A recent IRS ruling illustrates the application of the IRC § 4943 excise tax on excess business holdings, as well as the tax on unrelated business taxable income (UBTI), in the context of an apartment building owned by a private foundation.
In Private Letter Ruling 201422027, a private foundation owned an apartment building that included a coin-operated laundry. In addition to standard outdoor parking, which was included in the rent for each apartment, the building offered covered parking spaces for an extra monthly charge.
Section 4943 imposes an excise tax on the excess business holdings of a private foundation in a business enterprise, which under the Treasury Regulations is the active conduct of a trade or business and that is an unrelated business under § 513. However, under 4943, “business enterprise” does not include a trade or business that derives at least 95% of its gross income from passive sources which includes rents from real property. In applying this test, the IRS said that even if the revenue from the coin-operated laundry and optional covered parking are not passive, in this situation these two items constituted less than 5% of the gross income from the property. The apartment property was therefore not within the definition of a business enterprise under § 4943 and the foundation won’t be subject to the excise tax on excess business holdings.
This does not mean, however, that even this small amount of income from these two sources will escape the tax on UBTI. Section 512(b) generally excludes real property rents, along with income from services that are incidental to the lease of that property. However, income from services that are provided to tenants for their convenience is not excluded. In considering the coin-operated laundry, the Service noted that tenants could always take their clothes to an off-site commercial laundry. It was simply more convenient to use the facility in the building, and the income from the coin-operated machines was therefore ruled subject to UBTI.
On the other hand, even though there was an extra charge for the optional covered parking, the IRS concluded that no special services were provided in connection with these spaces, and that they were therefore not a special service for the convenience of tenants but instead were a characteristic of real property. The charges for covered parking were therefore not included in UBTI subject to tax.
In addition to confirming that the IRS treats income from coin-operated washing machines as UBTI, this ruling highlights an important distinction between the excess business holding rules and UBTI. The former is all or nothing: if gross income from the washing machines was 6% of the gross income from the apartment building, the entire asset would be a business enterprise subject to an excise tax of 10% on the entire value of the property under § 4943, while the tax on UBTI is applied proportionately, so that only the net income attributable to this 6% would be subject to tax.