(a) In general. For purposes of section 514 and the regulations
thereunder, the term debt-financed property means any property which is
held to produce income (e.g., rental real estate, tangible personal
property, and corporate stock), and with respect to which there is an
acquisition indebtedness (determined without regard to whether the
property is debt-financed property) at any time during the taxable year.
The term income is not limited to recurring income but applies as well
to gains from the disposition of property. Consequently, when any
property held to produce income by an organization which is not used in
a manner described in section 514(b)(1) (A), (B), (C), or (D) is
disposed of at a gain during the taxable year, and there was an
acquisition indebtedness outstanding with respect to such property at any time during the 12-month period
preceding the date of disposition (even though such period covers more
than 1 taxable year), such property is debt-financed property. For
example, assume that on June 1, 1972, an organization is given
mortgaged, unimproved property which it does not use in a manner
described in section 514(b)(1) (A), (B), (C), or (D) and that the
organization assumes payment of the mortgage on such property. On July
15, 1972, the organization sells such property for a gain. Such property
is debt-financed property and such gain is taxable as unrelated debt-
financed income. See section 514(c) and Sec. 1.514(c)-1 for rules
relating to when there is acquisition indebtedness with respect to
property. See paragraph (a) of Sec. 1.514(a)-1 for rules determining the
amount of income or gain from debt-financed property which is treated as
unrelated debt-financed income.
(1) Property related to certain exempt purposes.
(i) To the extent that the use of any property is substantially related
(aside from the need of the organization for income or funds or the use
it makes of the profits derived) to the exercise or performance by an
organization of its charitable, educational, or other purpose or
function constituting its basis for exemption under section 501 (or, in
the case of an organization described in section 511(a)(2)(B), to the
exercise or performance of any purpose or function designated in section
501(c)(3)) such property shall not be treated as debt-financed property.
See Sec. 1.513-1 for principles applicable in determining whether there
is a substantial relationship to the exempt purpose of the organization.
(ii) If substantially all of any property is used in a manner
described in subdivision (i) of this subparagraph, such property shall
not be treated as debt-financed property. In general the preceding
sentence shall apply if 85 percent or more of the use of such property
is devoted to the organization's exempt purpose. The extent to which
property is used for a particular purpose shall be determined on the
basis of all the facts and circumstances. These may include (where
appropriate):
(a) A comparison of the portion of time such property is used for
exempt purposes with the total time such property is used,
(b) A comparison of the portion of such property that is used for
exempt purposes with the portion of such property that is used for all
purposes, or
(c) Both the comparisons described in (a) and (b) of this
subdivision.
(iii) This subparagraph may be illustrated by the following
examples. For purposes of these examples it is assumed that the
indebtedness is acquisition indebtedness.
Example 1. W, an exempt organization, owns a computer with respect
to which there is an outstanding principal indebtedness and which is
used by W in the performance of its exempt purpose. W sells time for the
use of the computer to M corporation on occasions when the computer is
not in full-time use by W. W uses the computer in furtherance of its
exempt purpose more than 85 percent of the time it is in use and M uses
the computer less than 15 percent of the total operating time the
computer is in use. In this situation, substantially all the use of the
computer is related to the performance of W's exempt purpose. Therefore,
no portion of the computer is treated as debt-financed property.
