Welcome to CPA at Law, helping individuals and small businesses plan for the future and keep what they have.

This is the personal blog of Sterling Olander, a Certified Public Accountant and Utah-licensed attorney. For over thirteen years, I have assisted clients with estate planning and administration, tax mitigation, tax controversies, small business planning, asset protection, and nonprofit law.

I write about any legal, tax, or technological information that I find interesting or useful in serving my clients. All ideas expressed herein are my own and don't constitute legal or tax advice.

Unrelated Business Income Tax

Certain organizations are exempt from paying income tax under the Internal Revenue Code. These include charitable, religious, and scientific organizations; certain pension, profit sharing, and stock bonus plans; IRAs; colleges and universities; and medical savings and college savings accounts. To the extent that these organizations generate "exempt function income," such as "income from dues, fees, charges, or similar items paid by members for the purposes for which exempt status was granted," such income is not subject to federal income tax.

For exempt organizations, income that meets certain characteristics is not exempt function income and is instead unrelated business taxable income on which tax must be paid. Activities that (1) constitute a trade or business, (2) are regularly carried on, and (3) are not substantially related to furthering the exempt purpose of the organization generate unrelated business taxable income.

A "trade or business" is defined as "any activity carried on for the production of income from selling goods or performing services." To be "regularly carried on," the activities would "show a frequency and continuity, and [be] pursued in a manner similar to, comparable commercial activities of nonexempt organizations." Finally, for an activity to be "not substantially related" to the exempt purpose, the activity would lack a "[substantial] causal relationship to achieving exempt purposes (other than through the production of income)."

The specific rules regarding UBIT are numerous, with certain types of income being subject to UBIT depending on the type of exempt organization that generates the income or the intended purpose of the income. Deductions directly connected with producing the unrelated income are generally deductible in a similar manner as regular business deductions, although certain types of deductions are disallowed. Conceptually, the purpose behind the UBIT rules is to prevent normal for-profit businesses from experiencing unfair competition from an exempt organization engaging in the exact same activity without having to pay the tax that the for-profit business pays.

Avoid Owning Real Estate in a Corp

Tony Nitti, writing for Forbes, wrote a great article earlier this year that clearly explains Why You Should Never Hold Real Estate In A Corporation. Following is a summary of the primary reasons, contrasted with owning real estate in a partnership:

Capital Contributions: If an individual transfers real property to a corporation in exchange for stock, they must own 80% of the vote and value of the corporation immediately after the transfer; otherwise, a gain must be recognized and tax paid on the difference between the individual's basis in the property and the fair market value. In contrast, "appreciated property can be contributed to a partnership in exchange for a partnership interest [as small as a 1%] without triggering any gain."

Contributions of Property Subject to a Mortgage: Even if a contribution of real property to a corporation is otherwise exempt from gain, if the property is subject to a mortgage, "and the corporation assumes that liability as part of the transfer, the transfer triggers gain to the extent the liability exceeds the tax basis of the property." In contrast, it is "much less likely that a partner contributing leveraged property to a partnership will recognize gain" due to the inside and outside basis rules of partnership taxation.

Sale or Distribution: While it is possible to contribute real property to a corporation without being required to pay tax, the same is not true for getting the property out. If appreciated property is distributed from a corporation, "the corporation recognizes gain as if it had sold the property for its fair market value." The same treatment applies if the property is actually sold by the corporation. Furthermore, withdrawing the sales proceeds from a C-Corporation can result in double taxation to the shareholder. In the case of a distribution from an S-Corp, "the distribution will not be taxed a second time at the shareholder level..., [however the shareholder] cannot take the property out of the corporation without incurring a tax bill." In contrast, "when a partnership distributes property to a partner in a current distribution, generally no gain or loss is recognized by either the partnership or the partner;" only basis adjustments are required.

In addition to the problems listed above, owning real estate within a taxable entity other than a partnership can result in loss limitations, lost step-up in basis of the underlying assets upon the death of a shareholder, and lost step-up in basis for the purchaser of an interest in a corporation owning appreciated assets. It is almost always better to own real estate in a partnership or disregarded entity.