In general, when a charity or retirement account, such as an IRA or 401(k) Plan invest in income producing real estate, the rental income attributable such activity is generally exempt from tax. These investments are usually structured so that income derived from the real estate is exempt from the federal income tax on unrelated business taxable income under Internal Revenue Code section 511(a).
Section 511(a) subjects most organizations exempt from federal income taxation under section 501(a), and certain governmental colleges and universities, to a tax on their “unrelated business taxable income” (“UBTI“), as defined in section 512. With respect to an IRA or 401(k) Plan retirement plan, any active business activity would be considered “unrelated business taxable income.”
Internal Revenue Code Section 512(b)(3), enacted by the Revenue Act of 1950, modifies the definition of unrelated trade or business by excepting certain types of rents:
In the case of rents —
(A) Except as provided in subparagraph (B), there shall be excluded —
(i) all rents from real property (including property described in section 1245(a)(3)(C)), and
(ii) all rents from [certain] personal property.
Section 512(b)(3)(B) includes rent in UBTI (i) if more than 50% of the rent is attributable to personal property or (ii) if the amount of rent depends in whole or in part on the income or profits derived by any person from the property leased (other than an amount based on a fixed percentage or percentages of receipts or sales).
Treas. Reg. § 1.512(b)-1 sets forth guidance with respect to what types of income falls under the rental income exception for UBTI:
Whether a particular item of income falls within any of the modifications provided in section 512(b) shall be determined by all the facts and circumstances of each case. . . . [I]f a payment termed “rent” by the parties is in fact a return of profits by a person operating the property for the benefit of the tax-exempt organization or is a share of the profits retained by such organization as a partner or joint venturer, such payment is not within the modification for rents.
Treas. Reg. § 1.512(b)-1(c)(5) is the most important regulation in this area and provides:
Payments for the use or occupancy of rooms and other space where services are also rendered to the occupant, such as for the use or occupancy of rooms or other quarters in hotels, boarding houses, or apartment houses furnishing hotel services, or in tourist camps or tourist homes, motor courts or motels, or for the use or occupancy of space in parking lots, warehouses, or storage garages, does not constitute rent from real property. Payments for the use or occupancy of entire private residences or living quarters in duplex or multiple housing units, of offices in any office building, etc., are generally treated as rent from real property.
Thus, based on the language in Treas. Reg. § 1.512(b)-1(c)(5), income generated from a rental storage facility will likely not be considered rent from real property and, thus, would be subject to the UBTI tax rules.