The other day, Nate responded to many of Jana Riess’s criticisms of the City Creek mall in Salt Lake. As I read her piece, one sentence jumped out at me.
Before I look at that sentence, though, a couple disclaimers. First, I haven’t been to Utah in at least four years. As far as I know, the City Creek development plans hadn’t been developed yet.[fn1] Second, I can’t convince myself to care about City Creek. I’m neither from Utah, nor do I live there.[fn2] I don’t know the flow of Salt Lake, so I don’t have any idea if this development complements or ruins the city.[fn3]
In her piece, Jana says:
Moreover, such profits [from the sale of condos and lease of retail space] are tax-exempt.
To support that claim, she links to this KUTV story. That didn’t feel right to me, so I thought I’d run down the claim. And, it turns out, City Creek Reserve, Inc. (“CCRI”) may well not be taxable on rents it receives from retail tenants.[fn4] But the KUTV story doesn’t give us a good sense of why. So here’s what I can piece together:
You can read CCRI’s 2009 Business Income Tax Return here. Among other things, it tells us that, like the Church and the university for which I work, CCRI is a 501(c)(3) organization and, as such, is generally exempt from paying taxes.[fn5]
There are two big exceptions to this tax exemption, and those two exceptions apply to all 501(c)(3) organizations. First, if a tax-exempt organization borrows money to fund an investment, it will pay taxes on a portion of its return from that investment at ordinary corporate rates.[fn6] So if CCRI borrowed money, the KUTV story is wrong, and CCRI is liable for federal income taxes.
But that’s not terribly interesting, so let’s pretend that CCRI didn’t borrow any money to do the development. The other major way that a 501(c)(3) could owe income taxes is if it earns “unrelated business taxable income.”
Basically, unrelated business taxable income is income earned by a tax-exempt organization from participating in a business unrelated to its exempt purpose. So, for example, if the Church were to start manufacturing and selling macaroni, it would be taxable on its profits from those macaroni sales in the same manner as a taxable macaroni manufacturer.
The line between businesses related and unrelated to a tax-exempt’s exempt purpose can be a difficult one, on the margins, to parse. So, for example, advertising revenue the NCAA receives from the programs it sells at the NCAA tournament is not taxable as unrelated business taxable income, even though the ads may be the same ones that would appear in Sports Illustrated. Ad income from a monthly medical journal run by a tax-exempt organization, on the other hand, is taxable as unrelated business taxable income.
Intuitively, rent from commercial real estate tenants doesn’t seem to come close to the line. And actually, it doesn’t. Section 512(b)(3) of the Internal Revenue Code explicitly exempts from UBTI rents from real property. There is one exception to this exemption that may apply: if the rent is based on income or profits derived from the property, CCRI would be taxable on the rent.
Taubman says that it owns the property under a “participating lease” with CCRI. I don’t have any details on how that participating lease is structured but, if CCRI participates in Taubman’s income or profits, it will pay taxes on the rent it receives. On the other hand, if that participation is based on a fixed percentage of gross receipts or sales, CCRI will not be taxable on that income.
My ultimate conclusion: CCRI will probably not be taxable on the rent it receives from Taubman. If, however, CCRI borrowed money to invest in City Creek or if its participating lease is structured in a specific way, it will owe federal income tax on that rent.
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[fn1] And, if they had, I wasn’t aware of them at the time.
[fn2] I don’t mean this to be a subtle or not-so-subtle dig at Utah. I just don’t have any roots there, and I have very little family there, so development of Salt Lake’s downtown isn’t terribly high on my list of things to pay attention to.
[fn3] I will say, when in doubt, I don’t like malls. That said, I have a hard time objecting to the glitziness of the stores at City Creek. Its tenants read like a pretty standard list of mid-range chain retailers. But that may be because I work a block away from Chicago’s Magnificent Mile (and across the street from a Bentley dealership) and, before, I worked about five blocks from Times Square (which is not, by the way, home to upscale retailers, either). But that’s entirely to the side of the point of this post.
[fn4] I could be wrong, of course—all of the information I have about this deal is what’s publicly available on teh Internets, so there are undoubtedly details I’m not aware of. Interestingly enough (to me, anyway), CCRI wasn’t formed to do this deal: it was founded and received its tax-exempt status in 1941. (Which leads me to the question: is City Creek a geographical location in Salt Lake? or is the development named after CCRI (which seems kind of weird to me)? or is this just serendipitous naming?)
[fn5] Donors to CCRI can also take a deduction for their donations, though I’m not sure whether CCRI takes donations.
