising costs under standard account classifications, such as artwork and copy prep-aration, telephone, telegraph, postage, and similar costs directly connected with advertis-ing.

In addition, direct advertising costs include the part of mechanical and distribution costs at-tributable to advertising lineage. For this pur-pose, the general account classifications of items includible in mechanical and distribution costs ordinarily employed in business-paper and consumer-publication accounting provide a guide for the computation. Accordingly, the me-chanical and distribution costs include the part of the costs and other expenses of composition, press work, binding, mailing (including paper and wrappers used for mailing), and bulk post-age attributable to the advertising lineage of the publication.

In the absence of specific and detailed re-cords, the part of mechanical and distribution costs attributable to the periodical's advertising lineage can be based on the ratio of advertising lineage to total lineage in the periodical, if this allocation is reasonable.

Readership costs. These are all expenses, depreciation, and similar items directly connec-ted with the production and distribution of the readership content of the periodical.

Page 12Chapter 4Unrelated Business Taxable Income

Costs partly attributable to other activities. Deductions properly attributable to exempt ac-tivities other than publishing the periodical may not be allocated to the periodical. When expen-ses are attributable both to the periodical and to the organization's other activities, an allocation must be made on a reasonable basis. The method of allocation will vary with the nature of the item, but once adopted, it should be used consistently. Allocations based on dollar re-ceipts from various exempt activities generally aren’t reasonable since receipts usually don’t accurately reflect the costs associated with spe-cific activities that an exempt organization con-ducts.

Consolidated Periodicals

If an exempt organization publishes more than one periodical to produce income, it may treat all of them (but not less than all) as one in deter-mining UBTI from selling advertising. The gross income from all the periodicals, and the deduc-tions directly connected with them is figured on a consolidated basis. Consolidated treatment, once adopted, must be followed consistently and is binding. This treatment can be changed only with the consent of the IRS.

An exempt organization's periodical is pub-lished to produce income if:

1. The periodical generates gross advertising income to the organization equal to at least 25% of its readership costs, and

2. Publishing the periodical is an activity en-gaged in for profit.

Whether the publication of a periodical is an activity engaged in for profit can be determined only by all the facts and circumstances in each case. The facts and circumstances must show that the organization carries on the activity for economic profit, although there may not be a profit in a particular year. For example, if an or-ganization begins publishing a new periodical whose total costs exceed total income in the start-up years because of lack of advertising sales, that doesn’t mean that the organization didn’t have as its objective an economic profit. The organization may establish that it had this objective by showing it can reasonably expect advertising sales to increase, so that total in-come will exceed costs within a reasonable time.

Example. Y, an exempt trade association, publishes three periodicals that it distributes to its members: a weekly newsletter, a monthly magazine, and a quarterly journal. Both the monthly magazine and the quarterly journal contain advertising that accounts for gross ad-vertising income equal to more than 25% of their respective readership costs. Similarly, the total income attributable to each periodical has exceeded the total deductions attributable to each periodical for substantially all the years they have been published. The newsletter car-ries no advertising and its annual subscription price isn’t intended to cover the cost of publica-tion. The newsletter is a service that Y distrib-utes to all of its members in an effort to keep them informed of changes occurring in the busi-ness world. It is not engaged in for profit.

Under these circumstances, Y may consoli-date the income and deductions from the monthly and quarterly journals in computing its UBTI. It may not consolidate the income and deductions from the newsletter with the income and deductions of its other periodicals, since the newsletter isn’t published for the production of income.

Modifications

Net operating loss (NOL). An NOL arises when allowable deductions exceed gross unre-lated trade or business income. Subject to mod-ifications described in section 172, the NOL is allowed as a deduction against unrelated busi-ness taxable income for a tax year to which the NOL can be carried, as described below. The NOL for any tax year, the carryovers of NOLs, and the NOL deduction are determined without taking into account any amount of income or deduction that is specifically excluded in com-puting UBTI. For example, a loss from an unre-lated trade or business isn't diminished be-cause the organization received dividend income.

In line with this concept, an NOL can arise only in a tax year for which the organization is subject to tax on unrelated business income.

The Tax Cuts and Jobs Act (P.L. 115-97) and the CARES Act (P.L. 116-136) substantially modified the NOL provisions under section 172. Further, section 512(a)(6) (added by the Tax Cuts and Jobs Act) changed the way exempt organizations report and figure the tax on in-come from unrelated trade or business activity.

NOLs arising before 2018. Prior to the addi-tion of section 512(b)(6), an exempt organiza-tion would compute its NOL (if any) for each tax year on an aggregate basis, regardless of the number of separate unrelated trades or busi-ness conducted by the organization. NOLs aris-ing before 2018 (pre -2018 NOLs) can be car-ried forward for up to 20 years. Pre-2018 NOLs can be applied (subject to modifications) as a deduction to reduce unrelated business taxable income without regard to the unrelated trade or business activity that generated the income.

Even though an NOL can arise only in a tax year for which the organization is subject to tax on unrelated business income, the pre-2018 NOLs expire after 20 consecutive tax years. For example, if an organization was subject to the tax for 2014 and had an NOL for that year, the last tax year to which any part of that NOL may be carried over is 2034, regardless of whether the organization was subject to the unrelated business income tax in any of the intervening years.

NOLs arising in tax years after 2017. Sec-tion 512(a)(6) requires an organization with more than one unrelated trade or business to calculate UBTI in any tax year beginning after 2017, including for purposes of determining any NOL (post-2017 NOL) or applying any post-2017 NOL deduction, separately with re-spect to each such trade or business.

The Tax Cuts and Jobs Act (P.L.115-97, section 13302) amended section 172(b) to

eliminate both the expiration of NOL carryfor-wards and the ability to carryback NOLs to ear-lier tax years. Certain farming and insurance company losses are exceptions and can be car-ried back as described in section 172(b). See Publication 225, Farmer's Tax Guide; Publica-tion 536, Net Operating Losses; or Publication 542, Corporations; for additional information. However, the CARES Act added section 172(b)

(1)(D), which provides for carryback of NOLs arising in 2018, 2019, and 2020 to each of the 5 years preceding the tax year in which the NOL arose. An organization that wishes to carry these NOLs forward must waive the carryback. See the Instructions for Form 990-T for more in-formation.

In addition to largely eliminating NOL carry-backs (except for the CARES Act modification), the Tax Cuts and Jobs Act, as modified by the CARES Act, provides that the allowable NOL deduction for tax years beginning in 2021 can-not exceed 80% of taxable income.

An organization that had an NOL in a tax year beginning in 2018 or 2019 can file amen-ded returns Form 990-T to carryback the NOL. See Pub. 536 for more information.

For more details on the NOL deduction, in-cluding property eligible for an extended carry-back period, see section 172 and Pub. 536.

Charitable contributions deduction. An ex-empt organization is allowed to deduct its chari-table contributions in computing its UBTI even if the contributions are not directly connected with any unrelated business.

To be deductible, the contribution must be paid to another qualified organization. For ex-ample, an exempt university that operates an unrelated business may deduct a contribution made to another university for educational work, but may not claim a deduction for contri-butions of amounts spent for carrying out its own educational program.

For purposes of the deduction, a distribution by a trust made under the trust instrument to a beneficiary, which itself is a qualified organiza-tion, is treated the same as a contribution.

Deduction limits. An exempt organization that is subject to the unrelated business income tax at corporate rates is allowed a deduction for charitable contributions up to 10% of its UBTI computed without regard to the deduction for contributions. See the Instructions for Form 990-T for more information.

