26 U.S.C. § 514 : US Code - Section 514: Unrelated debt-financed income

Search 26 U.S.C. § 514 : US Code - Section 514: Unrelated debt-financed income

(a) Unrelated debt-financed income and deductions
In computing under section 512 the unrelated business taxable
income for any taxable year -
(1) Percentage of income taken into account
There shall be included with respect to each debt-financed
property as an item of gross income derived from an unrelated
trade or business an amount which is the same percentage (but not
in excess of 100 percent) of the total gross income derived
during the taxable year from or on account of such property as
(A) the average acquisition indebtedness (as defined in
subsection (c)(7)) for the taxable year with respect to the
property is of (B) the average amount (determined under
regulations prescribed by the Secretary) of the adjusted basis of
such property during the period it is held by the organization
during such taxable year.
(2) Percentage of deductions taken into account
There shall be allowed as a deduction with respect to each debt-
financed property an amount determined by applying (except as
provided in the last sentence of this paragraph) the percentage
derived under paragraph (1) to the sum determined under paragraph
(3). The percentage derived under this paragraph shall not be
applied with respect to the deduction of any capital loss
resulting from the carryback or carryover of net capital losses
under section 1212.
(3) Deductions allowable
The sum referred to in paragraph (2) is the sum of the
deductions under this chapter which are directly connected with
the debt-financed property or the income therefrom, except that
if the debt-financed property is of a character which is subject
to the allowance for depreciation provided in section 167, the
allowance shall be computed only by use of the straight-line
method.
(b) Definition of debt-financed property
(1) In general
For purposes of this section, the term "debt-financed property"
means any property which is held to produce income and with
respect to which there is an acquisition indebtedness (as defined
in subsection (c)) at any time during the taxable year (or, if
the property was disposed of during the taxable year, with
respect to which there was an acquisition indebtedness at any
time during the 12-month period ending with the date of such
disposition), except that such term does not include -
(A)(i) any property substantially all the use of which is
substantially related (aside from the need of the organization
for income or funds) to the exercise or performance by such
organization of its charitable, educational, or other purpose
or function constituting the basis for its 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)), or (ii)
any property to which clause (i) does not apply, to the extent
that its use is so substantially related;
(B) except in the case of income excluded under section
512(b)(5), any property to the extent that the income from such
property is taken into account in computing the gross income of
any unrelated trade or business;
(C) any property to the extent that the income from such
property is excluded by reason of the provisions of paragraph
(7), (8), or (9) of section 512(b) in computing the gross
income of any unrelated trade or business;
(D) any property to the extent that it is used in any trade
or business described in paragraph (1), (2), or (3) of section
513(a); or
(E) any property the gain or loss from the sale, exchange, or
other disposition of which would be excluded by reason of the
provisions of section 512(b)(19) in computing the gross income
of any unrelated trade or business.
For purposes of subparagraph (A), substantially all the use of a
property shall be considered to be substantially related to the
exercise or performance by an organization of its charitable,
educational, or other purpose or function constituting the basis
for its exemption under section 501 if such property is real
property subject to a lease to a medical clinic 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
such organization of its charitable, educational, or other
purpose or function constituting the basis for its exemption
under section 501.
(2) Special rule for related uses
For purposes of applying paragraphs (1) (A), (C), and (D), the
use of any property by an exempt organization which is related to
an organization shall be treated as use by such organization.
(3) Special rules when land is acquired for exempt use within 10
years
(A) Neighborhood land
If an organization acquires real property for the principal
purpose of using the land (commencing within 10 years of the
time of acquisition) in the manner described in paragraph
(1)(A) and at the time of acquisition the property is in the
neighborhood of other property owned by the organization which
is used in such manner, the real property acquired for such
future use shall not be treated as debt-financed property so
long as the organization does not abandon its intent to so use
the land within the 10-year period. The preceding sentence
shall not apply for any period after the expiration of the 10-
year period, and shall apply after the first 5 years of the 10-
year period only if the organization establishes to the
satisfaction of the Secretary that it is reasonably certain
that the land will be used in the described manner before the
expiration of the 10-year period.
