Does your nonprofit own real estate? If so, is the property exempt from real estate taxes? Many Section 501(c)(3) organizations qualify for this valuable state tax benefit, which can save thousands of dollars annually depending on applicable tax rates and location. On what legal basis may a nonprofit apply for property tax exemption? When and how should the nonprofit proceed with an application? And what could jeopardize exemption approval? This article explains key foundational aspects, provides practical answers for application materials, and includes recommendations for avoiding pitfalls – primarily for property located in Illinois but with broader legal applicability as well.
Legal Framework for Property Tax Exemption
The historical background and public policy related to property tax exemption help frame an appropriate perspective of its practical steps. Property tax exemption has long been a creature of state law, distinct from federal tax exemption as reflected in Section 501(c)(3) of the Internal Revenue Code.[1] Consistent with our country’s deeply embedded respect for organizations that serve the public good, states have often authorized property tax exemption within their state constitution, as is true for Illinois.
Governments hold the power to tax, and correspondingly they hold the power to provide exemptions. As Chief Justice Marshall famously pointed out long ago, “the power to tax involves the power to destroy.”[2] The Illinois Constitution similarly provides for taxation power, with exemption allowed as an exception to such rule: “The General Assembly by law may exempt from taxation only the property of the State, units of local government and school districts and property used exclusively for agricultural and horticultural societies, and for school, religious, cemetery and charitable purposes” (Ill. Const., Art. IX, §6). As a matter of Illinois constitutional law, all exemptions must be strictly construed against the taxpayer, and all debatable questions must be resolved in favor of taxation. Further, applicants must “clearly and conclusively” prove their qualification.[3] Section 501(c)(3) status is thus not enough on its own; a nonprofit must satisfy the more stringent state legal standard.
This article focuses on religious, educational, and charitable property tax exemption. Many nonprofit organizations provide significant beneficial services such as relief to the poor, housing, improvement of morals and community life, care for vulnerable persons, medical services, and education. A critical underlying rationale for property tax exemption is organizations’ common relief of government burdens through providing benefits and services that would otherwise be borne through taxpayer expense. Accordingly, state exemption may be well warranted from a public policy perspective. In addition, the more intangible benefits derived from organizations engaged in religious activities, the fine arts, recreation, and other community services make them likewise deserving of property tax exemptions. In sum, such nonprofit organizations merit property tax exemption based on their recognized value to local communities and society at large.
Who Should Apply, and When
In Illinois and many other states, a property owner must apply for property tax exemption; exemption does not transfer with the land. For example, if a church purchases or is gifted real estate, the property’s tax-exempt status will not automatically continue from the prior owner to the new owner. The new owner must apply for property tax exemption, providing proof of ownership (e.g., a deed), related information about its qualified organizational status, and descriptive information about the property’s usage.
Ownership is critical. As one key distinction, property rented by a nonprofit from a business owner generally will not qualify for property tax exemption.[4] However, some potentially significant nuances may apply. For example, the concept of “ownership” may be encompassed within various financing mechanisms such as sale-leaseback arrangements or installment contract structures, in which the beneficial (or “equitable”) ownership resides with the nonprofit organization seeking exemption. The legal concept of ownership may also be achieved through a multi-entity structure to the benefit of a nonprofit parent entity. For example, an LLC owned by a Section 501(c)(3) may qualify for property tax exemption, and a Section 501(c)(2) title-holding company may qualify as well.
Property tax exemption applications should be prepared and submitted as soon as possible after ownership is obtained. In Illinois, property taxes are charged one year in arrears (i.e., payable the year following the tax accrual), and the exemption application process can take several months. Consequently, the sooner a nonprofit’s exemption application is filed, the sooner it can enjoy the resulting tax benefits. Sometimes these considerations involve significant cash flow aspects, since a nonprofit property owner may need to pay taxes during the pendency of a tax exemption application.
How to Apply, and What to Submit
In Illinois, nonprofit property owners must submit an exemption application to the county in which the property is located, typically to a county “Board of Review.” The application is reviewed first by this county agency, then forwarded to the Illinois Department of Revenue for a final decision. Typically, the county agency provides a recommendation to the Department of Revenue, and it may convene a hearing to ask for additional information. The Department of Revenue also may seek additional information from the applicant.
Exemption applications can be tricky, particularly with respect to the type of exemption sought – religious, educational, or charitable. Under Illinois law, each category is interpreted disjunctively; that is, a property owner should fit within only one category. The term “religious” generally means a house of worship, parsonage, or possibly related religious activities.[5] The term “educational” generally means institutions of learning that relieve government burdens, such as grammar schools (but not trade schools). The term “charitable” is the catch-all category for organizations that widely distribute charitable benefits, potentially but not necessarily to offset government burdens[6], through all sorts of possible activities.[7] Note, however, that to the extent any such organizations (or their occupants) charge fees, they can run afoul of the prohibition on operating with a “view to profit.” Fee waivers, discounts, and other charitable indicia thus may be critical to a successful exemption application.