An exempt trust that is subject to the unrela-ted business income tax at trust rates is gener-ally allowed a deduction for charitable contribu-tions in the same amounts as allowed for individuals. However, the limit on the deduction is determined in relation to the trust's UBTI computed without regard to the deduction, rather than in relation to adjusted gross income.

Contributions in excess of the limits just de-scribed may be carried over to the next 5 tax years. A contribution carryover isn’t allowed, however, to the extent that it increases an NOL carryover.

Specific deduction. In computing UBTI, a specific deduction of $1,000 is allowed. How-ever, the specific deduction isn’t allowed in computing an NOL or the NOL deduction.

Chapter 4Unrelated Business Taxable IncomePage 13

Generally, the deduction is limited to $1,000 regardless of the number of unrelated busi-nesses in which the organization is engaged.

Exception. An exception is provided in the case of a diocese, province of a religious order, or a convention or association of churches that may claim a specific deduction for each parish, individual church, district, or other local unit. In these cases, the specific deduction for each lo-cal unit is limited to the lower of:

$1,000, or
Gross income derived from an unrelated trade or business regularly conducted by the local unit.

This exception applies only to parishes, dis-tricts, or other local units that aren’t separate le-gal entities, but are components of a larger en-tity (diocese, province, convention, or association) filing Form 990-T. The parent or-ganization must file a return reporting the unre-lated business gross income and related de-ductions of all units that aren’t separate legal entities. The local units can’t file separate re-turns. However, each local unit that is sepa-rately incorporated must file its own return and can’t include, or be included with, any other en-tity. See Title-holding corporations in chapter 1 for a discussion of the only situation in which more than one legal entity may be included on the same Form 990-T.

Example. X is an association of churches and is divided into local units A, B, C, and D. Last year, A, B, C, and D derived gross income of, respectively, $1,200, $800, $1,500, and $700 from unrelated businesses that they regu-larly conduct. X may claim a specific deduction of $1,000 with respect to A, $800 with respect to B, $1,000 with respect to C, and $700 with respect to D.

Partnership Income or Loss

An organization may have unrelated business income or loss as a member of an entity classi-fied as a partnership for federal tax purposes (see section 7701 and corresponding regula-tions), rather than through direct business deal-ings with the public. If so, it must treat its share of the partnership income or loss as if it had conducted the business activity in its own ca-pacity as a corporation or trust. No distinction is made between limited and general partners or managing or non-managing members of a limi-ted liability company. The organization is re-quired to notify the partnership of its tax-exempt status. See Regulations section 1.512(a)-6 for information and transition rules under section 512(a)(6) for aggregating income from partner-ships and debt-financed income from partner-ships.

Thus, if an organization is a member of a partnership regularly engaged in a trade or business that is an unrelated trade or business with respect to the organization, the organiza-tion must include in its UBTI its share of the partnership's gross income from the unrelated trade or business (whether or not distributed), and the deductions attributable to it. The

partnership income and deductions to be inclu-ded in the organization's UBTI are figured the same way as any income and deductions from an unrelated trade or business conducted di-rectly by the organization. The partnership is re-quired to provide the organization this informa-tion on Schedule K-1.

Example. An exempt educational organi-zation is a partner in a partnership that operates a factory. The partnership also holds stock in a corporation. The exempt organization must in-clude its share of the gross income from operat-ing the factory in its UBTI but may exclude its share of any dividends the partnership received from the corporation.

Different tax years. If the exempt organiza-tion and the partnership of which it is a member have different tax years, the partnership items that enter into the computation of the organiza-tion's UBTI must be based on the income and deductions of the partnership for the partner-ship's tax year that ends within the organiza-tion's tax year.

S Corporation Income or Loss

An organization that owns S corporation stock must take into account its share of the S corpo-ration's income, deductions, and losses in figur-ing UBTI, regardless of the actual source or na-ture of the income, deductions, and losses. For example, the organization's share of the S cor-poration's interest and dividend income will be taxable, even though interest and dividends are normally excluded from UBTI. The organization must also take into account its gain or loss on the sale or other disposition of the S corporation stock in figuring UBTI.

Special Rules for Foreign Organizations

The UBTI of a foreign organization exempt from tax under section 501(a) consists of the organi-zation's:

1. Unrelated business taxable income de-rived from sources within the United States but not effectively connected with the conduct of a trade or business within the United States; and

2. Unrelated business taxable income effec-tively connected with the conduct of a trade or business within the United States, whether or not this income is derived from sources within the United States.

To determine whether income realized by a foreign organization is derived from sources within the United States or is effectively connec-ted with the conduct of a trade or business within the United States, see sections 861 through 865 and the related regulations.

Special Rules for Social Clubs, VEBAs, and SUBs

The following discussion applies to:

Social clubs described in section 501(c)

(7),

Voluntary employees' beneficiary as-sociations (VEBAs) described in section 501(c)(9), and
Supplemental unemployment compen-sation benefit trusts (SUBs) described in section 501(c)(17).

In general, these organizations are subject to the tax on income from unrelated trade or busi-ness activities and must apply the rules under section 512(a)(6). See Regulations section 1.512(a)-6 for more information. However, they must also must figure UBTI under special rules. Unlike other exempt organizations, they can’t exclude their investment income (dividends, in-terest, rents, etc.). (See Exclusions under In-come, earlier.) Therefore, they are generally subject to unrelated business income tax on this income.

The UBTI of these organizations includes all gross income, less deductions directly connec-ted with the production of that income, except that gross income for this purpose doesn’t in-clude exempt function income. The deduction for dividends received by a corporation isn’t al-lowed in computing UBTI because it isn’t an ex-pense incurred in the production of income.

Losses from nonexempt activities. Losses from nonexempt activities of these organiza-tions can’t be used to offset investment income.

Modifications. The UBTI is modified by any NOL or charitable contributions deduction and by the specific deduction (described earlier un-der Deductions).

Exempt function income. This is gross in-come from dues, fees, charges, or similar items paid by members for goods, facilities, or serv-ices to the members or their dependents or guests, to further the organization's exempt pur-poses. Exempt function income also includes income set aside for qualified purposes.

Income that is set aside. This is income set aside to be used for religious, charitable, scientific, literary, or educational purposes or for the prevention of cruelty to children or animals. In addition, for a VEBA or SUB it is income set aside to provide for the payment of life, sick, ac-cident, or other benefits.

However, any amounts set aside by a VEBA or SUB that exceed the organization's qualified asset account limit (determined under section 419A) are unrelated business income. Special rules apply to the treatment of existing reserves for post-retirement medical or life insurance benefits. These rules are explained in section 512(a)(3)(E)(ii).

Income derived from an unrelated trade or business may not be set aside and therefore can’t be exempt function income. In addition, any income set aside and later spent for other purposes must be included in UBTI.

Page 14Chapter 4Unrelated Business Taxable Income

Set-aside income is generally excluded from gross income only if it is set aside in the tax year in which it is otherwise includible in gross income. However, income set aside on or be-fore the date for filing Form 990-T, including ex-tensions of time, may, at the election of the or-ganization, be treated as having been set aside in the tax year for which the return was filed. The income set aside must have been includi-ble in gross income for that earlier year.

Nonrecognition of gain. If the organization sells property used directly in performing an ex-empt function and purchases other property used directly in performing an exempt function, any gain on the sale is recognized only to the extent that the sales price of the old property exceeds the cost of the new property. The pur-chase of the new property must be made within 1 year before the date of sale of the old property or within 3 years after the date of sale.

This rule also applies to gain from an invol-untary conversion of the property resulting from its destruction in whole or in part, theft, seizure, requisition, or condemnation.