Example 2. X, an exempt college, owns a four story office building
which has been purchased with borrowed funds. In 1971, the lower two
stories of the building are used to house computers which are used by X
for administrative purposes. The top two stories are rented to the
public for purposes not described in section 514(b)(1) (A), (B), (C), or
(D). The gross income derived by X from the building is $6,000, all of
which is attributable to the rents paid by tenants. There are $2,000 of
expenses, allocable equally to each use of the building. The average
adjusted basis of the building for 1971 is $100,000, and the outstanding
principal indebtedness throughout 1971 is $60,000. Thus, the average
acquisition indebtedness for 1971 is $60,000. In accordance with
subdivision (i) of this subparagraph, only the upper half of the
building is debt-financed property. Consequently, only the rental income
and the deductions directly connected with such income are to be taken
into account in computing unrelated business taxable income. The portion
of such amounts to be taken into account is determined by multiplying
the $6,000 of rental income and $1,000 of deductions directly connected
with such rental income by the debt/basis percentage. The debt/basis
percentage is the ratio which the allocable part of the average acquisition indebtedness is of the allocable part of the average
adjusted basis of the property, that is, the ratio which $30,000 (one-
half of $60,000) bears to $50,000 (one-half of $100,000). Thus, the
debt/basis percentage for 1971 is 60 percent (the ratio of $30,000 to
$50,000). Under these circumstances, X shall include net rental income
of $3,000 in its unrelated business taxable income for 1971, computed as
follows:
Total rental income | $6,000 |
Deductions directly connected with rental income | $1,000 |
Debt/basis percentage ($30,000/$50,000) | 60% |
Rental income treated as gross income from an unrelated trade or business (60 percent of $6,000) | $3,600 |
Less the allowable portion of deductions directly connected with such income (60 percent of $1,000) | $600 |
Net rental income included by X in computing its unrelated business taxable income pursuant to section 514 | $ 3,000 |
Example 3. Assume the facts as stated in example 2 except that on
December 31, 1971, X sells the building and realizes a long-term capital
gain of $10,000. This is X's only capital transaction for 1971. An
allocable portion of this gain is subject to tax. This amount is
determined by multiplying the gain related to the nonexempt use, $5,000
(one-half of $10,000), by the ratio which the debtedness for the 12-
month period preceding the date of sale, $30,000 (one-half of $60,000),
is of the allocable part of the average adjusted basis, $50,000 (one-
half of $100,000). Thus, the debt/basis percentage with respect to
computing the gain (or loss) derived from the sale of the building is 60
percent (the ratio of $30,000 to $50,000). Consequently, $3,000 (60
percent of $5,000) is a net section 1201 gain (capital gain net income
for taxable years beginning after December 31, 1976). The portion of
such gain which is taxable shall be determined in accordance with rules
contained in subchapter P, chapter 1 of the Code (relating to capital
gains and losses). See also section 511(d) and the regulations
thereunder (relating to the minimum tax for tax preferences).
(2) Property used in an unrelated trade or business--
(i) In general. To the extent that the gross income from any property is treated as
income from the conduct of an unrelated trade or business, such property
shall not be treated as debt-financed property. However, any gain on the
disposition of such property which is not included in the income of an
unrelated trade or business by reason of section 512(b)(5) is includible
as gross income derived from or on account of debt-financed property
under paragraph (a)(1) of Sec. 1.514(a)-1.
(ii) Amounts specifically taxable under other provisions of the
Code. Section 514 does not apply to amounts which are otherwise included
in the computation of unrelated business taxable income, such as rents
from personal property includible pursuant to section 512(b)(13) or
rents and interest from controlled organizations includible pursuant to
section 512(b)(3). See paragraph (1)(5) of Sec. 1. 512(b)-1 for the
rules determining the manner in which amounts are taken into account
where such amounts may be included in the computation of unrelated
business taxable income by operation of more than one provision of the
Code.
(3) Examples. Subparagraphs (1) and (2) of this paragraph may be
illustrated by the following examples. For purposes of these examples it
is assumed that the indebtedness is acquisition indebtedness.
Example 1. X, an exempt scientific organization, owns a 10-story
office building. During 1972, four stories are occupied by X's
administrative offices, and the remaining six stories are rented to the
public for purposes not described in section 514(b)(1) (A), (B), (C), or
(D). On December 31, 1972, the building is sold and X realizes a long-
term capital gain of $100,000. This is X's only capital transaction for
1972. The debt/basis percentage with respect to computing the gain (or
loss) derived from the sale of the building is 30 percent. Since 40
percent of the building was used for X's exempt purpose, only 60 percent
of the building is debt-financed property. Thus, only $60,000 of the
gain (60 percent of $100,000) is subject to this section. Consequently,
the amount of gain treated as unrelated debt-financed income is $18,000
($60,000 multiplied by the debt/basis percentage of 30 percent). The
portion of such $18,000 which is taxable shall be determined in
accordance with the rules contained in subchapter P, chapter 1 of the
Code. See also section 511(d) and the regulations thereunder (relating
to the minimum tax for tax preferences).