An Illinois exemption application typically consists of the following documentation:
1. State-prescribed application form (e.g., the PTAX-300 form for non-religious applications);
2. Affidavit of use, describing the property owner and exempt usage;
3. Property deed;
4. The nonprofit’s articles of incorporation, any amendments thereto, and bylaws;
5. Organization’s IRS determination letter reflecting Section 501(c)(3) status (unless it is a church or other house of worship, which is categorically exempt under Section 508 of the Internal Revenue Code);
6. Property survey;
7. Floor plan, showing all exempt usage (and likewise identifying any non-exempt usage, to be excluded from the exemption certificate on a percentage basis);
8. Copies of any third-party non-commercial usage agreements, consistent with the absence of any prohibited view to profit (unless, per above, certain space is to be excluded from exemption);
9. Photos, interior and exterior, preferably showing tax-exempt activities (e.g., people worshipping, program participants engaged in activities, school children);
10. Recent revenue and expense statement, particularly to demonstrate all (or all significant) revenues derived from charitable sources along with tax-exempt expenditures;
11. If fees are charged, then fee waiver and fee reduction policies and related data showing that charitable benefits are widely distributed to all without undue obstacle[8];
12. Current tax bill (unless the property is exempt);
13. Website excerpts or other program materials reflecting exempt usage;
14. Applicant’s sales tax exemption certificate for retail purchases (since the same legal standard applies for the property owner in terms of Section 501(c)(3) status and qualified program activities);
15. “Adaptation and development” materials showing the property’s renovation, if such activity took a significant amount of time before the religious, educational, or charitable activities commenced, to qualify for property tax exemption during such time period; and
16. Copies of letters to taxing district notifying them of the exemption application (required if exemption approval will reduce the property’s assessed valuation by $100,000 or more).
Pitfalls to Avoid
First, exemption qualification is decided on a case-by-case basis in Illinois, so applicants should aim high to establish a winning case. For Illinois charitable exemption, a multi-factor test applies including the requirement that benefits be “widely available without undue obstacle.” [9] Consequently, any fees charged should allow for reductions and waivers on a charitable basis.
Second, certain usage of the space may disqualify the application either in full or in part. For example, any usage by a third-party business occupant (as opposed to a nonprofit entity) will not qualify for Illinois property tax exemption, even if the usage is for a ministry, educational, or charitable aim. Such regularly used portions of the subject property will likely fail to qualify for property tax exemption, even if they are also used for exempt purposes. Exemption hurdles may arise too in Illinois if non-commercial space usage is memorialized through a commercial lease, using terms such as “lease,” “rent,” landlord,” or “tenant.”[10] (Other states may not be so finicky.) If the property does not qualify for property tax exemption in full, then a valuation reduction application may be appropriate instead, so that the property owner may pay less taxes, rather than full taxes or none.
Third, nonprofits should not enter a property tax exemption application relying solely on Section 501(c)(3) tax-exemption. Remember, federal recognition is not enough. The specific property usage must qualify under applicable state law where the property is located, without any prohibited view to profit in connection with fees charged or specific usage.
Timing, Taxes, and Refunds
After the application is filed, the property owner should consider whether to pay any tax bills that may be issued while awaiting an exemption decision. Evaluation of related risks and other considerations may be warranted, depending on the applicant’s specific circumstances. In Illinois, once the exemption application is approved, the Illinois Department of Revenue will issue an exemption certificate for the specified tax year, which is typically the year of the application. The property owner may then apply to the local county officials for tax refunds for prior years in which taxes were paid, going back to the acquisition date (if three years or less before the exemption certificate year, with court action required for longer time periods). Qualification for such tax refunds depends on exempt property ownership and usage as described above, and such matters are typically within the county’s discretion.
Garnering Tax Success
Understanding the application requirements and common pitfalls outlined above will help an organization put forth a strong application for property tax exemption at the appropriate time. While a nonprofit cannot change the past – and sometimes a property will not qualify for tax exemption based on prior usage – the nonprofit’s leaders can plan effectively for the future.
Property tax exemption can be extremely valuable in terms of dollars and cents, as can Section 501(c)(3) federal income tax exemption. An exemption application for an eligible property is almost always worthwhile, but it should be undertaken with care to achieve an optimal outcome. A successful application will provide a nonprofit property owner with the opportunity to devote the nonprofit’s financial resources more fully to its missional aims.