Special Rules for Veterans' Organizations

Unrelated business taxable income of a veter-ans' organization that is exempt under section 501(c)(19) doesn’t include the net income from insurance business that is properly set aside. The organization may set aside income from payments received for life, sick, accident, or health insurance for the organization's mem-bers or their dependents for the payment of in-surance benefits or reasonable costs of insur-ance administration, or for use exclusively for religious, charitable, scientific, literary, or edu-cational purposes, or the prevention of cruelty to children or animals. For details, see section 512(a)(4) and the regulations under that sec-tion.

Income From Controlled Organizations

The exclusions for interest, annuities, royalties, and rents, explained earlier in this chapter un-der Income, may not apply to a payment of these items received by a controlling organiza-tion from its controlled organization. The pay-ment is included in the controlling organization's UBTI to the extent it reduced the net unrelated income (or increased the net unrelated loss) of the controlled organization. All deductions of the controlling organization directly connected with the amount included in its UBTI are al-lowed.

Excess qualifying specified payments. Ex-cess qualifying specified payments received or accrued from a controlled entity are included in a controlling exempt organization's UBTI only to the extent of the amount that exceeds that would have been paid or accrued if the pay-ments had been determined under section 482. Qualifying specified payments means any pay-ments of interest, annuities, royalties, or rents

received or accrued from the controlled organi-zation pursuant to a binding written contract in effect on August 17, 2006, or to a contract which is a renewal, under substantially similar terms of a binding written contract in effect on August 17, 2006, and the payments are re-ceived or accrued after December 31, 2014.

If a controlled participant isn’t required to file a U.S. income tax return, the participant must ensure that the copy or copies of the Regula-tions section 1.482-7 Cost Sharing Arrange-ment Statement and any updates are attached to Schedule M of any Form 5471, Information Return of U.S. Persons With Respect To Cer-tain Foreign Corporations, any Form 5472, In-formation Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business, or any Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, filed for that participant.

Addition to tax for valuation misstate-ments. Under section 512(b)(13)(E)(ii), the tax imposed on a controlling organization will be in-creased by 20% of the excess qualifying speci-fied payments that are determined with or with-out any amendments or supplements to a return of tax, whichever is larger. See section 512(b) (13)(E)(ii) for more information.

Net unrelated income. This is:

For an exempt organization, its UBTI, or
For a nonexempt organization, the part of its taxable income that would be UBTI if it were exempt and had the same exempt purposes as the controlling organization.

Net unrelated loss. This is:

For an exempt organization, its NOL, or
For a nonexempt organization, the part of its NOL that would be its NOL if it were ex-empt and had the same exempt purposes as the controlling organization.

Control. An organization is controlled if:

For a corporation, the controlling organiza-tion owns (by vote or value) more than 50% of the stock,
For a partnership, the controlling organiza-tion owns more than 50% of the profits or capital interests, or
For any other organization, the controlling organization owns more than 50% of the beneficial interest.

For this purpose, constructive ownership of stock (determined under section 318) or other interests is taken into account.

As a result, an exempt parent organization is treated as controlling any subsidiary in which it holds more than 50% of the voting power or value, whether directly (as in the case of a first-tier subsidiary) or indirectly (as in the case of a second-tier subsidiary).

Income From Property Financed With Qualified 501(c)(3) Bonds

If any part of a 501(c)(3) organization's property financed with qualified 501(c)(3) bonds is used in a trade or business of any person other than

a section 501(c)(3) organization or a govern-mental unit, and such use isn’t consistent with the requirements for qualified 501(c)(3) bonds under section 145, the section 501(c)(3) organi-zation is considered to have received unrelated business income in the amount of the greater of the actual rental income or the fair rental value of the property for the period it is used. No de-duction is allowed for interest on the private ac-tivity bond. See sections 150(b)(3) and (c) for more information.

Disposition of Property

Received From Taxable

Subsidiary and Used in

Unrelated Business

A taxable 80%-owned subsidiary corporation of one or more tax -exempt entities is generally subject to tax on a distribution in liquidation of its assets to its exempt parent (or parents). The assets are treated as if sold at fair market value.

Tax-exempt entities include organizations described in sections 501(a), 529, and 115, charitable remainder trusts, U.S. and foreign governments, Indian tribal governments, inter-national organizations, and similar non-taxable organizations.

A taxable corporation that transfers substan-tially all of its assets to a tax-exempt entity in a transaction that otherwise qualifies for nonre-cognition treatment must recognize gain on the transaction as if it sold the assets at fair market value. However, such a transfer isn’t taxable if it qualifies as a like-kind exchange under section 1031 or an involuntary conversion under sec-tion 1033. In such a case, the built-in apprecia-tion is preserved in the replacement property received in the transaction.

A corporation that changes status from taxa-ble to tax-exempt is treated generally as if it transferred all of its assets to a tax-exempt en-tity immediately before the change in status (thus subjecting it to the tax on a deemed sale for fair market value). This rule doesn’t apply where the taxable corporation becomes exempt within 3 years of formation, or had previously been exempt and within several years (gener-ally a period of 3 years) regains exemption, un-less the principal purpose of the transactions is to avoid the tax on the change in status.

In the transactions described above, the tax-able event is deferred for property that the tax-exempt entity immediately uses in an unre-lated business. If the parent later disposes of the property, then any gain (not in excess of the amount not recognized) is included in the pa-rent's UBTI. If there is partial use of the assets in unrelated business, then there is partial rec-ognition of gain or loss. Property is treated as disposed if the tax-exempt entity no longer uses it in an unrelated business.

Losses on the transfer of assets to a tax-ex-empt entity are disallowed if part of a plan with a principal purpose of recognizing losses.

Chapter 4Unrelated Business Taxable IncomePage 15

Income From Debt-Financed Property

Investment income that would otherwise be ex-cluded from an exempt organization's UBTI (see Exclusions under Income, earlier) must be included to the extent it is derived from debt-fi-nanced property. The amount of income inclu-ded is proportionate to the debt on the property.

Debt-Financed Property

In general, the term “debt-financed property” means any property held to produce income (in-cluding gain from its disposition) for which there is an acquisition indebtedness at any time dur-ing the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). However, the tax on unrelated debt-financed income un-der section 514 does not apply to property used for an exempt purpose. See Exceptions to Debt-Financed Property, later. Sources of unre-lated debt-financed income include rental real estate, tangible personal property, and corpo-rate stock.

Acquisition Indebtedness

For any debt-financed property, acquisition in-debtedness is the unpaid amount of debt incur-red by an organization:

1. When acquiring or improving the property,

2. Before acquiring or improving the property if the debt would not have been incurred except for the acquisition or improvement, and

3. After acquiring or improving the property if:

a. The debt would not have been incur-red except for the acquisition or im-provement, and

b. Incurring the debt was reasonably foreseeable when the property was acquired or improved.

The facts and circumstances of each situa-tion determine whether incurring a debt was reasonably foreseeable. That an organization may not have foreseen the need to incur a debt before acquiring or improving the property doesn’t necessarily mean that incurring the debt later wasn’t reasonably foreseeable.

Example 1. Y, an exempt scientific organi-zation, mortgages its laboratory to replace working capital used in remodeling an office building that Y rents to an insurance company for nonexempt purposes. The debt is acquisi-tion indebtedness since the debt, though incur-red after the improvement of the office building, would not have been incurred without the im-provement, and the debt was reasonably fore-seeable when, to make the improvement, Y re-duced its working capital below the amount necessary to continue current operations.

Example 2. X, an exempt organization, forms a partnership with A and B. The

partnership agreement provides that all three partners will share equally in the profits of the partnership, each will invest $3 million, and X will be a limited partner. X invests $1 million of its own funds in the partnership and $2 million of borrowed funds.