(B) Other cases
If the first sentence of subparagraph (A) is inapplicable
only because -
(i) the acquired land is not in the neighborhood referred
to in subparagraph (A), 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 Secretary that it is reasonably certain
that the land will be used in the manner described in
paragraph (1)(A) before the expiration of the 10-year period,
but the land is converted to such use by the organization
within the 10-year period, the real property (subject to the
provisions of subparagraph (D)) shall not be treated as debt-
financed property for any period before such conversion. For
purposes of this subparagraph, land shall not be treated as
used in the manner described in paragraph (1)(A) by reason of
the use made of any structure which was on the land when
acquired by the organization.
(C) Limitations
Subparagraphs (A) and (B) -
(i) shall apply with respect to any structure on the land
when acquired by the organization, or to the land occupied by
the structure, only if (and so long as) the intended future
use of the land in the manner described in paragraph (1)(A)
requires that the structure be demolished or removed in order
to use the land in such manner;
(ii) shall not apply to structures erected on the land
after the acquisition of the land; and
(iii) shall not apply to property subject to a lease which
is a business lease (as defined in this section immediately
before the enactment of the Tax Reform Act of 1976).
(D) Refund of taxes when subparagraph (B) applies
If an organization for any taxable year has not used land in
the manner to satisfy the actual use condition of subparagraph
(B) before the time prescribed by law (including extensions
thereof) for filing the return for such taxable year, the tax
for such year shall be computed without regard to the
application of subparagraph (B), but if and when such use
condition is satisfied, the provisions of subparagraph (B)
shall then be applied to such taxable year. If the actual use
condition of subparagraph (B) is satisfied for any taxable year
after such time for filing the return, and if credit or refund
of any overpayment for the taxable year resulting from the
satisfaction of such use condition is prevented at the close of
the taxable year in which the use condition is satisfied, by
the operation of any law or rule of law (other than chapter 74,
relating to closing agreements and compromises), credit or
refund of such overpayment may nevertheless be allowed or made
if claim therefor is filed before the expiration of 1 year
after the close of the taxable year in which the use condition
is satisfied.
(E) Special rule for churches
In applying this paragraph to a church or convention or
association of churches, in lieu of the 10-year period referred
to in subparagraphs (A) and (B) a 15-year period shall be
applied, and subparagraphs (A) and (B)(ii) shall apply whether
or not the acquired land meets the neighborhood test.
(c) Acquisition indebtedness
(1) General rule
For purposes of this section, the term "acquisition
indebtedness" means, with respect to any debt-financed property,
the unpaid amount of -
(A) the indebtedness incurred by the organization in
acquiring or improving such property;
(B) the indebtedness incurred before the acquisition or
improvement of such property if such indebtedness would not
have been incurred but for such acquisition or improvement; and
(C) the indebtedness incurred after the acquisition or
improvement of such property if such indebtedness would not
have been incurred but for such acquisition or improvement and
the incurrence of such indebtedness was reasonably foreseeable
at the time of such acquisition or improvement.
(2) Property acquired subject to mortgage, etc.
For purposes of this subsection -
(A) General rule
Where property (no matter how acquired) is acquired subject
to a mortgage or other similar lien, the amount of the
indebtedness secured by such mortgage or lien shall be
considered as an indebtedness of the organization incurred in
acquiring such property even though the organization did not
assume or agree to pay such indebtedness.
(B) Exceptions
Where property subject to a mortgage is acquired by an
organization by bequest or devise, the indebtedness secured by
the mortgage shall not be treated as acquisition indebtedness
during a period of 10 years following the date of the
acquisition. If an organization acquires property by gift
subject to a mortgage which was placed on the property more
than 5 years before the gift, which property was held by the
donor more than 5 years before the gift, the indebtedness
secured by such mortgage shall not be treated as acquisition
indebtedness during a period of 10 years following the date of
such gift. This subparagraph shall not apply if the
organization, in order to acquire the equity in the property by
bequest, devise, or gift, assumes and agrees to pay the
indebtedness secured by the mortgage, or if the organization
makes any payment for the equity in the property owned by the
decedent or the donor.