[fn6] As an example, let’s say that CCRI borrows $1 million, and invests that $1 million with $1 million of its own income in Apple stock. Apple pays a $200,000 dividend. CCRI will have to pay taxes, at ordinary corporate rates, on $100,000 of the dividend, but the other $100,000 will be exempt from taxation.
now we see the real reason for all that push about religious freedom. The church does not want to be taxed for its involvement in business and profit.
No offense, Dan, but where did that come from? The tax exemption has nothing to do with religious freedom. It has to do with long-standing tax policy decisions. Moreover, as the OP makes clear, a 501(c)(3) is taxable on its business profit.
Thanks, Sam, for this explanation. I had no idea that a 501(c)(3) might be exempt from taxation on something like City Creek.
Your post does raise again something I had wondered about–was this an all-cash deal? Or did the Church borrow some of that $1.5 billion? Anybody know?
Sam:
NCAA is a “regularly carried on” decision, the NCAA having conceded that program advertising was a not substantially related trade or business. And it is a pretty good bet that the rents CCRI receives does not depend on income or profits. All of which is to say that avoiding UBTI is a complex business, and my guess is that CCRI did it right, but only because it was carefully considered in advance.
The real question is whether you/we think there’s something wrong with the Church managing investments in a way that is sensitive to tax law, to minimize tax. I don’t. I think the legitimate questions are (1) whether the Church should hold reserves, and (2) whether there’s a right way and wrong way to hold reserves apart from or in addition to pure profit maximization? If the Church holds reserves at all (question 1), then I would think that minimizing tax is obvious and has no play in the “right way/wrong way” question.
Sam,
don’t mind me. you can erase that comment.
A shopping mall is a terrible use of land. Malls generate only $22,000 per acre per year in tax revenue, while low-rise mixed-use generates $70,000-90,000, and mid-rise mixed-use generates $550,000-800,000.
Part of the reason is the overbuilt parking lot that generally accompanies a mall. A single-use parking lot turns into a dead zone of urban blight after dark.
We are poor stewards of the Earth if we don’t make the best use of limited resources such as land. Shopping malls truly are immoral.
Thanks for this write-up, Sam. I’ve got a layman’s question that perhaps you could answer. In the penultimate paragraph you distinguish between “participating” in income or profits and receiving a fixed percentage of gross receipts. (The first is taxable, while the second is not.) How is receiving a fixed percentage of receipts not “participating” in the profits? If the stores do well, CCRI gets a bigger take even if the percentage is “fixed”…right?
Derek,
the City Creek Mall has an underground parking structure. If I weren’t the nuanced, quiescent guy that I am, I might say that blanket condemnations without bothering to get the facts is truly immoral.
How is receiving a fixed percentage of receipts not “participating” in the profits? If the stores do well, CCRI gets a bigger take even if the percentage is “fixed”…right?
If you are truly participating in profits, you have a stake in both receipts and expenses. To remain tax exempt, you have to give up your stake in the expenses. Tough call, huh?
Which makes me question Chris Kimball’s assertion that UBTI will be avoided only because it was carefully considered in advance. If I were CCRI, I would be seeking a percentage of the gross rather than the net even in the absence of UBTI.
LL, Thanks for the explanation. It could be a “tough call” if one must give up the potential for much larger returns in exchange for remaining tax-exempt.
Adam G., there is no such development called the “City Creek Mall”. This was the source of my confusion. By Hanlon’s razor, I will assume the deception from you and the author if this article was purely innocent.
Sam, City Creek is a geographical feature, so naming businesses or other organizations after it normally wouldn’t be that odd (Salt Lake City being analogously named). The oddish thing about it, though, is that City Creek had been diverted and run through underground pipes for a very long time (as early as 1941? I don’t know), and has only been brought back to the surface in places again beginning with two parks (one city, one church) at North Temple and State Street, then continued with the landscaping for the Conference Center and Church History Library, and now for a further distance in one of its forks with the City Creek mall landscaping.
Now back to taxes …
Derek, for a name that may not exist in formal business documents, “City Creek Mall” returns an astonishingly large number of hits at Google.
Mark B, it surprised me, too. I was ready to write up how Jana and KUTV were wrong, wrong, wrong. So I’m kind of glad I looked first.
Thanks, Ardis. That’s cool that, at least in places, the creek is surfacing again; to some extent, that balances my visceral dislike of malls/shopping centers/whatever the development is.
Robert, the funny thing is, like LL says, theoretically, the rent CCRI collects can be higher if you take the tax exemption. Essentially, if your lease says, “The lessee will pay the lessor 10% of its profits [that is, income less expenses],” the income will be taxable to CCRI. If, on the other hand, it says, “The lessee will pay the lessor 10% of the cash that comes across the counter [irrespective of costs],” that money will be exempt from taxes. The theory, I suspect, is that, if your rent takes into account both income and costs, it looks a lot more like you’re an active participant in the game. If it doesn’t take costs into account, otoh, it looks more like you’re a passive investor/landlord.