The partnership buys as its sole asset an of-fice building that it leases to the public for non-exempt purposes. The office building costs the partnership $24 million, of which $15 million is borrowed from Y bank. The loan is secured by a mortgage on the entire office building. By agreement with Y bank, X isn’t personally liable for payment of the mortgage.

X has acquisition indebtedness of $7 million. This amount is the $2 million debt X incurred in acquiring the partnership interest, plus the $5 million that is X's allocable part of the partner-ship's debt incurred to buy the office building (one-third of $15 million).

Example 3. A labor union advanced funds, from existing resources and without any bor-rowing, to its tax-exempt subsidiary title-holding company. The subsidiary used the funds to pay a debt owed to a third party that was previously incurred in acquiring two income-producing of-fice buildings. Neither the union nor the subsid-iary has incurred any further debt in acquiring or improving the property. The union has no out-standing debt on the property. The subsidiary's debt to the union is represented by a demand note on which the subsidiary makes payments whenever it has the available cash. The books of the union and the subsidiary list the outstand-ing debt as inter-organizational indebtedness.

Although the subsidiary's books show a debt to the union, it isn’t the type subject to the debt-financed property rules. In this situation, the very nature of the title-holding company and the parent-subsidiary relationship shows this debt to be merely a matter of accounting be-tween the two organizations. Accordingly, the debt isn’t acquisition indebtedness.

Change in use of property. If an organization converts property that isn’t debt-financed prop-erty to a use that results in its treatment as debt-financed property, the outstanding princi-pal debt on the property is thereafter treated as acquisition indebtedness.

Example. Four years ago a university bor-rowed funds to acquire an apartment building as housing for married students. Last year, the university rented the apartment building to the public for nonexempt purposes. The outstand-ing principal debt becomes acquisition indebt-edness as of the time the building was first ren-ted to the public.

Continued debt. If an organization sells prop-erty and, without paying off debt that would be acquisition indebtedness if the property were debt-financed property, buys property that is otherwise debt-financed property, the unpaid debt is acquisition indebtedness for the new property. This is true even if the original prop-erty wasn’t debt-financed property.

Example. To house its administration offi-ces, an exempt organization bought a building using $600,000 of its own funds and $400,000 of borrowed funds secured by a pledge of its

securities. The office building wasn’t debt-fi-nanced property. The organization later sold the building for $1 million without repaying the $400,000 loan. It used the sale proceeds to buy an apartment building it rents to the general public. The unpaid debt of $400,000 is acquisi-tion indebtedness with respect to the apartment building.

Property acquired subject to mortgage or lien. If property (other than certain gifts, be-quests, and devises) is acquired subject to a mortgage, the outstanding principal debt se-cured by that mortgage is treated as acquisition indebtedness even if the organization didn’t as-sume or agree to pay the debt.

Example. An exempt organization paid $50,000 for real property valued at $150,000 and subject to a $100,000 mortgage. The $100,000 of outstanding principal debt is ac-quisition indebtedness, as though the organiza-tion had borrowed $100,000 to buy the prop-erty.

Liens similar to a mortgage. In determin-ing acquisition indebtedness, a lien similar to a mortgage is treated as a mortgage. A lien is similar to a mortgage if title to property is en-cumbered by the lien for a creditor's benefit. However, when state law provides that a lien for taxes or assessments attaches to property be-fore the taxes or assessments become due and payable, the lien isn’t treated as a mortgage un-til after the taxes or assessments have become due and payable and the organization has had an opportunity to eliminate the lien by paying the amount it secured in accordance with state law. Liens similar to mortgages include (but aren’t limited to):

1. Deeds of trust,

2. Conditional sales contracts,

3. Chattel mortgages,

4. Security interests under the Uniform Com-mercial Code,

5. Pledges,

6. Agreements to hold title in escrow, and

7. Liens for taxes or assessments (other than those discussed earlier in this paragraph).

Exception for property acquired by gift, bequest, or devise. If property subject to a mortgage is acquired by gift, bequest, or de-vise, the outstanding principal debt secured by the mortgage isn’t treated as acquisition indebt-edness during the 10-year period following the date the organization receives the property. However, this applies to a gift of property only if:

1. The mortgage was placed on the property more than 5 years before the date the or-ganization received it, and

2. The donor held the property for more than 5 years before the date the organization received it.

This exception doesn't apply if an organiza-tion assumes and agrees to pay all or part of the debt secured by the mortgage or makes any payment for the equity in the property owned by the donor or decedent (other than a payment under an annuity obligation excluded from the

Page 16Chapter 4Unrelated Business Taxable Income

definition of acquisition indebtedness, dis-cussed under Debt That Isn’t Acquisition In-debtedness, later).

Whether an organization has assumed and agreed to pay all or part of a debt in order to ac-quire the property is determined by the facts and circumstances of each situation.

Modifying existing debt. Extending, renew-ing, or refinancing an existing debt is consid-ered a continuation of that debt to the extent its outstanding principal doesn’t increase. When the principal of the modified debt is more than the outstanding principal of the old debt, the ex-cess is treated as a separate debt.

Extension or renewal. In general, any modification or substitution of the terms of a debt by an organization is considered an exten-sion or renewal of the original debt, rather than the start of a new one, to the extent that the out-standing principal of the debt doesn’t increase.

The following are examples of acts resulting in the extension or renewal of a debt:

1. Substituting liens to secure the debt,

2. Substituting obligees whether or not with the organization's consent,

3. Renewing, extending, or accelerating the payment terms of the debt, and

4. Adding, deleting, or substituting sureties or other primary or secondary obligors.

Debt increase. If the outstanding principal of a modified debt is more than that of the un-modified debt, and only part of the refinanced debt is acquisition indebtedness, the payments on the refinanced debt must be allocated be-tween the old debt and the excess.

Example. An organization has an out-standing principal debt of $500,000 that is trea-ted as acquisition indebtedness. The organiza-tion borrows another $100,000, which isn’t acquisition indebtedness, from the same lender, resulting in a $600,000 note for the total obligation. A payment of $60,000 on the total obligation would reduce the acquisition indebt-

edness by $50,000 ($60,000 x $500,000/$600,000) and the excess debt by $10,000.

Debt That Isn’t Acquisition Indebtedness

Certain debt and obligations aren’t acquisition indebtedness. These include the following.

Debts incurred in performing an exempt purpose.

Annuity obligations.
Securities loans.
Real property debts of qualified organiza-tions.

Certain Federal financing.

Debt incurred in performing exempt pur-pose. A debt incurred in performing an exempt purpose isn’t acquisition indebtedness. For ex-ample, acquisition indebtedness doesn’t in-clude the debt an exempt credit union incurs in accepting deposits from its members or the debt an exempt organization incurs in accepting payments from its members to provide them with insurance, retirement, or other benefits.

Annuity obligation. The organization's obliga-tion to pay an annuity isn’t acquisition indebted-ness if the annuity meets all the following re-quirements.

1. It must be the sole consideration (other than a mortgage on property acquired by gift, bequest, or devise that meets the ex-ception discussed under Property ac-quired subject to mortgage or lien, earlier in this chapter) issued in exchange for the property received.

2. Its present value, at the time of exchange, must be less than 90% of the value of the prior owner's equity in the property re-ceived.

3. It must be payable over the lives of either one or two individuals living when issued.

4. It must be payable under a contract that:

a. Doesn’t guarantee a minimum nor specify a maximum number of pay-ments, and

b. Doesn’t provide for any adjustment of the amount of the annuity payments based on the income received from the transferred property or any other property.