Example 2. Y, an exempt organization, owns two properties, a
restaurant and an office building. In 1972, all the space in the office
building, except for the portion utilized by Y to house the
administrative offices of the restaurant, is rented to the public for
purposes not described in section 514(b)(1) (A), (B), (C), or (D). The
average adjusted basis of the office building for 1972 is $2 million.
The outstanding principal indebtedness throughout 1972 is $1 million. Thus,
the highest acquisition indebtedness in the calendar year of 1972 is $1
million. It is determined that 30 percent of the space in the office
building is used for the administrative functions engaged in by the
employees of the organization with respect to the restaurant. Since the
income attributable to the restaurant is attributable to the conduct of
an unrelated trade or business, only 70 percent of the building is
treated as debt-financed property for purposes of determining the
portion of the rental income which is unrelated debt-financed income. On
December 31, 1972, the office building is sold and Y realizes a long-
term capital gain of $250,000. This is Y's only capital transaction for
1972. In accordance with subparagraph (2)(i) of this paragraph, all the
gain derived from this sale is taken into account in computing the
amount of such gain subject to tax. The portion of such gain which is
taxable is determined by multiplying the $250,000 gain by the debt/basis
percentage. The debt/basis percentage is the ratio which the highest
acquisition indebtedness for the 12-month period preceding the date of
sale, $1 million, is of the average adjusted basis, $2 million. Thus,
the debt/basis percentage with respect to computing the gain (or loss)
derived from the sale of the building is 50 percent (the ratio of $1
million to $2 million). Consequently, $125,000 (50 percent of $250,000)
is a net section 1201 gain (net capital gain for taxable years beginning
after December 31, 1976). The amount of such gain which is taxable shall
be determined in accordance with the rules contained in subchapter P,
chapter 1 of the Code. See also section 511(d) and the regulations
thereunder.
Example 3. (a) Z, an exempt university, owns all the stock of M, a
nonexempt corporation. During 1971 M leases from Z University a factory
unrelated to Z's exempt purpose and a dormitory for the students of Z,
for a total annual rent of $100,000: $80,000 for the factory and $20,000
for the dormitory. During 1971, M has $500,000 of taxable income,
disregarding the rent paid to Z: $150,000 from the dormitory and
$350,000 from the factory. The factory is subject to a mortgage of
$150,000. Its average adjusted basis for 1971 is determined to be
$300,000. Z's deductions for 1971 with respect to the leased property
are $4,000 for the dormitory and $16,000 for the factory. In accordance
with subdivision (ii) of this subparagraph, section 514 applies only to
that portion of the rent which is excluded from the computation of
unrelated business taxable income by operation of section 512(b)(3) and
not included in such computation pursuant to section 512(b)(13). Since
all the rent received by Z is derived from real property, section
512(b)(3) would exclude all such rent from computation of Z's unrelated
business taxable income. However, 70 percent of the rent paid to Z with
respect to the factory and 70 percent of the deductions directly
connected with such rent shall be taken into account by Z in determining
its unrelated business taxable income pursuant to section 512(b)(15),
computed as follows:
M's taxable income (disregarding rent paid to Z) | $500,000 |
Less taxable income from dormitory | $150,000 |
Excess taxable income | $350,000 |
Ratio ($350,000/$500,000) | 7/10 |
Total rent paid to Z | $100,000 |
Total deductions ($4,000+$16,000) | $20,000 |
Rental income treated under section 512(b)(15) as gross income from an unrelated trade or business (7/10 of $100,000) | $70,000 |
Less deductions directly connected with such income (7/10 of $20,000) | $14,000 |
Net rental income included by Z in computing its unrelated business taxable income pursuant to section 512(b)(15) | $56,000 |
(b) Since only that portion of the rent derived from the factory and
the deductions directly connected with such rent not taken into account
pursuant to section 512(b)(15) may be included in computing unrelated
business taxable income by operation of section 514, only $10,000
($80,000 minus $70,000) of rent and $2,000 ($16,000 minus $14,000) of
deductions are so taken into account. The portion of such amounts to be
taken into account is determined by multiplying the $10,000 of income
and $2,000 of deductions by the debt/basis percentage. The debt/basis
percentage is the ratio which the average acquisition indebtedness
($150,000) is of the average adjusted basis of the property ($300,000).