[1] The Internal Revenue Code followed the Sixteenth Amendment’s ratification in 1913, which authorized federal income taxation. Correspondingly, precursor provisions to Section 501(c)(3) exempted corporations, companies, or associations organized and conducted solely for charitable, religious, or educational purposes, on principles similar to those on which state property tax exemption is based. In the landmark case Walz v. Tax Commission, the U.S. Supreme Court upheld a New York property tax exemption law as applicable to religious organizations consistent with “benevolent neutrality toward churches and religious exercise” requirements. 397 U.S. 664, 676, 90 S. Ct. 1405, 1415 (1970).
[2] McCulloch v. Maryland, 17 U.S. 316, 431 (1819). See also Murdock v. Pennsylvania, 319 U.S. 105, 112 (1943) (“The power to tax the exercise of a privilege is the power to control or suppress its enjoyment.”) and S. Diamond, Efficiency and Benevolence: Philanthropic Tax Exemptions in 19th Century America, E. Brody, Legal Theories of Tax Exemption: A Sovereignty Perspective,
[3] See, e.g., Provena Covenant Medical Center v. Department of Revenue, 236 Ill.2d 368, 925 N.E.2d 1131, 1144 (2010); Chicago & Northeast Illinois District Council of Carpenters Apprentice & Trainee Program v. Illinois Department of Revenue, 293 Ill.App.3d 600, 688 N.E.2d 721, 725 (1st Dist. 1997); In re Jones, 285 Ill.App.3d 8, 673 N.E.2d 703, 706 (3d Dist. 1996); and in our law firm's blog article here.
[4] Additionally, however, a leasehold tax may be imposed, and in that limited case exemption may be sought by the leaseholder.
[5] For more information about religious qualification, see our law firm’s Great Lakes blog article.
[6] See Provena Covenant Medical Center v. Department of Revenue, 236 Ill.2d 368, 925 N.E.2d 1131, 1145, 1148 (2010): “While Illinois law has never required that there be a direct, dollar-for-dollar correlation between the value of the tax exemption and the value of the goods or services provided by the charity, it is a sine qua non of charitable status that those seeking a charitable exemption be able to demonstrate that their activities will help alleviate some financial burden incurred by the affected taxing bodies in performing their governmental functions.”
[7] See Lena Community Trust Fund, Inc. v. Department of Revenue, 322 Ill.App.3d 884, 750 N.E.2d 1261, 1266 (2d Dist. 2001) (“There is no comprehensive way to define charitable activity.”); Randolph Street Gallery v. Zehnder, 315 Ill.App.3d 1060, 735 N.E.2d 100, 107 (1st Dist. 2000) (“Illinois Administrative Code, which governs the Department, embraces this broad concept of charity...'a charitable purpose may refer to almost anything which promotes the well-being of society’”), quoting 86 Ill. Admin. Code §130.2005(i)(2) (1996); Decatur Sports Foundation v. Department of Revenue of State of Illinois, 177 Ill.App.3d 696, 532 N.E.2d 576, 584 (4th Dist. 1988) (activities promoting physical fitness constitute legitimate charitable use and lessen governmental burdens); Highland Park Hospital v. State of Illinois, Department of Revenue, 155 Ill.App.3d 272, 507 N.E.2d 1331, 1338 (2d Dist. 1987) (“major criterion” for charitable use is relief of government burden); People ex rel. Hellyer v. Morton, 373 Ill. 72, 25 N.E.2d 504, 506 (1940) (approving charitable exemption for property dedicated to research work in horticulture and arboriculture); People v. Y.M.C.A. of Chicago, 365 Ill. 118, 6 N.E.2d 166, 169 (1936) (“charity” extends to rich as well as poor; charitable nature of organization depends on whether it is maintained for charitable purposes or to make profit).
[8] See, e.g., Methodist Old Peoples Home v. Korzen, 39 Ill. 2d 149, 157, 233 N.E.2d 537, 541-42 (1968).
[9] Methodist Old Peoples Home, 233 N.E.2d 537, 541-542; Provena Covenant Medical Center v. Department of Revenue, 236 Ill.2d 368, 925 N.E.2d 1131, 1145 (2010); Arts Club of Chicago v. Department of Revenue of State of Illinois, 334 Ill.App.3d 235, 777 N.E.2d 700, 707 (1st Dist. 2002) (factors are “guidelines rather than definitive requirements”).
[10] See also our firm’s “Making Room” series addressing third-party facility usage in terms of potential federal unrelated business income taxation, advisability of a facility usage policy, key components of a facility usage agreement, and additional property tax exemption aspects.