Example. X, an exempt organization, re-ceives property valued at $100,000 from donor A, a male age 60. In return X promises to pay A $6,000 a year for the rest of A's life, with neither a minimum nor maximum number of payments specified. The amounts paid under the annuity aren’t dependent on the income derived from the property transferred to X. The present value of this annuity is $81,156, determined from IRS valuation tables. Since the value of the annuity is less than 90 percent of A's $100,000 equity in the property transferred and the annuity meets all the other requirements just discussed, the obligation to make annuity payments isn’t ac-quisition indebtedness.

Securities loans. Acquisition indebtedness doesn’t include an obligation of the exempt or-ganization to return collateral security provided by the borrower of the exempt organization's securities under a securities loan agreement (discussed under Exclusions, earlier in this chapter). This transaction isn’t treated as the borrowing by the exempt organization of the collateral furnished by the borrower (usually a broker) of the securities.

However, if the exempt organization incur-red debt to buy the loaned securities, any in-come from the securities (including income from lending the securities) would be debt-fi-nanced income. For this purpose, any pay-ments because of the securities are considered to be from the securities loaned and not from collateral security or the investment of collateral security from the loans. Any deductions that are directly connected with collateral security for the loan, or with the investment of collateral se-curity, are considered deductions that are di-rectly connected with the securities loaned.

Short sales. Acquisition indebtedness doesn’t include the “borrowing” of stock from a broker to sell the stock short. Although a short sale creates an obligation, it doesn’t create debt.

Real property debts of qualified organiza-tions. In general, acquisition indebtedness doesn't include debt incurred by a qualified or-ganization in acquiring or improving any real property. A qualified organization is:

1. A qualified retirement plan under section 401(a),

2. An educational organization described in section 170(b)(1)(A)(ii) and certain of its affiliated support organizations,

3. A title-holding company described in sec-tion 501(c)(25), or

4. A retirement income account described in section 403(b)(9) in acquiring or improving real property in tax years beginning on or after August 17, 2006.

This exception from acquisition indebted-ness doesn’t apply in the following six situa-tions.

1. The acquisition price isn’t a fixed amount determined as of the date of the acquisi-tion or the completion of the improvement. However, the terms of a sales contract may provide for price adjustments due to customary closing adjustments such as prorating property taxes. The contract also may provide for a price adjustment if it is for a fixed amount dependent upon subse-quent resolution of limited, external contin-gencies such as zoning approvals, title clearances, and the removal of ease-ments. These conditions in the contract will not cause the price to be treated as an undetermined amount. However, see Note 1 at the end of this list.

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 rev-enue, income, or profits derived from the real property. However, see Note 1 at the end of this list.

3. The real property is leased back to the seller of the property or to a person related to the seller as described in section 267(b) or section 707(b). However, see Note 2 at the end of this list.

4. The real property is acquired by a qualified retirement plan from, or after its acquisition is leased by a qualified retirement plan to, a related person. However, see Note 2 at the end of this list. For this purpose, a rela-ted person is:

a. An employer who has employees cov-ered by the plan,

b. An owner with at least a 50% interest in an employer described in (a),

c. A member of the family of any individ-ual described in (a) or (b),

d. A corporation, partnership, trust, or estate in which a person described in (a), (b), or (c) has at least a 50% inter-est, or

e. An officer, director, 10% or more shareholder, or highly compensated employee of a person described in (a), (b), or (d).

Chapter 4Unrelated Business Taxable IncomePage 17

5. The seller, a person related to the seller (under section 267(b) or section 707(b)), or a person related to a qualified retire-ment plan (as described in (4)) provides fi-nancing for the transaction on other than commercially reasonable terms.

6. The real property is held by a partnership in which an exempt organization is a part-ner (along with taxable entities), and the principal purpose of any allocation to an exempt organization is to avoid tax. This generally applies to property placed in service after 1986. For more information, see section 514(c)(9)(B)(vi) and section 514(c)(9)(E).

Note 1. Qualifying sales by financial institu-tions of foreclosure property or certain conser-vatorship or receivership property aren’t inclu-ded in (1) or (2) and, therefore, don’t give rise to acquisition indebtedness. For more information, see section 514(c)(9)(H).

Note 2. For purposes of (3) and (4), small leases are disregarded. A small lease is one that covers no more than 25% of the leasable floor space in the property and has commer-cially reasonable terms.

Certain federal financing. Acquisition indebt-edness doesn’t include an obligation, to the ex-tent it is insured by the Federal Housing Admin-istration, to finance the purchase, rehabilitation, or construction of housing for low or moderate income people.

In addition, acquisition indebtedness doesn’t include indebtedness incurred by a small business investment company licensed under the Small Business Investment Act of 1958 after October 22, 2004, if such indebted-ness is evidenced by a debenture issued by such company and held or guaranteed by the Small Business Administration. However, this provision doesn’t apply to any small business investment company during any period that any organization which is exempt from tax (other than a governmental unit) owns more than 25% of the capital or profits interest in such com-pany, or organizations which are exempt from tax (including governmental agencies other than any agency or instrumentality of the United States) own, in the aggregate, 50% or more of the capital or profits interest in such company.

Exceptions to Debt-Financed Property

Certain property is excepted from treatment as debt-financed property.

Property related to exempt purposes. If substantially all (85% or more) of the use of any property is substantially related to an organiza-tion's exempt purposes, the property isn’t trea-ted as debt-financed property. Related use doesn’t include a use related solely to the or-ganization's need for income, or its use of the profits. The extent to which property is used for a particular purpose is determined on the basis of all the facts. They may include:

1. A comparison of the time the property is used for exempt purposes with the total time the property is used,

2. A comparison of the part of the property that is used for exempt purposes with the part used for all purposes, or

3. Both of these comparisons.

If less than 85% of the use of any property is devoted to an organization's exempt purposes, only that part of the property used to further the organization's exempt purposes isn’t treated as debt-financed property.

Property used in an unrelated trade or busi-ness. To the extent that the gross income from any property is treated as income from the con-duct of an unrelated trade or business, the property isn’t treated as debt-financed property. However, any gain on the disposition of the property not included in income from an unrela-ted trade or business is includible as gross in-come derived from, or on account of, debt-fi-nanced property.

The rules for debt-financed property don’t apply to rents from personal property, certain passive income from controlled organizations, and other amounts that are required by other rules to be included in computing UBTI.

Property used in research activities. Prop-erty isn’t treated as debt-financed property when it produces gross income derived from re-search activities otherwise excluded from the unrelated trade or business tax. See Income from research under Exclusions, earlier in this chapter.

Property used in certain excluded activi-ties. Debt-financed property doesn’t include property used in a trade or business that is ex-cluded from the definition of “unrelated trade or business” because:

1. It has a volunteer workforce,

2. It is conducted for the convenience of its members, or

3. It consists of selling donated merchandise.

See Excluded Trade or Business Activities in chapter 3.

Related exempt uses. Property owned by an exempt organization and used by a related ex-empt organization, or by an exempt organiza-tion related to that related exempt organization, isn’t treated as debt-financed property when the property is used by either organization to further its exempt purpose. Furthermore, property isn’t treated as debt-financed property when a rela-ted exempt organization uses it for research ac-tivities or certain excluded activities, as descri-bed above.

Related organizations. An exempt organ-ization is related to another exempt organiza-tion only if:

1. One organization is an exempt holding company and the other receives profits derived by the exempt holding company,

2. One organization controls the other as dis-cussed under Income From Controlled Or-ganizations earlier in this chapter,

3. More than 50% of the members of one or-ganization are members of the other, or

4. Each organization is a local organization directly affiliated with a common state, na-tional, or international organization that also is exempt.