(C) Liens for taxes or assessments
Where State law provides that -
(i) a lien for taxes, or
(ii) a lien for assessments,
made by a State or a political subdivision thereof attaches to
property prior to the time when such taxes or assessments
become due and payable, then such lien shall be treated as
similar to a mortgage (within the meaning of subparagraph (A))
but only after such taxes or assessments become due and payable
and the organization has had an opportunity to pay such taxes
or assessments in accordance with State law.
(3) Extension of obligations
For purposes of this section, an extension, renewal, or
refinancing of an obligation evidencing a pre-existing
indebtedness shall not be treated as the creation of a new
indebtedness.
(4) Indebtedness incurred in performing exempt purpose
For purposes of this section, the term "acquisition
indebtedness" does not include indebtedness the incurrence of
which is inherent in the performance or exercise of the purpose
or function constituting the basis of the organization's
exemption, such as the indebtedness incurred by a credit union
described in section 501(c)(14) in accepting deposits from its
members.
(5) Annuities
For purposes of this section, the term "acquisition
indebtedness" does not include an obligation to pay an annuity
which -
(A) is the sole consideration (other than a mortgage to which
paragraph (2)(B) applies) issued in exchange for property if,
at the time of the exchange, the value of the annuity is less
than 90 percent of the value of the property received in the
exchange,
(B) is payable over the life of one individual in being at
the time the annuity is issued, or over the lives of two
individuals in being at such time, and
(C) is payable under a contract which -
(i) does not guarantee a minimum amount of payments or
specify a maximum amount of payments, and
(ii) does not provide for any adjustment of the amount of
the annuity payments by reference to the income received from
the transferred property or any other property.
(6) Certain Federal financing
(A) In general
For purposes of this section, the term "acquisition
indebtedness" does not include -
(i) an obligation, to the extent that it is insured by the
Federal Housing Administration, to finance the purchase,
rehabilitation, or construction of housing for low and
moderate income persons, or
(ii) indebtedness incurred by a small business investment
company licensed after the date of the enactment of the
American Jobs Creation Act of 2004 under the Small Business
Investment Act of 1958 if such indebtedness is evidenced by a
debenture -
(I) issued by such company under section 303(a) of such
Act, and
(II) held or guaranteed by the Small Business
Administration.
(B) Limitation
Subparagraph (A)(ii) shall not apply with respect to any
small business investment company during any period that -
(i) any organization which is exempt from tax under this
title (other than a governmental unit) owns more than 25
percent of the capital or profits interest in such company,
or
(ii) organizations which are exempt from tax under this
title (including governmental units other than any agency or
instrumentality of the United States) own, in the aggregate,
50 percent or more of the capital or profits interest in such
company.
(7) Average acquisition indebtedness
For purposes of this section, the term "average acquisition
indebtedness" for any taxable year with respect to a debt-
financed property means the average amount, determined under
regulations prescribed by the Secretary of the acquisition
indebtedness during the period the property is held by the
organization during the taxable year, except that for the purpose
of computing the percentage of any gain or loss to be taken into
account on a sale or other disposition of debt-financed property,
such term means the highest amount of the acquisition
indebtedness with respect to such property during the 12-month
period ending with the date of the sale or other disposition.
(8) Securities subject to loans
For purposes of this section -
(A) payments with respect to securities loans (as defined in
section 512(a)(5)) shall be deemed to be derived from the
securities loaned and not from collateral security or the
investment of collateral security from such loans,
(B) any deductions which are directly connected with
collateral security for such loan, or with the investment of
collateral security, shall be deemed to be deductions which are
directly connected with the securities loaned, and
(C) an obligation to return collateral security shall not be
treated as acquisition indebtedness (as defined in paragraph
(1)).
(9) Real property acquired by a qualified organization
(A) In general
Except as provided in subparagraph (B), the term "acquisition
indebtedness" does not, for purposes of this section, include
indebtedness incurred by a qualified organization in acquiring
or improving any real property. For purposes of this paragraph,
an interest in a mortgage shall in no event be treated as real
property.
