In an interesting recent decision, International Schools Services Inc. v. West Windsor Township, N.J., the New Jersey Superior Court Appellate Division ruled that a not-for-profit organization whose purposes were to aid, promote and encourage educational organizations should lose its property tax exemption because its operation and use of the property was conducted for profit. This decision should make not-for-profits with affiliated for-profits or an ongoing working relationship with for-profits carefully scrutinize their activities with these for-profit entities.
The not-for-profit challenged property tax assessments for the 2002 and 2003 tax years on office condominium units it owned in the township. The not-for-profit argued the property was exempt under N.J.S.A. 54:4-3.6 as property actually used in the work of a not-for-profit corporation organized exclusively for the moral and mental improvement of men, women and children. Following the township’s denial of tax exemption, the not-for-profit appealed to the New Jersey Tax Court. The not-for-profit admitted that a portion of the property was leased to unrelated and related for-profit organizations, and did not claim an exemption for the portion of the property used for those purposes.
The NJ Tax Court found that the not-for-profit failed to satisfy the first of three prongs for its property tax exemption in New Jersey – to directly uplift the general public morally and mentally. On appeal, the NJ Superior Court Appellate Division reversed and remanded, finding that the not-for-profit did in fact meet the first-prong. The Tax Court thus had to determine whether the not-for-profit satisfied the second and third prongs for exemption (i.e., whether the not-for-profit actually used the property for the tax exempt purpose and whether the operation and use of the property were not conducted for profit). The NJ Tax Court ultimately found that the not-for-profit failed to satisfy the remaining two prongs, and entered judgment denying the exemption. The not-for-profit again appealed.
The court focused in on the third prong and its exception that exemption extend to cases where the exempt organization’s work is supported partly by fees received from the occupants, as long as the building is wholly controlled by and all of the income is used for the not-for-profit’s exempt purposes. The Tax Court found that the not-for-profit operated and maintained the property for the purpose of making a profit.
In short, all not-for-profits should be aware of and avoid any or a combination of: (i) the provision of professional services that are not “charged back;” (ii) below-market rents; (iii) unsecured loans that do not appear to have been timely repaid; (iv) lending their names and reputations to promote joint profit-making ventures; and (v) promotion of a for-profit’s products. These factors are potential downfalls for a nonprofit corporation.
Importantly, the court did not allow the not-for-profit to lose exemption on only a portion of the building because of its for-profit activities, as permitted by the statute and argued by the not-for-profit, but instead prevented property tax exemption entirely even though the court believed that the not-for-profit had a public benefit purpose and was operating to further that purpose. Accordingly, not-for-profits applying for property tax exemption in states that have partial exemption denials should carefully scrutinize their activities with for-profit entities to ensure that their properties would not be viewed as operating for profit, preventing them from claiming property tax exemption for the entire property.