The term "unrelated business taxable income" generally means the gross income derived from any unrelated trade or business regularly carried on by the exempt organization, less the deductions directly connected with carrying on the trade or business. If an organization regularly carries on two or more unrelated business activities, its unrelated business taxable income is the total of gross income from all such activities less the total allowable deductions attributable to all the activities.
In computing unrelated business taxable income, gross income and deductions are subject to the modifications and special 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 circumstances 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 operating the property for the benefit of the organization, or that is a share of the profits retained by the organization as a partner or joint venturer, the payment is not within the income exclusion for rents, discussed later under Exclusions. taxmap/pubs/p598-006.htm#en_us_publink100067525
Generally, unrelated business income is taxable, but there are exclusions and special rules that must be considered when figuring the income. taxmap/pubs/p598-006.htm#en_us_publink100067526
The following types of income (and deductions directly connected with the income) are generally excluded when figuring unrelated business taxable income.taxmap/pubs/p598-006.htm#en_us_publink100067527
All dividends, interest, annuities, payments with respect to securities loans, income from notional principal contracts, and other income from an exempt organization's ordinary and routine investments that the IRS determines are substantially similar to these types of income are excluded in computing unrelated business taxable income. taxmap/pubs/p598-006.htm#en_us_publink100067528
This exclusion does not apply to income from certain insurance activities of an exempt organization's controlled foreign corporation. The income is not excludable dividend income, but instead is unrelated business taxable income to the extent it would be so treated if the exempt organization had earned it directly. Certain exceptions to this rule apply. For more information, see section 512(b)(17). taxmap/pubs/p598-006.htm#en_us_publink100067529
This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later), to interest or annuities received from a controlled corporation (discussed under Income From Controlled Organizations, later). taxmap/pubs/p598-006.htm#en_us_publink100067530
Payments received with respect to a security loan are excluded in computing unrelated business taxable income only if the loan is made under an agreement that:
- Provides for the return to the exempt organization of securities identical to the securities loaned,
- Requires payments to the organization of amounts equivalent to all interest, dividends, and other distributions that the owner of the securities is entitled to receive during the period of the loan,
- Does not reduce the organization's risk of loss or opportunity for gain on the securities,
- Contains reasonable procedures to implement the obligation of the borrower to furnish collateral to the organization with a fair market value each business day during the period of the loan in an amount not less than the fair market value of the securities at the close of the preceding business day, and
- Permits the organization to terminate the loan upon notice of not more than 5 business days.
Payments with respect to securities loans include:
- Amounts in respect of dividends, interest, and other distributions,
- Fees based on the period of time the loan is in effect and the fair market value of the security during that period,
- Income from collateral security for the loan, and
- Income from the investment of collateral security.
The payments 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 security, are considered deductions that are directly connected with the securities loaned.
Royalties, including overriding royalties, are excluded in computing unrelated business taxable income.
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 signature are ordinarily considered royalties. However, royalties do not include payments for personal services. Therefore, payments for personal appearances and interviews are not excluded as royalties and must be included in figuring unrelated business taxable income.
Unrelated business taxable income does not include royalty income received from licensees by an exempt organization that is the legal and beneficial owner of patents assigned to it by inventors for specified percentages of future royalties.
Mineral royalties are excluded whether measured by production or by gross or taxable income from the mineral property. However, the exclusion does not 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 are not 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 unrelated business taxable income. 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. taxmap/pubs/p598-006.htm#en_us_publink100067532
This exclusion does not apply to debt-financed income (discussed under Income From Debt-Financed Property, later) or to royalties received from a controlled corporation (discussed under Income From Controlled Organizations, later). taxmap/pubs/p598-006.htm#en_us_publink100067533
Rents from real property, including elevators and escalators, are excluded in computing unrelated business taxable income. Rents from personal property are not excluded. However, special rules apply to "mixed leases" of both real and personal property. taxmap/pubs/p598-006.htm#en_us_publink100067534
In a mixed lease, all of the rents are excluded if the rents attributable to the personal property are not 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 personal property are more than 10% but not more than 50% of the total rents, only the rents attributable 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 lessee first may use it under the terms of a lease. For example, property subject to a lease entered 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 property must be recomputed, and the treatment of the rents must be redetermined, if:
- The rent attributable to all the leased personal property increases by 100% or more because additional or substitute personal property is placed in service, or
- 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.