Medical clinics. Real property isn’t debt-fi-nanced property if it is leased to a medical clinic and the lease is entered into primarily for purpo-ses related to the lessor's exercise or perform-ance of its exempt purpose.

Example. An exempt hospital leases all of its clinic space to an unincorporated association of physicians and surgeons. They, under the lease, agree to provide all of the hospital's out-patient medical and surgical services and to train all of the hospital's residents and interns. In this case the rents received aren’t unrelated debt-financed income.

Life income contract. If an individual trans-fers property to a trust or a fund with the income payable to that individual or other individuals for a period not to exceed the life of the individual or individuals, and with the remainder payable to an exempt charitable organization, the prop-erty isn’t treated as debt-financed property. This exception applies only where the payments to the individual aren’t the proceeds of a sale or exchange of the property transferred.

Neighborhood land rule. If an organization acquires real property with the intention of using the land for exempt purposes within 10 years, it will not be treated as debt-financed property if it is in the neighborhood of other property that the organization uses for exempt purposes. This rule applies only if the intent to demolish any ex-isting structures and use the land for exempt purposes within 10 years isn’t abandoned.

Property is considered in the neighborhood of property that an organization owns and uses for its exempt purposes if it is contiguous with the exempt purpose property or would be con-tiguous except for an intervening road, street, railroad, stream, or similar property. If it isn’t contiguous with the exempt purpose property, it still may be in the same neighborhood if it is within 1 mile of the exempt purpose property and if the facts and circumstances make it un-reasonable to acquire the contiguous property.

Some issues to consider in determining whether acquiring contiguous property is unrea-sonable include the availability of land and the intended future use of the land.

Example. A university tries to buy land contiguous to its present campus, but can’t do so because the owners either refuse to sell or ask unreasonable prices. The nearest land of sufficient size and utility is a block away from the campus. The university buys this land. Un-der these circumstances, the contiguity require-ment is unreasonable and not applicable. The land bought would be considered neighborhood land.

Exceptions. For all organizations other than churches and conventions or associations of churches, discussed later under Churches, the neighborhood land rule doesn’t apply to property after the 10 years following its

Page 18Chapter 4Unrelated Business Taxable Income

acquisition. Further, the rule applies after the first 5 years only if the organization satisfies the IRS that use of the land for exempt purposes is reasonably certain before the 10-year period expires. The organization need not show bind-ing contracts to satisfy this requirement; but it must have a definite plan detailing a specific im-provement and a completion date, and it must show some affirmative action toward the fulfill-ment of the plan. This information should be for-warded to the IRS for a ruling at least 90 days before the end of the 5th year after acquisition of the land. Send information to:

Internal Revenue Service

Attn: CC:PA:LPD:DRU

P.O. Box 120, Ben Franklin Station Washington, DC 20044

If a private delivery service is used, the address is:

Internal Revenue Service

Attn: CC:PA:LPD:DRU, Room 5336 1111 Constitution Ave. NW Washington, DC 20224

The IRS may grant a reasonable extension of time for requesting the ruling if the organization can show good cause. For more information, contact the IRS.

For any updates to these addresses go

to IRS.gov/Pub598.

CAUTION

Actual use. If the neighborhood land rule doesn’t apply because the acquired land isn’t in the neighborhood of other land used for an or-ganization's exempt purposes, or because the organization fails to establish after the first 5 years of the 10-year period that the property will be used for exempt purposes, but the land is used eventually by the organization for its ex-empt purposes within the 10-year period, the property isn’t treated as debt-financed property for any period before the conversion.

Limits. The neighborhood land rule or ac-tual use rule applies to any structure on the land when acquired, or to the land occupied by the structure, only so long as the intended future use of the land in furtherance of the organiza-tion's exempt purpose requires that the struc-ture be demolished or removed in order to use the land in this manner. Thus, during the first 5 years after acquisition (and for later years if there is a favorable ruling), improved property isn’t debt financed so long as the organization doesn’t abandon its intent to demolish the exist-ing structures and use the land in furtherance of its exempt purpose. If an actual demolition of these structures occurs, the use made of the land need not be the one originally intended as long as its use furthers the organization's ex-empt purpose.

In addition to this limit, the neighborhood land rule and the actual use rule don’t apply to structures erected on land after its acquisition. They don’t apply to property subject to a busi-ness lease (as defined in section 1.514(f)-1 of the regulations) whether an organization ac-quired the property subject to the lease, or whether it executed the lease after acquisition. A business lease is any lease, with certain

exceptions, of real property for a term of more than 5 years by an exempt organization if at the close of the lessor's tax year there is a business lease (acquisition) indebtedness on that prop-erty.

Refund of taxes. When the neighborhood land rule doesn’t initially apply, but the land is eventually used for exempt purposes, a refund or credit of any overpaid taxes will be allowed for a prior tax year as a result of the satisfaction of the actual use rule. A claim must be filed within 1 year after the close of the tax year in which the actual use rule is satisfied. Interest rates on any overpayment are governed by the regulations.

Example. In January 2009, Y, a calendar year exempt organization, acquired real prop-erty contiguous to other property that Y uses in furtherance of its exempt purpose. Assume that without the neighborhood land rule, the property would be debt-financed property. Y didn’t sat-isfy the IRS by January 2014 that the existing structure would be demolished and the land would be used in furtherance of its exempt pur-pose. From 2014 until the property is converted to an exempt use, the income from the property is subject to the tax on unrelated business in-come. During July 2018, Y will demolish the ex-isting structure on the land and begin using the land in furtherance of its exempt purpose. At that time, Y can file claims for refund for the open years 2015 through 2017.

Further, Y also can file a claim for refund for 2014, even though a claim for that tax year may be barred by the statute of limitations, provided the claim is filed before the close of 2019.

Churches. The neighborhood land rule as described here also applies to churches, or a convention or association of churches, but with two differences:

1. The period during which the organization must demonstrate the intent to use ac-quired property for exempt purposes is in-creased from 10 to 15 years, and

2. Acquired property doesn’t have to be in the neighborhood of other property used by the organization for exempt purposes.

Thus, if a church or association or conven-tion of churches acquires real property for the primary purpose of using the land in the exer-cise or performance of its exempt purpose, within 15 years after the time of acquisition, the property isn’t treated as debt-financed property as long as the organization doesn't abandon its intent to use the land in this manner within the 15-year period.

This exception for a church or association or convention of churches doesn’t apply to any property after the 15-year period expires. Fur-ther, this rule will apply after the first 5 years of the 15-year period only if the church or associa-tion or convention of churches establishes to the satisfaction of the IRS that use of the ac-quired land in furtherance of the organization's exempt purpose is reasonably certain before the 15-year period expires.

If a church or association or convention of churches can’t establish after the first 5 years of the 15-year period that use of acquired land for its exempt purpose is reasonably certain within

the 15-year period, but the land is in fact con-verted to an exempt use within the 15-year pe-riod, the land isn’t treated as debt-financed property for any period before the conversion.

The same rule for demolition or removal of structures, as discussed earlier in this chapter under Limits, applies to a church or an associa-tion or a convention of churches.

Computation of Debt-Financed Income

For each debt-financed property, the unrelated debt-financed income is a percentage (not over 100%) of the total gross income derived during a tax year from the property. This percentage is the same percentage as the average acquisi-tion indebtedness with respect to the property for the tax year of the property's average adjus-ted basis for the year (the debt/basis percent-age). Thus, the formula for deriving unrelated debt-financed income is:

	average acquisition		gross income
	indebtedness	x	from
			debt-financed

average adjusted basis			property

Example. X, an exempt trade association, owns an office building that is debt-financed property. The building produced $10,000 of gross rental income last year. The average ad-justed basis of the building during that year was $100,000, and the average acquisition indebt-edness with respect to the building was $50,000. Accordingly, the debt/basis percent-age was 50% (the ratio of $50,000 to $100,000). Therefore, the unrelated debt-fi-nanced income with respect to the building was $5,000 (50% of $10,000).

