Real Estate Journal — Owners, Developers & Managers — July 25 - August 14, 2014 — 3B
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M id A tlantic
O wners , D evelopers & M anagers By Sara Palovick, WithumSmith&Brown Special rules for leasing to tax-exempt entities
L andlords should be aware that if they have a tenant that is a tax-exempt entity leas- ing nonresi- dential real p r o p e r t y , special rules for deprecia- tion may ap- ply. A tax- ex- empt entity is defined as: •The United States, any state or its political subdivi- sion, any U.S. possession, or any agency or instrumentality of the foregoing. •An organization exempt from Federal income tax, in- cluding any organizations that were exempt at any time dur- ing the five-year period ending on the date the organization first used the property. •Any foreign person or en- tity, defined as a foreign gov- ernment, any international organization, any instrumen- tality of the foregoing, and any other person who is not a U.S. person. This does not apply where more than 50% of the gross income derived by the foreign person or entity is subject to Federal income tax. •Any Indian tribal govern- ment under Code Sec. 7701(a) (40). Landlords should also be aware that leasing property to a partnership with a partner that is a tax-exempt entity, a share of the property is treated as leased to that tax- exempt entity. Once identified that a land- lord is leasing to a tax-exempt entity, a determination must be made if this results in a disqualified lease under Code Sec. 168(h)(1)(A). A disquali- fied lease means any lease to a tax-exempt entity but only if: 1.Part or all of the property was financed (directly or in- directly) by an obligation the interest on which is exempt from tax under Sec. 103(a) and such entity (or related entity) participated in such financing; 2.There is a fixed or deter- minable price purchase or sale option which involves such entity (or related entity) or there is the equivalent of such option; 3.The lease has a term in excess of 20 years; or 4.The lease occurs after a sale (or other transfer) of the property by, or lease of the property from, such entity Sara Palovick
(or a related entity) and such property has been used by such entity (or related party) before sale (or other transfer) or lease. With regard to determining the lease term, for both resi- dential rental property and nonresidential real property, options to renew will be taken into account unless the op- tion is to renew at fair value, determined at the time of the renewal. The special depreciation rules will apply only if the portion of the property leased to tax-exempt entities in a
disqualified lease is more than 35% of the property. For example: If a landlord leases office space to a tax- exempt entity that makes up 10% of the total space for lease in the building, excluding com- mon area, and has a lease term of 25 years, since the total space leased to the tax-exempt entity is less than 35% of the property, normal depreciation rules apply. Tax-exempt use property must be depreciated under the MACRS alternative deprecia- tion system (ADS) under Code
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