Does an organization’s tax-exempt status under 501(c)(3) automatically qualify it for property tax exemption? According to many state revenue departments, the answer is No! Recent news stories highlight how states can be rather miserly with their property tax exemptions. Why? To begin with, many states face mounting fiscal challenges. In addition, significant political pressure exists for nonprofits to pay their “fair share” of state taxes since they benefit from the state’s services. For nonprofits, this combination translates to an increased dual need: (a) to justify their existence as organizations worthy of their privileged tax-exempt status; and (b) to demonstrate their qualification for state real estate tax exemption under most states’ higher burden of proof.
In Illinois, a tax-exempt nonprofit must demonstrate exemption qualification by “clear and convincing evidence,” with all “debatable facts resolved against tax exemption.” That’s a steep hill to climb! Most states have similar high standards that are difficult to satisfy. So what is a fiscally responsible, property-owning nonprofit to do?
Evaluate your organization’s exemption qualification according to the detailed guidance provided through our law firm’s general memorandum on state tax exemptions. The following is a brief summary.
1. Which exemption category fits? To qualify for real estate tax exemption, an organization must fit into a prescribed category. Such categorical classification should be reflected in the organization’s charter documents (articles of incorporation, bylaws, or other organizing documents).
In Illinois, most nonprofits are either “religious,” “educational,” or “charitable.” Since the Illinois statute is strictly construed by the courts and is phrased in the disjunctive (i.e., religious OR educational OR charitable), the Department of Revenue’s position is that an applicant needs to fall into one – and only one – category for exemption. As a practical matter, many organizations’ activities fall within two or more of these categories. For example, a church may provide charitable “free soup” and other benevolence, educate its parishioners and others, as well as conduct religious activities. As a legal matter, however, only one category technically will fit. And for legal purposes, each word is a term of art.
In Illinois, the word “religious” is limited to houses of worship or related religious institutions. Being a faith-based outreach ministry or social service provider will not satisfy the “religious” category under Illinois state property tax exemption law. (E.g., a religious nonprofit hospital is not “religious”; it is a charitable institution.)
Likewise, the word “educational” is restricted to schools that “relieve a government burden” to provide educational instruction, such as grammar schools, high schools, and colleges. Dance schools, cosmetology schools, trade schools, and other organizations that provide educational programming will not satisfy this strict test. This is true even though colleges may offer dance instruction, and trade schools may relieve other government burdens in terms of economic growth. Notably, preschools will not qualify as “educational,” because no government burden exists per se to provide preschool programs. Again, this is true even though government funding for such programs is widely available and, as most would agree, such programs are highly beneficial to society.
Last, the term “charitable” is the big exemption “bucket” for most other tax-exempt organizations. This category may include social service providers, faith-based organizations, community sports organizations, and even child-care providers. The key for charitable qualification, in Illinois and most other states, is that the nonprofit organization makes its benefits “widely available to all without undue obstacle.”
An easy example is Chicago’s Buckingham Foundation, in downtown Grant Park. All may come and enjoy; no entrance fee is charged. Another example is a soup kitchen for homeless people. Where’s the charity? In all the free soup, at least until it runs out!
2. May a nonprofit organization charge fees? Yes, but be careful. Organizations that seek to qualify for property tax exemption may charge fees only if they are not charged with “a view to profit.”
Charging “rent” typically looks commercial and therefore is likely to be viewed as impermissibly profit-oriented, particularly under Illinois’ high standard of demonstrating qualifications for exemption by “clear and convincing evidence”. On the other hand, charging a “cost-sharing” or “space sharing” fee for reasonably anticipated property-related expenses is viewed more like stewardship – i.e., non-commercial property usage.
For Illinois organizations seeking to fit within the “charitable” qualifications, they must also demonstrate that benefits provided by the organization are made “widely available to all without undue obstacle.” In other words, the beneficiaries’ financial ability to pay for the programs cannot be a barrier to access. That’s why museums and zoos have “free days,” and why property-owning charitable organizations likewise should proactively provide ample access to their fee-based programs.
Charitable organizations that charge fees should have financial aid applications that are readily available (and publicized), board-approved financial assistance policies, and a demonstrated track record of providing financial aid. For many organizations, such measures are not only good for tax-exempt protection; they can provide extremely attractive fundraising opportunities. For example, an organization that helps at-risk children may be far more successful in soliciting donations for “scholarships” than simply for general overhead. By raising more scholarship support, more children can participate, and the organization can thereby continue to grow and advance its mission. On a related note, the Department of Revenue expects organizations seeking to qualify as “charitable” to be substantially supported by public contributions. Thus, it is critical for organizations seeking to qualify as “charitable” to demonstrate ample contributions, which likewise can be satisfied through such “scholarship” fundraising efforts.
Qualifying for real estate tax exemption can be a daunting and challenging process. But through careful planning, a nonprofit can successfully obtain this valuable tax advantage. In addition, the organization may also improve its legal compliance and its overall ability to benefit society. These results make the effort well worth it!