Gain or loss from sale or other disposition of property. If an organization sells or other-wise disposes of debt-financed property, it must include, in computing UBTI, a percentage (not over 100%) of any gain or loss. The percentage is that of the highest acquisition indebtedness with respect to the property during the 12-month period preceding the date of disposi-tion, in relation to the property's average adjus-ted basis.

The tax on this percentage of gain or loss is determined according to the usual rules for cap-ital gains and losses.

Debt-financed property exchanged for subsidiary's stock. A transfer of debt-fi-nanced property by a tax-exempt organization to its wholly owned taxable subsidiary, in ex-change for additional stock in the subsidiary, isn’t considered a gain subject to the tax on un-related business income.

Example. A tax-exempt hospital wants to build a new hospital complex to replace its present old and obsolete facility. The most de-sirable location for the new hospital complex is a site occupied by an apartment complex. Sev-eral years ago the hospital bought the land and apartment complex, taking title subject to a first mortgage already on the premises.

For valid business reasons, the hospital pro-posed to exchange the land and apartment

Chapter 4Unrelated Business Taxable IncomePage 19

complex, subject to the mortgage on the prop-erty, for additional stock in its wholly owned subsidiary. The exchange satisfied all the re-quirements of section 351(a).

The transfer of appreciated debt-financed property from the tax-exempt hospital to its wholly owned subsidiary in exchange for stock didn’t result in a gain subject to the tax on unre-lated business income.

Gain or loss on disposition of certain brownfield property. Gain or loss from the qualifying sale, exchange, or other disposition of a qualifying brownfield property (as defined in section 512(b)(19)(C)), which was acquired by the organization after December 31, 2004, is excluded from UBTI and is excepted from the debt-financed rules for such property. See sec-tions 512(b)(19) and 514(b)(1)(E).

Average acquisition indebtedness. This is the average amount of outstanding principal debt during the part of the tax year that the or-ganization holds the property.

Average acquisition indebtedness is compu-ted by determining how much principal debt is outstanding on the first day in each calendar month during the tax year that the organization holds the property, adding these amounts, and dividing the sum by the number of months dur-ing the year that the organization held the prop-erty. Part of a month is treated as a full month in computing average acquisition indebtedness.

Indeterminate price. If an organization ac-quires or improves property for an indetermi-nate price (that is, neither the price nor the debt is certain), the unadjusted basis and the initial acquisition indebtedness are determined as fol-lows, unless the organization obtains the IRS's consent to use another method:

The unadjusted basis is the fair market value of the property or improvement on the date of acquisition or completion of the improvement.

The initial acquisition indebtedness is the fair market value of the property or im-provement on the date of acquisition or completion of the improvement, less any down payment or other initial payment ap-plied to the principal debt.

organization acquires debt-financed property in a complete or partial liquidation of a corporation in exchange for its stock, the organization's ba-sis in the property is the same as it would be in the hands of the transferor corporation. This ba-sis is increased by the gain recognized to the transferor corporation upon the distribution and by the amount of any gain that, because of the distribution, is includible in the organization's gross income as unrelated debt-financed in-come.

Computation of debt/basis percentage. The following example shows how to compute the debt/basis percentage by first determining the average acquisition indebtedness and average adjusted basis.

Example. On July 7, an exempt organiza-tion buys an office building for $510,000 using $300,000 of borrowed funds. The organization files its return on a calendar year basis. During the year the only adjustment to basis is $20,000 for depreciation. Starting July 28, the organiza-tion pays $20,000 each month on the mortgage principal plus interest. The debt/basis percent-age for the year is calculated as follows:

	Debt on first day
Month		of each month
		property is held

July . . . . . . . . . . . . . . . . . . . . .	$		300,000
August . . . . . . . . . . . . . . . . . .			280,000
September . . . . . . . . . . . . . . . .			260,000
October . . . . . . . . . . . . . . . . . .			240,000
November . . . . . . . . . . . . . . . .			220,000
December . . . . . . . . . . . . . . . .			200,000
Total	$		1,500,000
Average acquisition

indebtedness:	$		250,000
$1,500,000 ÷ 6 months

		Basis
As of July 7 . . . . . . . . . . . . . . .	$	510,000
As of December 31 . . . . . . . . . .		490,000
Total	$	1,000,000
Average adjusted basis:
	$	500,000
$1,000,000 ÷ 2
Debt/basis percentage

$250,000 ÷ $500,000	= 50%

To be directly connected with debt-financed property or with the income from it, a deductible item must have proximate and primary relation-ship to the property or income. Expenses, de-preciation, and similar items attributable solely to the property qualify for deduction, to the ex-tent they meet the requirements of an allowable deduction.

For example, if the straight-line depreciation allowance for an office building is $10,000 a year, an organization can deduct depreciation of $10,000 if the entire building is debt-financed property. However, if only half of the building is debt-financed property, the depreciation al-lowed as a deduction is $5,000.

Capital losses. If a sale or exchange of debt-financed property results in a capital loss, the loss taken into account in the tax year in which the loss arises is computed as provided earlier. See Gain or loss from sale or other dis-position of property under Computation of Debt-Financed Income, earlier.

If any part of the allowable capital loss isn’t taken into account in the current tax year, it may be carried back or carried over to another tax year as provided in section 1212 , without appli-cation of the debt/basis percentage for that year.

Example. X, an exempt educational organ-ization, owned debt-financed securities that were capital assets. Last year, X sold the secur-ities at a loss of $20,000. The debt/basis per-centage for computing the loss from the sale of the securities is 40%. Thus, X sustained a capi-tal loss of $8,000 (40% of $20,000) on the sale of the securities. Last year and the preceding 3 tax years, X had no other capital transactions. Under these circumstances, the $8,000 of capi-tal loss may be carried over to succeeding years (subject to limitations under section 1212) without further application of the debt/basis per-centage.

NOL. If, after applying the debt/basis percent-age to the income from debt-financed property and the deductions directly connected with this income, the deductions exceed the income, an organization has an NOL for the tax year. This amount may be carried over to other tax years

Average adjusted basis. The average adjus-ted basis of debt-financed property is the aver-age of the adjusted basis of the property as of the first day and as of the last day that the or-ganization holds the property during the tax year.

Determining the average adjusted basis of the debt-financed property isn’t affected if the organization was exempt from tax for prior tax years. The basis of the property must be adjus-ted properly for the entire period after the prop-erty was acquired. As an example, adjustment must be made for depreciation during all prior tax years whether or not the organization was tax-exempt. If only part of the depreciation al-lowance may be taken into account in comput-ing the percentage of deductions allowable for each debt-financed property, that doesn’t affect the amount of the depreciation adjustment to use in determining average adjusted basis.

Basis for debt-financed property ac-quired in corporate liquidation. If an exempt

Deductions for Debt-Financed Property

The deductions allowed for each debt-financed property are determined by applying the debt/ basis percentage to the sum of allowable de-ductions.

The allowable deductions are those directly connected with the debt-financed property or with the income from it (including the divi-dends-received deduction), except that:

1. The allowable deductions are subject to the modifications for computation of the UBTI (discussed earlier in this chapter); and

2. The depreciation deduction, if allowable, is computed only by use of the straight-line method.

in the same manner as any other NOL of an or-ganization with UBTI. (For a discussion of the NOL deduction, see Modifications under De-ductions, earlier in this chapter.) However, the debt/basis percentage is not applied in those other tax years to determine the deductions that may be taken in those years.