Thus, the debt/basis percentage for 1971 is 50 percent (the ratio of
$150,000 to $300,000). Under these circumstances, Z shall include net
rental income of $4,000 in its unrelated business taxable income for
1971, computed as follows:
Total rents | $10,000 |
Deductions directly connected with such rents | $2,000 |
Debt/basis percentage ($150,000/$300,000) | 50% |
Rental income treated as gross income from an unrelated trade or business (50 percent of $10,000) | $5,000 |
Less the allowable portion of deductions directly connected with such income (50 percent of $2,000) | $1,000 |
Net rental income included by Z in computing its unrelated business taxable income pursuant to section 514 | $4,000 |
(4) Property related to research activities. To the extent that the
gross income from any property is derived from research activities
excluded from the tax on unrelated business income by paragraph (7),
(8), or (9) of section 512(b), such property shall not be treated as
debt-financed property.
(5) Property used in thrift shops, etc. To the extent that property
is used in any trade or business which is excepted from the definition of unrelated
trade or business by paragraph (1), (2), or (3) of section 513(a), such
property shall not be treated as debt-financed property.
(6) Use by a related organization. For purposes of subparagraph (1),
(4), or (5) of this paragraph, use of property by a related exempt
organization (as defined in paragraph (c)(2)(ii) of this section) for a
purpose described in such subparagraphs shall be taken into account in
order to determine the extent to which such property is used for a
purpose described in such subparagraphs.
(1) Medical clinic. Property is not debt-financed
property if it is real property subject to a lease to a medical clinic,
and the lease is entered into primarily for purposes which are
substantially related (aside from the need of such organization for
income or funds or the use it makes of the rents derived) to the
exercise or performance by the lessor of its charitable, educational, or
other purpose or function constituting the basis for its exemption under
section 501. For example, assume that an exempt hospital leases all of
its clinic space to an unincorporated association of physicians and
surgeons who, by the provisions of 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 situation, the
rents received by the hospital from this clinic are not to be treated as
unrelated debt-financed income.
(2) Related exempt uses--
(i) In general. Property owned by an exempt
organization and used by a related exempt organization or by an exempt
organization related to such related exempt organization shall not be
treated as debt-financed property to the extent such property is used by
either organization in furtherance of the purpose constituting the basis
for its exemption under section 501. Furthermore, property shall not be
treated as debt-financed property to the extent such property is used by
a related exempt organization for a purpose described in paragraph
(b)(4) or (5) of this section.
(ii) Related organizations. For purposes of subdivision (i) of this
subparagraph, an exempt organization is related to another exempt
organization only if:
(a) One organization is an exempt holding company described in
section 501(c)(2) and the other organization receives the profits
derived by such exempt holding company,
(b) One organization has control of the other organization within
the meaning of paragraph (1)(4) of Sec. 1.512(b)-1,
(c) More than 50 percent of the members of one organization are
members of the other organization, or
(d) Each organization is a local organization which is directly
affiliated with a common state, national, or international organization
which is also exempt.
(iii) Examples. This subparagraph may be illustrated by the
following examples. For purposes of these examples it is assumed that
the indebtedness is acquisition indebtedness.
Example 1. M, an exempt trade association described in section
501(c)(6), leases 70 percent of the space of an office building for
furtherance of its exempt purpose. The title to such building is held by
N, an exempt holding company described in section 501(c)(2), which
acquired title to the building with borrowed funds. The other 30 percent
of the space in this office building is leased to L, a nonstock exempt
trade association described in section 501(c)(6). L uses such office
space in furtherance of its exempt purpose. The members of L's Board of
Trustees serves for fixed terms and M's Board of Directors has the power
to select all such members. N pays over to M all the profits it derives
from the leasing of space in this building to M and L. Accordingly, M is
related to N (as such term is defined in subdivision (ii)(a) of this
subparagraph) and L is related to M (as such term is defined in
subdivision (ii)(b) of this subparagraph). Under these circumstances,
since all the available space in the building is leased to either an
exempt organization related to the exempt organization holding title to
the building or an exempt organization related to such related exempt
organization, no portion of the building is treated as debt-financed
property.
