How Non-Profits Can Keep Tax Exemptions on Real Property

Because there are many different types of exemptions permitted by statute, we will focus on the necessary ingredients for exemption and issues potentially confronting a non-profit or a buyer of its property that might affect its vested exemption from paying property taxes. Under the New Jersey Constitution and Tax Exempt Statute, a non-profit organization is exempt from paying real estate taxes on the land and building it owns provided that the buildings are actually used to further charitable purposes.

The Tax Exemption Statute exempts property owned by non-profits from taxation if: (1) the building(s) actually and exclusively is used for one of the designated purposes; (2) the land is necessary for the fair enjoyment of the building(s), is devoted to a designated purpose and does not exceed five acres; and (3) the building(s) or land is not used for profit and the organization is not a profit-making institution.

In general, the New Jersey Tax Exemption Statute (N.J.S.A. 54:4-3.6 et seq.) requires that the buildings be exclusively used in the work of the organization and that the land also be devoted to those purposes. However, as we will see, exceptions apply.

Lands whereon there are tax-exempt buildings are themselves exempt, but only to the extent necessary to the charity's fair use and enjoyment, not exceeding five acres for each building (Pingry Corp. v. Hillside Tp., 46 N.J. 457 [1966]). While the courts equate fair enjoyment with "use" to the extent considered "necessary," to be exempt the land need not be absolutely indispensable to the exempt buildings so long as it is "reasonably necessary" to accomplish the purposes of the organization. (See Fairleigh Dickinson University v. Florham Park Boro., 5 N.J. Tax 343 [Tax 1983]).

A property's tax status, exempt or taxable, can dramatically effect a non-profit's balance sheet. Loss of a property's tax-exempt status can have a significant negative impact on the bottom line. Two scenarios help to illustrate this point.

Scenario 1. A qualified not-for-profit organization purchases a seven-acre tract containing two existing buildings. At the time of purchase, the annual property taxes were $50,000. The organization obtains a tax exemption for the buildings used to carry on charitable activities. However, several years later, a drop in income has caused a cash flow problem. The organization is forced to explore ways to generate revenue outside of its usual sources by renting out space to a for-profit organization. It is concerned, however, that it may cost it its property tax exemption.

QUESTION: Can the non-profit lease its building space without jeopardizing its property tax exemption?

ANSWER: Yes, with care. Prior to 2001, performing the non-profit's plan would have cost the organization its exemption. However, a 2001 change to the law makes the effect less onerous. The change permits a non-profit to retain its tax-exempt status on that portion of the property still used for charitable purposes; however, the portion leased to a profit-making organization is subject to taxation. It is recommended that a non-profit perform a cost-benefit analysis to evaluate whether the added real estate tax burden is offset by the rental income from the for-profit entity. Additionally, the non-profit landlord could negate the tax penalty by entering into a net lease, under which the for-profit entity pays all real estate taxes assessed.

There is another, potentially better option. The Tax Exempt Statute authorizes a non-profit to lease space to another non-profit and collect rent without adverse consequences to its tax-exempt status. Thus, leasing to a non-profit is an effective method of generating additional revenue without jeopardizing the property tax exemption in place. While the Internal Revenue Code and regulations governing tax-exempt organizations are complex, generally, a § 501(c)(3) charitable organization can collect rent from another § 501(c)(3) organization without loss of its property tax exemption.

Scenario 2: A non-profit organization operates an overnight camp for youth during the summer season on a 50-acre parcel with lodging residences, dining hall and numerous activities. Except for the summer months when camp is in session, the property is unoccupied. The camp operates at a loss every year, and in order to mitigate that, the organization rents the facilities to for-profit entities when the summer camp is not operated. Other users of the property include for-profit operations of camping trips and local college groups using the property for environmental studies.

QUESTION: Does the non-profit's leasing of its facilities in the off-season to generate income jeopardize the property tax exemption, where the non-profit operates at an annual loss and the purpose of the actions are to generate income?

ANSWER: Under New Jersey law, the non-profit may engage in actions described above and would not lose its property tax exemption. In Boys' Club of Clifton, Inc. v. Township of Jefferson, 72 N.J. 389 (App. Div. 1977), the New Jersey Supreme Court held that where an organization's expenditures exceeded income with respect to the camp operation and with respect to the non-profit organization as a whole, the fact that the organization received payment from for-profit entities' use of land during the off-season did not cause the property to lose its property tax exemption. Though the Boys' Club case was decided under the law in effect prior to the 2001 amendment bifurcating the exemption from for-profit use, that amendment was favorable to non-profits, and thus this decision would most likely be upheld.

Although statutes granting exemptions from taxation are narrowly construed against the grant of an exemption, on the theory that the burden of paying taxes should be borne equally, the Boys' Club decision illustrates that non-profit organizations are permitted some latitude to use reasonable means to generate income from for-profit entities without negative consequences on its property tax exemption.

This is particularly relevant to those non-profit organizations operating in depressed urban areas with little income. With proper guidance, there is potential to generate revenue by leasing the organization's facilities to outside organizations, for a fee, that the Tax Exemption Statute on its face would otherwise prohibit.

Even where a particular non-profit operation has produced a profit, the property tax exemption will not be lost as long as excess funds generated by leasing the organization's land have been applied to carry out the organization's beneficent policies. In this situation, care must be taken to avoid being characterized as profit-driven.

As illustrated above, with proper planning, a non-profit organization may seek alternative methods of generating revenue to carry out charitable purposes without the loss of the property tax exemption. With a little creativity, consideration for the stringent requirements of the Tax Exempt Statute and guidance of an experienced attorney, a non-profit organization can achieve its fund-raising goals by leasing space in its buildings.

The views expressed here are those of the author and not of Real Estate Media or its publications.

Jeffrey M. Hall is a partner in the law firm of Fox Rothschild, Princeton, NJ, and can be reached at jhall@foxrothschild.com . This article was prepared with the assistance of Alexander Wixted, a real estate and land use associate at the firm.