Renting to a profit-oriented business by a church is categorized as an unrelated business activity, which is not directly aligned with the purpose of the organization’s exempt status. Such activities must be reported on Federal Form 990-T and will be subject to tax. However, certain expenses can be allocated to reduce the income, including utilities, depreciation, and mortgage interest (if applicable), which can be attributed to the portion of space occupied by the tenant.

Renting a church kitchen to a for-profit business can have several tax consequences under the Internal Revenue Code (IRC).Here are the key points to consider:

  1. Unrelated Business Income Tax (UBIT):

    • General Rule: Under IRC Section 511, tax-exempt organizations, including churches, are subject to tax on their unrelated business taxable income (UBTI). UBTI is defined as income from a trade or business that is regularly carried on and not substantially related to the organization’s exempt purposes, aside from the need for income or funds.
    • Rental Income: Generally, rents from real property are excluded from UBTI under IRC Section 512(b)(3). However, this exclusion does not apply if the rental income is derived from debt-financed property or if the lease includes the provision of substantial services to the lessee.

  2. Debt-Financed Property:

    • If the church’s kitchen is considered debt-financed property, a portion of the rental income may be subject to UBIT. Debt-financed property is any property held to produce income and with respect to which there is acquisition indebtedness at any time during the tax year.

  3. Provision of Services:

    • If the church provides substantial services to the for-profit business as part of the lease (e.g., cleaning, maintenance, or other services beyond the mere rental of space), the rental income may be considered unrelated business income and subject to UBIT.

  4. Fair Market Value:

    • The lease agreement should be at fair market value to avoid any issues of private inurement or private benefit, which could jeopardize the church’s tax-exempt status. Transactions with private parties must be conducted at arm’s length and reflect fair market value to ensure that no part of the church’s net earnings inures to the benefit of private individuals.

  5. Recordkeeping and Reporting:

    • The church must maintain adequate records of the rental income and any related expenses. If the rental income is subject to UBIT, the church must file IRS Form 990-T, Exempt Organization Business Income Tax Return, to report the income and pay any applicable taxes.

If you provide additional services such as cleaning, office services, or similar, a portion of these costs can also be allocated. It is important to monitor this activity to ensure it does not become a significant part of the exempt organization’s financial activities, as this could jeopardize its exempt status. Although there is no specific percentage to apply, it should clearly not impair the function of the exempt entity or alter the performance of its exempt purpose.

In summary, Renting a church kitchen to a for-profit business can result in UBIT if the rental income is derived from debt-financed property or if substantial services are provided. The lease should be at fair market value to avoid private inurement issues, and the church must maintain proper records and file the necessary tax returns if the income is subject to UBIT.

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Clergy Financial Resources serves as a resource for clients to help analyze the complexity of clergy tax law, church payroll & HR issues. Our professionals are committed to helping clients stay informed about tax news, developments and trends in various specialty areas.

This article is intended to provide readers with guidance in tax matters. The article does not constitute, and should not be treated as professional advice regarding the use of any particular tax technique. Every effort has been made to assure the accuracy of the information. Clergy Financial Resources and the author do not assume responsibility for any individual’s reliance upon the information provided in the article. Readers should independently verify all information before applying it to a particular fact situation, and should independently determine the impact of any particular tax planning technique. If you are seeking legal advice, you are encouraged to consult an attorney.

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11214 86th Avenue N.
Maple Grove, MN 55369

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