Non-Profit/For-Profit Partnerships and Affordable Housing

In order to avoid risking its tax exemption, a tax-exempt organization on must focus on two areas when structuring development partnerships with for-profit entities.  First, it is critical that an organization maintain control over the activities of the partnership in order to assure that the partnership furthers its charitable purpose.  Second, if the organization does not maintain formal control of the partnership with for-profit developers, the partnership must be “an insubstantial part” of the organization’s activities.  The organization risks losing its tax exemption (or, depending on whether the activity is substantial, being subject to unrelated business income tax (“UBIT”)) unless: (i) the partnership’s governing documents are compliant with Rev. Rul. 2004-51, and the for-profit partner acts in accordance with those documents; or (ii) the organization can demonstrate effective control of the day-to-day management of the partnership, based on both the rights provided in the governing documents and a demonstrated willingness to exercise those rights.  In the absence of formal control or compliance with Rev. Rul. 2004-51, retention of effective control is a highly fact-specific analysis that does not yield itself to sound planning.

The substantiality of the non-charitable activities of an exempt organization/for-profit partnership will determine the effect of ceding control to the for-profit partner.  Substantiality is also a highly fact-specific inquiry, and reliance on percentage limitations established in prior cases is risky.  If control of an exempt organization/for-profit partnership is ceded to the for-profit partner but the activity is not “substantial,” the exempt organization will not lose its Code § 501(c)(3) status, but it will be subject to the UBIT.  Conversely, if control is ceded and the unrelated business activity is “substantial,” the exempt organization will lose its tax exemption.

Arrangements between nonprofit housing corporations and for-profit developers will be closely examined to be sure that they do not result in impermissible private benefit or inurement.  Rev. Proc. 96-32 provides: If an organization furthers a charitable purpose such as relieving the poor and distressed, it nevertheless may fail to qualify for exemption because private interests of individuals with a financial stake in the project are furthered.  For example, the role of a private developer or management company in the organization’s activities must be carefully scrutinized to ensure in the absence of inurement or impermissible private benefit resulting from real property sales, development fees, or management contracts.

Most of the literature in connection with nonprofit/for-profit partnerships deals with nonprofit hospitals which, like nonprofit housing corporations, are exempt as “charitable” organizations under Code § 501(c)(3). Because both types of organizations must meet the same general tests for tax exemption under Code § 501(c)(3), these materials are instructive on how a tax-exempt organization must structure its partnerships.  The IRS has also issued several private letter rulings dealing with nonprofit housing corporations that, although not reliable as binding precedent, are indicative of how the IRS views these arrangements.