Publication 598 |
2001 Tax Year |
Income
Generally, unrelated business income is taxable, but there are
exclusions and special rules that must be considered when figuring the
income.
Exclusions
The following types of income (and deductions directly connected
with the income) are generally excluded when figuring unrelated
business taxable income.
Dividends, interest, annuities and other investment income.
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.
Exception for insurance activity income of a controlled
foreign corporation.
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).
Other exceptions.
This exclusion does not apply to unrelated debt-financed income
(discussed under Income From Debt-Financed Property, later)
or to interest or annuities received from a controlled corporation
(discussed under Income From Controlled Corporations,
later).
Income from lending securities.
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.
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.
Exceptions.
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 Corporations, later).
Rents.
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.
Mixed leases.
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.
Exception for rents based on net profit.
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.
Exception for income from personal services.
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.
Other exceptions.
This exclusion does not apply to unrelated debt-financed income
(discussed under Income From Debt-Financed Property, later)
or to rents received from a controlled corporation (discussed under
Income From Controlled Corporations, later).
Income from research.
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.
Gains and losses from disposition of property.
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.
Lapse or termination of options.
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.
Exception.
This exclusion does not apply to unrelated debt-financed income,
discussed later under Income From Debt-Financed Property.
Income from services provided under federal license.
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.
Exception.
This exclusion does not apply to unrelated debt-financed income
(discussed later under Income From Debt-Financed Property).
Dues of Agricultural Organizations and Business Leagues
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.
Exception.
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
$112 for 2000.
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.
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