And, although I haven’t seen the lease, I suspect that the participation is with respect to the rents Taubman collects. If I’m right, CCRI’s income won’t depend on how well Tiffany’s sells diamonds. Rather, it will depend on how well Taubman rents out its storefronts.
Thanks, Sam. As you explain it, it seems that that’s a rather odd loophole in the 501(c)(3) UBTI code.
I’m probably just being thick-skulled, but wouldn’t it be more likely that any deal between CCRI and Taubman would reward greater risk-taking on the part of CCRI? In other words, perhaps they could get 10% of profits (the taxable scenario) or 1% of gross receipts (tax-free). I’m just pulling those numbers out of the air, but wouldn’t it be more likely that greater risk (and greater tax burden) would offer potentially greater rewards?
Robert, I suspect that your intuition is right; more likely than not, we’re not talking about 10% of gross receipts vs. 10% of net income. And I suspect that it would be easier to negotiate for a higher upside where CCRI was willing to also accept the downside (so your 10%/1% numbers are probably the right way to think about it).
If I have time, I’ll see if I can find out why Congress put in the exception for real property, but I can’t promise that I’ll find the time.
One of the largest landowners in Manhattan is Trinity Church (so says their website). You think their lobbyists might have encouraged Congress to help them avoid taxes on rental income from that property?
There’s no magic in the economics of tax-exempt investing. All the normal gross vs net, risk/reward, ROI, time value, supply and demand, competitive pricing, etc. concepts apply. Sometimes there may be a question whether the tax-exempt will accept a lower return because of the exempt status, but that mostly works out in competitive pricing rather than explicitly related to exemption.
Sam, by memory, I think you will find that the participation rule is an active/passive distinction (as you suggested in a reply).
As for lobbying for a rent exception, it’s worth remembering that while churches and schools hold a lot of land, most is for their direct use. When talking about tax-exempt investment in real estate, the pension fund money is huge and probably dominates any policy discussion.
City Creek flooded as part of the 1983 flooding in Utah that also raised the Great Salt Lake to inundate I-80. From the canyon mouth to 13th South, State Street was banked with sandbags and crossed with footbridges to channel the water down to a larger capacity storm drain. My belief is that the planning done to cope with future potential floods led to the use of City Creek in planning of the public park in the canyon, the small Church park east of the Church Office Building, the artificial creek bed along the south edge of the Conference Center block, and now the water feature that unifies the two blocks on either side of Main Street between South Temple and First South.
I am thinking that the posessory interest of business tenants in the development is taxable real property. I do know that if a private entity leases Federal land (which is tax exempt) and builds a privately owned structure on it, the structure can be taxed as normal real property by the state and local governments if the Federal initerest is merely proprietary rather than exclusive jurisdictional (meaning the state has no authority to enforce its laws in certain Federal enclaves, such as many pre-World War II military bases). If so, the business tenants could be paying real property taxes, personal property taxes on inventory, sales taxes and income taxes.
The Church ranches owned in Texas are all taxed.
Raymond Takashi Swenson — do you know if anyone has contacted the Church’s contact person to ask the tax question?
So often, in practical terms, if it generates revenue directly, rather than indirectly (i.e. a church social hall used for bingo is generating revenue indirectly, a church owned bingo hall is generating it directly) it ends up being taxed.
;)
So Sam, given your scenarios in Situation 14, it sounds like its giving REIT status to the church venture, without the requirement to distribute the income to the shareholders, no? Or am I missing something? I guess the notion being if the Church couldn’t get tax-exempt status here, it could at least turn the investment into a REIT, with the same results.
I too find it strange that this would not be taxed. It kind of bothers me, but will have to wait until April 15 passes to really let it keep me up at night.
In my local downtown ‘urban renewal’ project, ultimately the tax payer would’ve spent far more than 1.5 billion to do something similar. In Kansas City we spent billions, and the City continues to subsizide loans for non-profitable businesses… in this way, could the entire investment be seen as a ‘benefit-in-kind’ for the city/state.
RE: #20 Stephen M.
It is my understanding that if the ranch is a commercial business operation versus a Chruch welfare operation, then it is taxed. If it is a welfare ranch supplying beef to the Church Welfare program then it is not taxed, at least so it is/was in Nevada, several years ago when I was in a position to know.
I think city creek mall has been terrific for salt lake city’s economy. While much of the country was mired in a lack luster period of growth salt lake was a beehive of activity and this might just be the thing to jump start a revival of a decaying downtown. Moving forward this will only bring viditors of all types to come and see what salt lake has to offer. Brilliant i say!