July 5, 2006

Rooms to Rent (Tax Free)

Looking to eke out extra money wherever possible in an era of declining revenues, many colleges and universities rent out their dormitories or other residence halls when they’re not in use — offering a convenient and often low-cost housing alternative to prospective students and their parents, guest speakers, and even members of the public.

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A new ruling from the Internal Revenue Service may expand institutions’ ability to offer such services, by allowing them to rent rooms to a broader array of people without having to pay taxes on the revenue they collect in the process.

The private letter ruling, which the tax agency issued in March but released last month, came in response to a request from a nonprofit theology school. (Private letter rulings like this one formally apply only to the entity in question, but are closely examined by others for a sense of the government’s view.)

The institution provides “temporary living quarters” for an array of people: family members of students and faculty members, potential students and their parents, guest speakers at the institution, guests of other regional nonprofit groups who speak or perform at the theology school, and members of the general public. Are the revenues the school receives for providing that housing taxable as “unrelated business income,” school officials asked the IRS?

The answer: only when the rentals are to members of the general public, the IRS ruling said. Federal tax law requires colleges and other nonprofit entities to pay “unrelated business income” tax on any revenues that are not “substantially related” to their primary tax-exempt purpose — in the case of colleges, providing an education. In the theology school’s case, the IRS said, “the provision of living quarters for your faculty has a substantial causal relationship to furthering your exempt purpose, as well as the provision of temporary living quarters to family members of your students and faculty, potential students, family members of potential students, and guest speakers at your institution.” Proceeds from room rentals to the general public, however, would remain taxable.

The IRS’s interpretation in this case, if widely adopted as policy, would represent a broadening of the government’s view of revenues like this, said Bertrand Harding Jr., a lawyer who specializes in nonprofit and higher education tax issues.

The prevailing position until now was contained in a 1979 general counsel memorandum (GCM 38060) involving a college’s hotel rentals to family members of prospective students, which the IRS found to be taxable because it was little different from the family members’ staying at a local for-profit motel. That ruling was generally viewed as applying to dormitory rentals, too, Harding said.

The ruling in the theology school’s case suggests a “substantial change from the prior position,” Harding said. And “it may serve to expand the IRS’s position for what is OK from a hotel standpoint, too.”

— Doug Lederman

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