(B) Exceptions
The provisions of subparagraph (A) shall not apply in any
case in which -
(i) the price for the acquisition or improvement is not a
fixed amount determined as of the date of the acquisition or
the completion of the improvement;
(ii) the amount of any indebtedness or any other amount
payable with respect to such indebtedness, or the time for
making any payment of any such amount, is dependent, in whole
or in part, upon any revenue, income, or profits derived from
such real property;
(iii) the real property is at any time after the
acquisition leased by the qualified organization to the
person selling such property to such organization or to any
person who bears a relationship described in section 267(b)
or 707(b) to such person;
(iv) the real property is acquired by a qualified trust
from, or is at any time after the acquisition leased by such
trust to, any person who -
(I) bears a relationship which is described in
subparagraph (C), (E), or (G) of section 4975(e)(2) to any
plan with respect to which such trust was formed, or
(II) bears a relationship which is described in
subparagraph (F) or (H) of section 4975(e)(2) to any person
described in subclause (I);
(v) any person described in clause (iii) or (iv) provides
the qualified organization with financing in connection with
the acquisition or improvement; or
(vi) the real property is held by a partnership unless the
partnership meets the requirements of clauses (i) through (v)
and unless -
(I) all of the partners of the partnership are qualified
organizations,
(II) each allocation to a partner of the partnership
which is a qualified organization is a qualified allocation
(within the meaning of section 168(h)(6)), or
(III) such partnership meets the requirements of
subparagraph (E).
For purposes of subclause (I) of clause (vi), an organization
shall not be treated as a qualified organization if any income
of such organization is unrelated business taxable income.
(C) Qualified organization
For purposes of this paragraph, the term "qualified
organization" means -
(i) an organization described in section 170(b)(1)(A)(ii)
and its affiliated support organizations described in section
509(a)(3);
(ii) any trust which constitutes a qualified trust under
section 401; or
(iii) an organization described in section 501(c)(25).
(D) Other pass-thru entities; tiered entities
Rules similar to the rules of subparagraph (B)(vi) shall also
apply in the case of any pass-thru entity other than a
partnership and in the case of tiered partnerships and other
entities.
(E) Certain allocations permitted
(i) In general
A partnership meets the requirements of this subparagraph
if -
(I) the allocation of items to any partner which is a
qualified organization cannot result in such partner having
a share of the overall partnership income for any taxable
year greater than such partner's share of the overall
partnership loss for the taxable year for which such
partner's loss share will be the smallest, and
(II) each allocation with respect to the partnership has
substantial economic effect within the meaning of section
704(b)(2).
For purposes of this clause, items allocated under section
704(c) shall not be taken into account.
(ii) Special rules
(I) Chargebacks
Except as provided in regulations, a partnership may
without violating the requirements of this subparagraph
provide for chargebacks with respect to disproportionate
losses previously allocated to qualified organizations and
disproportionate income previously allocated to other
partners. Any chargeback referred to in the preceding
sentence shall not be at a ratio in excess of the ratio
under which the loss or income (as the case may be) was
allocated.
(II) Preferred rates of return, etc.
To the extent provided in regulations, a partnership may
without violating the requirements of this subparagraph
provide for reasonable preferred returns or reasonable
guaranteed payments.
(iii) Regulations
The Secretary shall prescribe such regulations as may be
necessary to carry out the purposes of this subparagraph,
including regulations which may provide for exclusion or
segregation of items.
(F) Special rules for organizations described in section
501(c)(25)
(i) In general
In computing under section 512 the unrelated business
taxable income of a disqualified holder of an interest in an
organization described in section 501(c)(25), there shall be
taken into account -
(I) as gross income derived from an unrelated trade or
business, such holder's pro rata share of the items of
income described in clause (ii)(I) of such organization,
and
(II) as deductions allowable in computing unrelated
business taxable income, such holder's pro rata share of
the items of deduction described in clause (ii)(II) of such
organization.
Such amounts shall be taken into account for the taxable year
of the holder in which (or with which) the taxable year of
such organization ends.
(ii) Description of amounts
For purposes of clause (i) -
(I) gross income is described in this clause to the
extent such income would (but for this paragraph) be
treated under subsection (a) as derived from an unrelated
trade or business, and
(II) any deduction is described in this clause to the
extent it would (but for this paragraph) be allowable under
subsection (a)(2) in computing unrelated business taxable
income.
