Originally published on Forbes.com Oct 1st, 2014
Gaining recognition as a tax exempt organization under Code Section 501(c)(3) can be a little challenging. Once that hurdle is passed an organization might find that gaining exemption from local property taxes can be even more challenging. In many states, activities that qualify as exempt under 501(c)(3), do not pass muster when it comes to property tax exemption. That does not, however, seem to be what is at the heart of the recent decision by the Supreme Court of The State of Idaho in the case of Idaho Youth Ranch Inc v Ada County Board of Equalization. Rather it seems that planners may have gotten blindsided by applying a benign federal income tax principle in a different arena. The lesson in this case seems to be that we need to be a little more careful about the effects that using Limited Liability Companies can have.
Background
Idaho Youth Ranch Inc is a fairly substantial charity providing “troubled children a bridge to a valued, responsible and productive future”. In its most recent IRS filing (Form 990), it had $17,858,570 in revenue. In August 2006 Nagel Beverage Company approached IYR offering it a building at below appraisal as a non-cash charitable contribution. Nagel was a Pepsi bottler that sold its business to Pepsi Bottling Venutures LLC in 2009. The Nagel name persists in the form of a foundation, which in its most recently reported year (2012) distributed nearly a million dollars in educational grants. Being a Pepsi bottler, they must have been bottling Mountain Dew, so they have me rooting for them, not that it is much help.
In order to facilitate financing, Key Bank suggested that IYR acquire the property through a single member LLC. As described in a footnote there were some compelling federal tax reasons for the structure.
KeyBank encouraged the Youth Ranch to form a separate LLC to purchase and hold the property in order to capitalize on lower interest rates under a financing plan that would take advantage of the New Market Tax Credits Program. The Youth Ranch owned other properties. In order to qualify for the financing plan, each of those properties would need to meet the requirements of the New Market Tax Credits Program. As Nagel was required to sell the property quickly to complete the 1031 exchange, rather than demonstrating that each property owned by the Youth Ranch met the requirements of the New Market Tax Credits Program, it was deemed preferable to create the LLC to purchase and hold the property.
Putting on my federal tax hat, which is pretty much my favorite, I would think that was no problem. A single member LLC, unless it elects otherwise, is a disregarded entity. That means that you can freely take things out of it and put things into it without recognizing gain or loss and, for federal income tax purposes, transactions between you and your single member LLC have as much tax significance as transactions between me and my shadow. So the fact that the Youth Ranch was leasing from the LLC for the greater of $25,000 per month or its mortgage payments would be a transaction that could be washed right out of any federal tax significance.
Then they applied for a property tax exemption on the building, which apparently was solely dedicated to charitable use. Oops.
According to the plain language of the statute, if a property is leased by the owner, the property is not exempt from taxation. The plain language of the statute does not require an analysis of the purpose of the lease — whether commercial or charitable. The purpose of the lease is irrelevant.
The district court then identified the statutory language it perceived would be controlling: “if any building or property belonging to any such limited liability company, corporation or society is leased by such owner … then the same shall be assessed and taxed as any other property….”
That was what they heard from the District Court. The news from the Idaho Supreme Court was not any better.
Accordingly, we do not decide whether the district court correctly decided that the LLC was not a charitable limited liability company. The fact that the LLC rented the entirety of the property to the Youth Ranch is dispositive of this appeal. The district court correctly determined that the property was not exempt from taxation for the 2009 tax year.
The Lesson
This decision comes on top of a New York decision I wrote about yesterday, that appears to be entirely unrelated. It involved individuals being held liable for sales tax incurred by a defunct night club. What that decision and this decision have in common is that they both involved Limited Liability Companies and taxes other than federal income tax. There were no federal problems created by the use of Limited Liability Companies, but they were blindsided by other taxes.
This inspires me to enunciate another one of Reilly’s laws of tax planning. This would be the fourth. It goes something like “Your plan is not done till somebody who knows about every material tax you might be subject to has blessed it”. It is not nearly pithy enough and needs work, but it is the best I can do right now. Suggestions are welcome.