Example 2. W, an exempt labor union described in section 501(c)(5),
owns a 10-story office building which has been purchased with borrowed
funds. Five floors of the building are used by W in furtherance of its
exempt purpose. Four of the other floors are rented to X which is an
exempt voluntary employees' beneficiary association described in section
501(c)(9), operated for the benefit of W's members. X uses such office
space in furtherance of its exempt purpose. Seventy percent of the members of W
are also members of X. Accordingly, X is related to W (as such term is
defined in subdivision (ii)(c) of this subparagraph). The remaining
floor of the building is rented to the general public for purposes not
described in section 514(b)(1) (A), (B), (C), or (D). Under these
circumstances, no portion of this building is treated as debt-financed
property since more than 85 percent of the office space available in
this building is used either by W or X, an exempt organization related
to W, in furtherance of their respective exempt purpose. See paragraph
(b)(1) of this section for rules relating to the use of property
substantially related to an exempt purpose. See paragraph (b)(6) of this
section for rules relating to uses by related exempt organizations.
Example 3. Assume the same facts as in example 2, except that W and
X are each exempt local labor unions described in section 501(c)(5)
having no common membership and are each affiliated with N, an exempt
international labor union described in section 501(c)(5). Under these
circumstances, no portion of this building is treated as debt-financed
property since more than 85 percent of the office space available in
this building is used either by W or X, an exempt organization related
to W, in furtherance of their respective exempt purpose.
Example 4. Assume the same facts as in example 3, except that W and
X are directly affiliated with different exempt international labor
unions and that W and X are not otherwise affiliated with, or members
of, a common exempt organization, other than an association of
international labor unions. Under these circumstances, the portions of
this building which are rented to X and to the general public are
treated as debt-financed property since X is not related to W and W uses
less than 85 percent of the building for its exempt purpose.
(3) Life income contracts.
(i) Property shall not be treated as debt-financed property when:
(a) An individual transfers property to a trust or a fund subject to
a contract providing that the income is to be paid to him or other
individuals or both for a period of time not to exceed the life of such
individual or individuals in a transaction in which the payments to the
individual or individuals do not constitute the proceeds of a sale or
exchange of the property so transferred, and
(b) The remainder interest is payable to an exempt organization
described in section 501(c)(3).
(ii) Subdivision (i) of this subparagraph is illustrated by the
following example.
Example. On January 1, 1967, A transfers property to X, an exempt
organization described in section 501(c)(3), which immediately places
the property in a fund. On January 1, 1971, A transfers additional
property to X, which property is also placed in the fund. In exchange
for each transfer, A receives income participation fund certificates
which entitle him to a proportionate part of the fund's income for his
life and for the life of another individual. None of the payments made
by X are treated by the recipients as the proceeds of a sale or exchange
of the property transferred. In this situation, none of the property
received by X from A is treated as debt-financed property.
(d) Property acquired for prospective exempt use--
(1) Neighborhood land--
(i) In general. If an organization acquires real property for the
principal purpose of using the land in the exercise or performance of
its exempt purpose, commencing within 10 years of the time of
acquisition, such property will not be treated as debt-financed
property, so long as (a) such property is in the neighborhood of other
property owned by the organization which is used in the performance of
its exempt purpose, and (b) the organization does not abandon its intent
to use the land in such a manner within the 10-year period. The rule
expressed in this subdivision is hereinafter referred to as the
neighborhood land rule.
(ii) Neighborhood defined. Property shall be considered in the
neighborhood of property owned and used by the organization in the
performance of its exempt purpose if the acquired property is contiguous
with the exempt purpose property or would be contiguous with such
property except for the interposition of a road, street, railroad,
stream, or similar property. If the acquired property is not contiguous
with exempt function property, it may still be in the neighborhood of
such property, but only if it is within 1 mile of such property and the
facts and circumstances of the particular situation make the acquisition
of contiguous property unreasonable. Some of the criteria to consider in
determining this question include the availability of land and the
intended future use of the land. For example, a university attempts to
purchase land contiguous to its present campus but cannot 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 purchases such land. Under these circumstances, the
contiguity requirement is unreasonable and the land purchased would be
considered neighborhood land.
(iii) Exception. The neighborhood land rule shall not apply to any
property after the expiration of 10 years from the date of acquisition.