(iii) Disqualified holder
For purposes of this subparagraph, the term "disqualified
holder" means any shareholder (or beneficiary) which is not
described in clause (i) or (ii) of subparagraph (C).
(G) Special rules for purposes of the exceptions
Except as otherwise provided by regulations -
(i) Small leases disregarded
For purposes of clauses (iii) and (iv) of subparagraph (B),
a lease to a person described in such clause (iii) or (iv)
shall be disregarded if no more than 25 percent of the
leasable floor space in a building (or complex of buildings)
is covered by the lease and if the lease is on commercially
reasonable terms.
(ii) Commercially reasonable financing
Clause (v) of subparagraph (B) shall not apply if the
financing is on commercially reasonable terms.
(H) Qualifying sales by financial institutions
(i) In general
In the case of a qualifying sale by a financial
institution, except as provided in regulations, clauses (i)
and (ii) of subparagraph (B) shall not apply with respect to
financing provided by such institution for such sale.
(ii) Qualifying sale
For purposes of this clause, there is a qualifying sale by
a financial institution if -
(I) a qualified organization acquires property described
in clause (iii) from a financial institution and any gain
recognized by the financial institution with respect to the
property is ordinary income,
(II) the stated principal amount of the financing
provided by the financial institution does not exceed the
amount of the outstanding indebtedness (including accrued
but unpaid interest) of the financial institution with
respect to the property described in clause (iii)
immediately before the acquisition referred to in clause
(iii) or (v), whichever is applicable, and
(III) the present value (determined as of the time of the
sale and by using the applicable Federal rate determined
under section 1274(d)) of the maximum amount payable
pursuant to the financing that is determined by reference
to the revenue, income, or profits derived from the
property cannot exceed 30 percent of the total purchase
price of the property (including the contingent payments).
(iii) Property to which subparagraph applies
Property is described in this clause if such property is
foreclosure property, or is real property which -
(I) was acquired by the qualified organization from a
financial institution which is in conservatorship or
receivership, or from the conservator or receiver of such
an institution, and
(II) was held by the financial institution at the time it
entered into conservatorship or receivership.
(iv) Financial institution
For purposes of this subparagraph, the term "financial
institution" means -
(I) any financial institution described in section 581 or
591(a),
(II) any other corporation which is a direct or indirect
subsidiary of an institution referred to in subclause (I)
but only if, by virtue of being affiliated with such
institution, such other corporation is subject to
supervision and examination by a Federal or State agency
which regulates institutions referred to in subclause (I),
and
(III) any person acting as a conservator or receiver of
an entity referred to in subclause (I) or (II) (or any
government agency or corporation succeeding to the rights
or interest of such person).
(v) Foreclosure property
For purposes of this subparagraph, the term "foreclosure
property" means any real property acquired by the financial
institution as the result of having bid on such property at
foreclosure, or by operation of an agreement or process of
law, after there was a default (or a default was imminent) on
indebtedness which such property secured.
(d) Basis of debt-financed property acquired in corporate
liquidation
For purposes of this subtitle, if the property was acquired in a
complete or partial liquidation of a corporation in exchange for
its stock, the basis of the property shall be the same as it would
be in the hands of the transferor corporation, increased by the
amount of gain recognized to the transferor corporation upon such
distribution and by the amount of any gain to the organization
which was included, on account of such distribution, in unrelated
business taxable income under subsection (a).
(e) Allocation rules
Where debt-financed property is held for purposes described in
subsection (b)(1)(A), (B), (C), or (D) as well as for other
purposes, proper allocation shall be made with respect to basis,
indebtedness, and income and deductions. The allocations required
by this section shall be made in accordance with regulations
prescribed by the Secretary to the extent proper to carry out the
purposes of this section.
(f) Personal property leased with real property
For purposes of this section, the term "real property" includes
personal property of the lessor leased by it to a lessee of its
real estate if the lease of such personal property is made under,
or in connection with, the lease of such real estate.
(g) Regulations
The Secretary shall prescribe such regulations as may be
necessary or appropriate to carry out the purposes of this section,
including regulations to prevent the circumvention of any provision
of this section through the use of segregated asset accounts.