To Profit or Not to Profit?
Is the RealtorŪ association tax status a help or a hurdle in today’s business model?

By Carolyn Schwaar

If you’re built like a nonprofit, can you run like a business? That’s the question many associations are asking themselves as they digest the new association business models document issued by NAR’s Association Executive Committee last spring. The renewed focus on the business effect of tax-exempt status has also been influenced by the need for associations to generate more nondues revenue in order to provide more services. To remain tax-exempt, associations are limited as to how much revenue they can earn and how they can generate it.

While nonprofit and tax-exempt are not synonymous, most nonprofit associations are tax-exempt. Yet, today more have chosen to keep the nonprofit status but pay corporation taxes in order to have more flexibility in profit-generating activities.

From website hosting to property rental to management consulting, associations are seeking out more creative ways to make money.

“Associations today need to make more money than they used to,” says Terry Penza, CEO of the North Shore Association of RealtorsŪ, Ill. “When the government gave us the nonprofit status in the ‘50s, we weren’t making much money anyway,” she says. “But now, associations are trying to juggle affinity programs, technology services, and their financial strategies.” As a result, an increasing share of associations’ revenue now comes from nondues income.

To be nonprofit, or not to be?
An association’s tax-exempt status can be a wrench in the works when it comes to generating revenue.

The government says a tax-exempt association is one that is organized and operated for a purpose that is beneficial to the public, or at least a specific community, such as real estate professionals. And while this tax status is in line with the typical RealtorŪ association’s mission, the restrictions that come with it are beginning to hamper the new association business model that encourages seeking out creative ways to generate nondues revenue.

Know your code
Section 501c6 of the U.S. tax code allows certain organizations to operate and not pay most federal income taxes. RealtorŪ associations can fall into this category and many do not pay federal income taxes. The downside is that substantially all of the activities of the association must be related to the association’s tax-exempt purposes. Activities such as meetings, educational programs, publishing, and even trade shows generally are considered related to an organization’s exempt purpose and any net income earned on them is not taxable. In fact, there are no limitations on how much nondues income an association can generate, provided that the activities generating the income are related to the association’s tax-exempt purposes, although, as a practical matter, an association that earns an extraordinary amount of income on such activities may jeopardize its exempt status.

Tax-exempt associations can engage in revenue-generating activities that are not related to real estate but would have to pay taxes on those revenues. An association can risk its tax-exempt status by becoming more than “insubstantially” engaged in nonrelated revenue gener-ating activity (referred to as unrelated business income), which can raise red flags at the IRS. When unrelated business income predominates, an association appears to be in business for unrelated purposes, rather than exempt purposes.

Unfortunately, no rule states how much unrelated business income is too much. Generally speaking, an association should be concerned about its tax status when its unrelated business income approaches 50 percent of the association’s total revenue.

Of course, some associations may not actually need tax-exempt status. “If your association isn’t paying lots of taxes, the tax status is of little use to you,” says Judith Lindenau, CEO of the Traverse Area Association of RealtorsŪ, Mich. “There’s not much bottomline benefit in being tax-exempt.”

TAAR, like many other associations, has always been a for-profit association. “We make money and embark on all kinds of income-generating activities,” Lindenau says. “I think that the tax-exempt status has been a big liability for local RealtorŪ boards. It just isn’t realistic positioning when we have so much income-generating potential.”

Other associations argue that while the tax-exempt status can be a hurdle, the nonprofit status is a public relations tool and something members feel good about. Associations find that members may feel more inclined to donate their time to an organization that isn’t set up to make money.

There are other local benefits to being a nonprofit, even if the organization isn’t tax-exempt on the federal level. Some states give sales tax and real property tax breaks to nonprofits. The directors and officers of nonprofit associations also enjoy limited legal liability in some states.

While the local benefits of being non-profit has led many associations to keep that status while giving up their federal tax-emption, other associations want the best of both worlds and are realizing the need for both for-profit and nonprofit entities to manage the multiple aspects of association management today.

A growing number of associ-ations have turned to setting up separate but wholly-owned and con-trolled for-profit companies for their new revenue generating pursuits—like many associ-ations have done with their MLSs in the past. These for-profit entities can be set up as equity corporations, limited-liability corporations, or joint venture partnerships, to name a few. A separate for-profit company can house the revenue generating activities of the association that are not related to real estate and thus are taxable, while the revenue-generating activities that are related to real estate remain tax-exempt under the association’s tax-exempt status.

According to NSAR’s Penza, “separate corporations can house these profit-generating activities that allow for increased income, which translates to increased member services.”

Other strategies include making the association for-profit, and setting up a nonprofit company for the association’s educational or charity programs. There is a wide variety of ways that associations can incorporate depending on their particular circumstances.

Yet two separate entities can be a record-keeping nightmare, according to Elaine West, CEO of the Greater Lansing Association of RealtorsŪ. “We were wasting too much time and effort to maintain separate accounts for the MLS and a tax-exempt association,” says West. The association’s tax-exempt status also put too many restrictions on lobbying activities. “When we really took the time to put pencil to paper, we found that the restrictions on our activities cost us more than we saved not paying income taxes,” says West.

The solution was to restructure the association’s articles of incorporation and give up its tax-exempt status, but remain a nonprofit association.

Note: This article is not intended to be tax or legal advice. Associations should consult a tax professional and attorney before engaging in revenue-generating activities or changing tax status.

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