Example. Last year, Y, an exempt organi-zation, received $20,000 of rent from a debt-fi-nanced building that it owns. Y had no other UBTI for the year. The deductions directly con-nected with this building were property taxes of $5,000, interest of $5,000 on the acquisition in-debtedness, and salary of $15,000 to the build-ing manager. The debt/basis percentage with respect to the building was 50%. Under these circumstances, Y must take into account, in computing its UBTI, $10,000 (50% of $20,000) of income and $12,500 (50% of $25,000) of the deductions directly connected with that income.

Page 20Chapter 4Unrelated Business Taxable Income

Thus, Y sustained an NOL of $2,500 ($10,000 of income less $12,500 of deduc-tions), which may be carried back or carried over to other tax years (as provided in section

172) without further application of the debt/ basis percentage.

Allocation Rules

When only part of the property is debt-financed property, proper allocation of the basis, debt, in-come, and deductions with respect to the prop-erty must be made to determine how much in-come or gain derived from the property to treat as unrelated debt-financed income.

Example. X, an exempt college, owns a four-story office building that it bought with bor-rowed funds (assumed to be acquisition indebt-edness). During the year, the lower two stories of the building were used to house computers that X uses for administrative purposes. The two upper stories were rented to the public and used for nonexempt purposes.

The gross income X derived from the build-ing was $6,000, all of which was attributable to the rents paid by tenants. The expenses were $2,000 and were equally allocable to each use of the building. The average adjusted basis of the building for the year was $100,000 and the average acquisition indebtedness for the year was $60,000.

Since the two lower stories were used for exempt purposes, only the upper half of the building is debt-financed property. Conse-quently, only the rental income and the deduc-tions directly connected with this income are taken into account in computing UBTI. The part

taken into account is determined by multiplying the $6,000 of rental income and $1,000 of de-ductions directly connected with the rental in-come by the debt/basis percentage.

The debt/basis percentage is the ratio of the allocable part of the average acquisition indebt-edness to the allocable part of the property's average adjusted basis: that is, in this case, the ratio of $30,000 (one-half of $60,000) to $50,000 (one-half of $100,000). Thus, the debt/ basis percentage for the year is 60% (the ratio of $30,000 to $50,000).

Under these circumstances, X must include net rental income of $3,000 in its UBTI for the year, computed as follows:

Rental income treated as gross income
from an unrelated trade or business (60% of	$3,600
$6,000) ...........................
Less the allowable portion of
deductions directly connected with that income	600
(60% of $1,000) . . . . . . . . . . . . . . . . . . . . .
Net rental income included by X in
computing its UBTI from debt-financed	$3,000
property. . . . . . . . . . . . . . . . . . . . . . . . . . .

5.

How To Get Tax Help

Photographs of Missing Children. The IRS is a proud partner with the National Center for

Missing and Exploited Children. Photographs of missing children selected by the Center may appear in instructions on pages that would oth-erwise be blank. You can help bring these chil-dren home by looking at the photographs and calling 1-800-THE-LOST (1-800-843-5678) if you recognize a child.

Phone Help. If you have questions and/or need help completing this form, please call 877-829-5500. This toll-free telephone service is available Monday through Friday.

Internet. You can access the IRS website 24 hours a day, 7 days a week, at IRS.gov to:

Download forms and publications.
Order IRS products online.
Research your tax questions online.
Search publications online by topic or key-word.

Use the online Internal Revenue Code (IRC), Regulations, or other official guid-ance.
View Internal Revenue Bulletins (IRBs) published in the last few years.

Sign up to receive local and national tax news by email. To subscribe, visit IRS.gov/ Charities.

Ordering Forms and Publications. Visit IRS.gov/FormsPubs to download forms and publications. Otherwise, you can go to IRS.gov/ OrderForms to order current and prior-year forms and instructions. Your order should arrive within 10 business days.

Chapter 5How To Get Tax HelpPage 21

	To help us develop a more useful index, please let us know if you have ideas for index entries.

Index
	See “Comments and Suggestions” in the “Introduction” for the ways you can reach us.

A

Acquisition indebtedness 20 Annuity obligations 17

By gift or bequest of mortgaged property 16

Change in property use 16 Continued debt 16

Debt modifying existing 17 Federal financing 18

For performing exempt purpose 17

Obligation to return collateral 17 Property subject to mortgage or

lien 16

Real property 17

Advertising income 12

Agricultural organization dues 11

B

Business league dues 11

C

Churches 19

Contributions deduction 13

Convention or trade show activity 8

D

Debt-financed property 16 Acquired in liquidation 20

Dues, agricultural organizations and business leagues 11

E

Exchange or rental of member lists 8

Excluded trade or business activities 7

Exclusions 9

Sponsorship 8

Exempt function income 14

Exploitation of exempt activity:

Advertising income 12

Exploitation of exempt

functions

4

U

Unrelated business:

Hospital laboratory 6

F

Unrelated business

9

income

Form 990-T

3

Advertising income 12

Certain trusts

14

Controlled organizations 15

I

Debt-financed property

16

Income from research

10

Deductions 11

Employees

beneficiary

associations 14

L

Exclusions 9

Limits

19

Foreign organizations 14

Income from gambling

activities

7

N

13

Income from

lending

Net operating loss deduction

securities

10

Nonrecognition of gain

15

Modifications

13

14

Partnership income or loss

Products of exempt functions

4

P

S corporation income 14

Publications

21

loss

14

S corporation income or

Social clubs

14

15

Veterans organizations

R

Unrelated debt-financed

Rents 10

income 18

Return

Average

3

acquisition

Royalties

10

indebtedness 20

Average adjusted

20

basis

Computation

19

S

20

Debt/basis percentage

Specific deduction 13

Deductions 20

Gains from

19

dispositions

20

Indeterminate property price

T

Unrelated trade or business

4

Tax 2

2

Artists facilities 4

Colleges and universities

Broadcasting rights

4

Deposits

3

Business league's parking and

Estimated

3

bus services

5

Organizations

affected 2

Convenience of

members

8

Payment

3

Convention or trade show

8

Rates

3

Directory of members 6

Return

3

Distribution of low-cost

Title-holding corporations

3

articles

8

4

U.S. instrumentalities

2

Dual use facilities, etc.

Tax Help

21

Employees association

sales

8

corporations

3

Exclusions

7

Title-holding

Exploitation of exempt functions 4

Gambling activities other than bingo 7

Halfway house 5

Health club program 5

Hearing aid sales 6

Hospital facilities 5

Hospital services 8

Insurance programs 5

Magazine publishing 5

Member lists rentals, etc. 8

Membership list sales 5

Miniature golf course 5

Museum eating facilities 5

Museum greeting card sales 5

Pet boarding and grooming

services 6

Pole rentals 8

Public entertainment activity 8

Publishing legal notices 6

Regularly conducted 4

Sales commissions 6

Sales of advertising space 6

School facilities 6

School handicraft shop 6

Selling donated merchandise 9

Selling endorsements 7

Sponsoring entertainment

events 7

Substantially related 4

Trade or business defined 4

Travel tour programs 7

Volunteer workforce 9

Yearbook advertising 7

Youth residence 7

Unstated trade or business:

Bingo games 7

V

Volunteer fire company 9

W

When to file 3

Page 22Publication 598 (March 2021)

IRS Releases Publication 598 (3/2021), Tax on Unrelated Business Income of Exempt Organizations