Further, the neighborhood land rule shall apply after the first 5 years
of the 10-year period only if the organization establishes to the
satisfaction of the Commissioner that future use of the acquired land in
furtherance of the organization's exempt purpose before the expiration
of the 10-year period is reasonably certain. In order to satisfy the
Commissioner, the organization does not necessarily have to show binding
contracts. However, it must at least have a definite plan detailing a
specific improvement and a completion date, and some affirmative action
toward the fulfillment of such a plan. This information shall be
forwarded to the Commissioner of Internal Revenue, Washington, DC 20224,
for a ruling at least 90 days before the end of the fifth year after
acquisition of the land.
(2) Actual use. If the neighborhood land rule is inapplicable
because:
(i) The acquired land is not in the neighborhood of other property
used by the organization in performance of its exempt purpose, or
(ii) The organization (for the period after the first 5 years of the
10-year period) is unable to establish to the satisfaction of the
Commissioner that the use of the acquired land for its exempt purposes
within the 10-year period is reasonably certain,
but the land is actually used by the organization in furtherance of its
exempt purpose within the 10-year period, such property (subject to the
provisions of subparagraph (4) of this paragraph) shall not be treated
as debt-financed property for any period prior to such conversion.
(3) Limitations--
(i) Demolition or removal required.
(a) Subparagraphs (1) and (2) of this paragraph shall apply with respect to
any structure on the land when acquired by the organization, or to the
land occupied by the structure, only so long as the intended future use
of the land in furtherance of the organization's exempt purpose requires
that the structure be demolished or removed in order to use the land in
such a manner. Thus, during the first 5 years after acquisition (and for
subsequent years if there is a favorable ruling in accordance with
subparagraph (1)(iii) of this paragraph) improved property is not debt-
financed so long as the organization does not abandon its intent to
demolish the existing structures and use the land in furtherance of its
exempt purpose. Furthermore, if there is an actual demolition of such
structures, the use made of the land need not be the one originally
intended. Therefore, the actual use requirement of this subdivision may
be satisfied by using the land in any manner which furthers the exempt
purpose of the organization.
(b) Subdivision (i)(a) of this subparagraph may be illustrated by
the following examples. For purposes of the following examples it is
assumed that but for the application of the neighborhood land rule such
property would be debt-financed property.
Example 1. An exempt university acquires a contiguous tract of land
on which there is an apartment building. The university intends to
demolish the apartment building and build classrooms and does not
abandon this intent during the first 4 years after acquisition. In the
fifth year after acquisition it abandons the intent to demolish and
sells the apartment building. Under these circumstances, such property
is not debt-financed property for the first 4 years after acquisition
even though there was no eventual demolition or use made of such land in
furtherance of the university's exempt purpose. However, such property
is debt-financed property as of the time in the fifth year that the
intent to demolish the building is abandoned and any gain on the sale of
property is subject to section 514.
Example 2. Assume the facts as stated in Example 1 except that the
university did not abandon its intent to demolish the existing building
and construct a classroom building until the eighth year after
acquisition when it sells the property. Assume further that the
university did not receive a favorable ruling in accordance with subparagraph (1)(iii) of this paragraph. Under
these circumstances, the building is debt- financed property for the
sixth, seventh, and eighth years. It is not, however, treated as debt-
financed property for the first 5 years after acquisition.
Example 3. Assume the facts as stated in Example 2 except that the
university received a favorable ruling in accordance with subparagraph
(1)(iii) of this paragraph. Under these circumstances, the building is
not debt-financed property for the first 7 years after acquisition. It
only becomes debt-financed property as of the time in the eighth year
when the university abandoned its intent to demolish the existing
structure.
Example 4. (1) Assume that a university acquires a contiguous tract
of land containing an office building for the principal purpose of
demolishing the office building and building a modern dormitory. Five
years later the dormitory has not been constructed, and the university
has failed to satisfy the Commissioner that the office building will be
demolished and the land will be used in furtherance of its exempt
purpose (and consequently has failed to obtain a favorable ruling under
subparagraph (1)(iii) of this paragraph). In the ninth taxable year
after acquisition the university converts the office building into an
administration building. Under these circumstances, during the sixth,
seventh, and eighth years after acquisition, the office building is
treated as debt-financed property because the office building was not
demolished or removed. Therefore, the income derived from such property
during these years shall be subject to the tax on unrelated business
income.