The exclusion for rents does not 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. taxmap/pubs/p598-006.htm#en_us_publink100067536
Payment for occupying space when personal services are also rendered to the occupant does not constitute rent from real property. Therefore, the exclusion does not apply to transactions such as renting hotel rooms, rooms in boarding houses or tourist homes, and space in parking lots or warehouses. taxmap/pubs/p598-006.htm#en_us_publink100067537
This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later), or to interest, annuities, royalties and rents received from a controlled corporation (discussed under Income From Controlled Organizations, later), investment income (dividends, interest, rents, etc.) received by organizations described in sections 501(c)(7), 501(c)(9), 501(c)(17), and 501(c)(20). See Special Rules for Social Clubs, VEBAs, SUBs, and GLSOs, discussed later for more information.taxmap/pubs/p598-006.htm#en_us_publink100067538
A tax-exempt organization may exclude income from research grants or contracts from unrelated business taxable income. However, the extent 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 excluded when computing unrelated business taxable income.
For a college, university, or hospital, all income from research, whether fundamental or applied, is excluded in computing unrelated business taxable income.
When an organization is operated primarily to conduct fundamental research (as distinguished from applied research) and the results are freely available to the general public, all income from research performed for any person is excluded in computing unrelated business taxable income.
The term research, for this purpose, does not include activities of a type normally carried on as an incident to commercial or industrial operations, such as testing or inspecting materials or products, or designing or constructing equipment, buildings, etc. In addition, the term fundamental research does not include research carried on for the primary purpose of commercial or industrial application. taxmap/pubs/p598-006.htm#en_us_publink100067539
Also excluded from unrelated business taxable income are gains or losses from the sale, exchange, or other disposition of property other than:
- Stock in trade or other property of a kind that would properly be includable in inventory if on hand at the close of the tax year,
- Property held primarily for sale to customers in the ordinary course of a trade or business, or
- Cutting of timber that an organization has elected to consider as a sale or exchange of the timber.
It should be noted that the last exception relates only to cut timber. The sale, exchange, or other disposition of standing timber is excluded from the computation of unrelated business income, unless it constitutes property held for sale to customers in the ordinary course of business.taxmap/pubs/p598-006.htm#en_us_publink100067540
Any gain from the lapse or termination of options to buy or sell securities is excluded from unrelated business taxable income. The exclusion applies only if the option is written in connection with the exempt organization's investment activities. Therefore, this exclusion is not available if the organization is engaged in the trade or business of writing options or the options are held by the organization as inventory or for sale to customers in the ordinary course of a trade or business. taxmap/pubs/p598-006.htm#en_us_publink100067541
This exclusion does not apply to unrelated debt-financed income, discussed later under Income From Debt-Financed Property. taxmap/pubs/p598-006.htm#en_us_publink100067542
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 unrelated business taxable income and is excepted from the debt-financed rules for such property. See sections 512(b)(19) and 514(b)(1)(E).taxmap/pubs/p598-006.htm#en_us_publink100067543
There is a further exclusion from unrelated business taxable income of income from a trade or business carried on by a religious order or by an educational organization maintained by the order.
This exclusion applies only if the following requirements are met.
- The trade or business must have been operated by the order or by the institution since before May 27, 1959.
- The trade or business must consist of providing services under a license issued by a federal regulatory agency.
- More than 90% of the net income from the business for the tax year must be devoted to religious, charitable, or educational purposes that constitute the basis for the religious order's exemption.
- The rates or other charges for these services must be fully competitive with the rates or other charges of similar taxable businesses. Rates or other charges for these services will be considered as fully competitive if they are neither materially higher nor materially lower than the rates charged by similar businesses operating in the same general area.
This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later). taxmap/pubs/p598-006.htm#en_us_publink100067545
Income of a mutual or cooperative electric company described in section 501(c)(12) which is treated as member income under subparagraph (H) of that section is excluded from unrelated business taxable income.taxmap/pubs/p598-006.htm#en_us_publink100067546
Dues received from associate members by organizations exempt under section 501(c)(5) or section 501(c)(6) may be treated as gross income from an unrelated trade or business if the associate member category exists for the principal purpose of producing unrelated business income. For example, if an organization creates an associate member category solely to allow associate members to purchase insurance through the organization, the associate member dues may be unrelated business income. taxmap/pubs/p598-006.htm#en_us_publink100067547
Associate member dues received by an agricultural or horticultural organization are not treated as gross income from an unrelated trade or business, regardless of their purpose, if they are not more than the annual limit. The limit on dues paid by an associate member is $139 for 2008.
If the required annual dues are more than the limit, the entire amount is treated as income from an unrelated business unless the associate member category was formed or availed of for the principal purpose of furthering the organization's exempt purposes.