To be "debt-financed property" (described in chapter 5),
property of an exempt organization must be subject to acquisition
indebtedness at some time during the tax year. This chapter defines
"acquisition indebtedness" and describes the kinds of debt that
are included and not included in that definition.
Acquisition indebtedness defined.
Acquisition indebtedness means, for any debt-financed property, the
unpaid amount of:
- Debt incurred by the organization when acquiring or
improving the property,
- Debt incurred before acquiring or improving the
property if the debt would not have been incurred except for the
acquisition or improvement, and
- Debt incurred after the acquisition or
improvement of the property if:
- The debt would not have been incurred except for the
acquisition or improvement, and
- Incurring the debt was reasonably foreseeable when the
property was acquired or improved.
The facts and circumstances of each situation determine whether
incurring a debt was reasonably foreseeable. That an organization may
not have foreseen the need to incur a debt before acquiring or
improving the property does not necessarily mean that incurring the
debt later was not reasonably foreseeable.
Example 1.
Y, an exempt scientific organization, mortgages its laboratory to
replace working capital used in remodeling an office building that Y
rents to an insurance company for nonexempt purposes. The debt is
acquisition indebtedness since the debt, though incurred after the
improvement of the office building, would not have been incurred
without the improvement, and the debt was reasonably foreseeable when,
to make the improvement, Y reduced its working capital below the
amount necessary to continue current operations.
Example 2.
X, an exempt organization, forms a partnership with A and B. The
partnership agreement provides that all three partners will share
equally in the profits of the partnership, each will invest $3
million, and X will be a limited partner. X invests $1 million of its
own funds in the partnership and $2 million of borrowed funds.
The partnership buys as its sole asset an office building that it
leases to the public for nonexempt purposes. The office building costs
the partnership $24 million, of which $15 million is borrowed from Y
bank. The loan is secured by a mortgage on the entire office building.
By agreement with Y bank, X is not personally liable for payment of
the mortgage.
X has acquisition indebtedness of $7 million. This amount is the
$2 million debt X incurred in acquiring the partnership interest, plus
the $5 million that is X's allocable part of the partnership's debt
incurred to buy the office building (one-third of $15 million).
Example 3.
A labor union advanced funds, from existing resources and without
any borrowing, to its tax-exempt subsidiary title-holding company. The
subsidiary used the funds to pay a debt owed to a third party that was
previously incurred in acquiring two income-producing office
buildings. Neither the union nor the subsidiary has incurred any
further debt in acquiring or improving the property. The union has no
outstanding debt on the property. The subsidiary's debt to the union
is represented by a demand note on which the subsidiary makes payments
whenever it has the available cash. The books of the union and the
subsidiary list the outstanding debt as interorganizational
indebtedness.
Although the subsidiary's books show a debt to the union, it is not
the type subject to the debt-financed property rules. In this
situation, the very nature of the title-holding company and the
parent-subsidiary relationship shows this debt to be merely a matter
of accounting between the two organizations. Accordingly, the debt is
not acquisition indebtedness.
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