(2) Assume that instead of converting the office building to an
administration building, the university demolishes the office building
in the ninth taxable year after acquisition and then constructs a new
administration building. Under these circumstances, the land would not
be considered debt-financed property for any period following the
acquisition, and the university would be entitled to a refund of taxes
paid on the income derived from such property for the sixth through
eighth taxable years after the acquisition in accordance with
subparagraph (4) of this paragraph.
(ii) Subsequent construction. Subparagraphs (1) and (2) of this
paragraph do not apply to structures erected on the land after the
acquisition of the land.
(iii) Property subject to business lease. Subparagraphs (1) and (2)
of this paragraph do not apply to property subject to a lease which is a
business lease (as defined in Sec. 1.514(f)-1) whether the organization
acquired the property subject to the lease or whether it executed the
lease subsequent to acquisition. If only a portion of the real property
is subject to a lease, paragraph (c) of Sec. 1.514(f)-1 applies in
determining whether such lease is a business lease.
(4) Refund of taxes.
(i) If an organization has not satisfied the
actual use condition of subparagraph (2) of this paragraph or paragraph
(e)(3) of this section before the date prescribed by law (including
extensions) for filing the return for the taxable year, the tax for such
year shall be computed without regard to the application of such actual
use condition. However, if:
(a) A credit or refund of any overpayment of taxes is allowable for
a prior taxable year as a result of the satisfaction of such actual use
condition, and
(b) Such credit or refund is prevented by the operation of any law
or rule of law (other than chapter 74, relating to closing agreements
and compromises), such credit or refund may nevertheless be allowed or made, if a claim is
filed within 1 year after the close of the taxable year in which such
actual use condition is satisfied. For a special rule with respect to
the payment of interest at the rate of 4 percent per annum, see section
514(b)(3)(D), prior to its amendment by section 7(b) of the Act of
January 3, 1975 (Pub. L. 93-625, 88 Stat. 2115).
(ii) This subparagraph may be illustrated by the following example.
For purposes of this example it is assumed that but for the neighborhood
land rule such property would be debt-financed property.
Example. Y, a calendar year exempt organization, acquires real
property in January 1970, which is contiguous with other property used
by Y in furtherance of its exempt purpose. However, Y does not satisfy
the Commissioner by January 1975, that the existing structure will be
demolished and the land will be used in furtherance of its exempt
purpose. In accordance with this subparagraph, from 1975 until the
property is converted to an exempt use, the income derived from such
property shall be subject to the tax on unrelated business income.
During July 1979, Y demolishes the existing structure on the land and
begins using the land in furtherance of its exempt purpose. At this time
Y may file claims for refund for the open years 1976 through 1978.
Further, in accordance with this subparagraph, Y may also file a claim
for refund for 1975, even though a claim for
such taxable year may be barred by the statute of limitations, provided
such claim is filed before the close of 1980.
(1) In general. If a church or association or
convention of churches acquires real property, for the principal purpose
of using the land in the exercise or performance of its exempt purpose,
commencing within 15 years of the time of acquisition, such property
shall not be treated as debt-financed property so long as the
organization does not abandon its intent to use the land in such a
manner within the 15-year period.
(2) Exception. This paragraph shall not apply to any property after
the expiration of the 15-year period. Further, this paragraph shall
apply after the first 5 years of the 15-year period only if the church
or association or convention of churches establishes to the satisfaction
of the Commissioner that use of the acquired land in furtherance of the
organization's exempt purpose before the expiration of the 15-year
period is reasonably certain. For purposes of the preceding sentence,
the rules contained in paragraph (d)(1)(iii) of this section with
respect to satisfying the Commissioner that the exempt organization
intends to use the land within the prescribed time in furtherance of its
exempt purpose shall apply.
(3) Actual use. If the church or association or convention of
churches for the period after the first 5 years of the 15-year period is
unable to establish to the satisfaction of the Commissioner that the use
of the acquired land for its exempt purpose within the 15-year period is
reasonably certain, but such land is in fact converted to an exempt use
within the 15-year period, the land (subject to the provisions of
paragraph (d)(4) of this section) shall not be treated as debt-financed
property for any period prior to such conversion.
(4) Limitations. The limitations stated in paragraph (d)(3)(i) and
(ii) of this section shall similarly apply to the rules contained in
this paragraph.
[Nov. 3, 1980]
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