Over the last two years, REALTOR® associations have remained resilient throughout the COVID-19 pandemic while adapting to the economic pressures of a new normal. This fiscal year, you may be considering ways to pivot, expand, or even monetize certain activities to meet short- or longterm financial goals.
Before you make any decisions, be sure you understand how the IRS treats income generated from unrelated activities of tax-exempt organizations. In general, REALTOR® associations are not-for-profit business organizations that enjoy federal tax exemption. This is a great financial benefit for an association, especially when it undertakes certain activities to expand the association’s purpose. But what happens when an association engages in activities not substantially related to its tax-exempt purpose? Will the association continue to enjoy the benefit of federal income tax exemption?
Be aware that when tax-exempt organizations, like REALTOR® associations, engage in activities substantially unrelated to their exempt purpose, the income generated from those activities may be subject to federal income tax liability. This tax liability is known as unrelated business income tax, or UBIT, and may come as a surprise to some, especially if UBIT obligations are not factored into the association’s financial projections. To determine whether income generated from a certain activity is subject to UBIT, a REALTOR® association should first determine whether the activity meets the following three-part test:
UBIT Three-Part Test
- Is the activity a trade or business? This is any activity conducted with the intent to make a profit from selling goods or performing services.
- Is the activity regularly carried on? This means any activity, conducted with frequency and continuity, pursued similarly to a comparable commercial activity of a for-profit business.
- Is the activity not substantially related? This means the activity does not contribute importantly to accomplishing the association’s exempt purpose. This will depend on the facts of each case, such as whether the activity is reasonably necessary to perform the association’s exempt purpose.
The three-part test is centered around the activity. Whether the association uses the profits derived from the activity does not, alone, make the activity substantially related to the association’s exempt purpose.
If an activity meets the three-part test and the gross income derived from the activity is $1,000 or more, the association will likely be subject to UBIT and required to file Form 990-T. Unrelated business income must be calculated for each activity that meets the three-part test.
For every rule, there is usually an exception. Generally, royalties, qualified sponsorship payments, certain rental income, and a trade or business where substantially all the work is performed by volunteers receiving no compensation are not subject to UBIT.
As your REALTOR® association considers new or existing activities, remember that the activity must meet all three parts of the test to trigger tax liability. If an activity is conducted as a trade or business and is regularly carried on but the activity substantially relates to the association’s exempt purpose, then the activity fails the three-part test. The association will likely avoid UBIT on the income generated from the activity.
If your association finds itself generating an excessive amount of unrelated business income relative to its tax-exempt related activities, then your association may want to reconsider its activities to avoid jeopardizing its tax-exempt status. Consulting with qualified legal counsel and tax professionals can ensure that your association’s income-generating activities keep you in line to meet fiscal goals, while protecting your tax-exempt status.