Rarely does an appellate court address property tax exemption, though sometimes legal ambiguities cause consternation and confusion for property owners and their legal counsel. Thankfully, the Illinois Court of Appeals recently issued a ruling in First United Methodist Church v. Dep’t of Revenue (“FUMC”) providing much needed clarification for nonprofit property owners through reconciling the Illinois Constitution, applicable statutory language on property tax exemptions, and the venerable six-factor charitable usage test first articulated in Methodist Old Peoples Home v. Korzen. This FUMC landmark decision additionally provides powerful reminders about the steep hill for exemption approval along with key insights for applying the charitable usage test. This article unpacks the court’s ruling and its implications, with related pointers too.
The Church’s Property Ownership and Usage
On May 7, 2021, the First United Methodist Church (Church) in Pekin, Illinois, was gifted a house named “Charis Place” on the condition that it be used for a housing ministry serving families in transition and not sold for general church purposes. The Church planned to utilize the house, a 1,070 square foot, two-bedroom, single-family residence, as part of a housing ministry intended to support families facing housing insecurity. The Church arranged for a two-year landlord-tenant agreement in which tenants would occupy Charis Place rent-free for the first 12 months with 50% of the utility costs covered by the Church. Rent would then increase to $100 in month 13 with an additional $25 per month thereafter through month 24. Under those terms, total rent over the two-year term would be $2,850, less than one-third of the roughly $9,000 the property might have generated at an assumed market rate.
Additional charitable elements were involved such as for tenants to apply payments toward existing debts and begin a savings program, for the Church to provide related education to the tenants, and for the tenants to meet periodically with a spiritual mentor. The Church also made many additional expenditures to improve the condition of the property for the residents. Notably, the Church included several provisions as part of the lease agreement, such as an addendum stating that the property was to remain crime-free throughout the residency. The first resident moved into Charis Place in September 2021. As explained below, details of this nature matter!
The Path to Exemption Appeal
On May 20, 2021, the Church filed an exemption application asserting religious qualification for tax year 2021. The Church later requested approval based on charitable qualification, even though the Church is a religious organization. The Illinois Department of Revenue (DOR) denied the application, finding no exempt usage.
The Church then appealed – first through the DOR’s administrative appeals process, then to county circuit court (as prescribed per applicable law), and then on further appeal to the Illinois Court of Appeals (Fourth District). Within the DOR’s administrative appeals process, the assigned Administrative Law Judge (ALJ) received additional evidence and then rejected the Church’s exemption application based on an ultimate finding of no religious usage, since the housing is a private single-family residence. The DOR then formally adopted the ALJ’s findings as its decision. The county circuit court disagreed with the DOR, concluding instead that the Church qualified for charitable property tax exemption notwithstanding its religious nature and based on the court’s finding that the property usage was indeed charitable based on all relevant facts. On further appeal, the Court focused on the DOR’s decision rather than the county circuit court’s ruling, consistent with legal requirements for appeals involving state government agencies.
Constitutional Dimensions of Property Tax Exemption - Usage
As the Illinois Court of Appeals recognized in FUMC, and as pivotal for this ruling, the property starting place for property tax exemption is the Illinois Constitution:
Article IX of the 1970 Illinois Constitution [(Ill. Const. 1970, art. IX)] generally subjects all real property to taxation. Under Illinois law, taxation is the rule. Tax exemption is the exception. The constitution does, however, give the legislature the authority to exempt particular kinds of properties from taxation. Section 6 of article IX provides as follows: “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. [Citations omitted.]
The key language here is “used exclusively, such as for religious, educational, and charitable purposes. Significantly, this constitutional language does not require that a specific type of exempt usage (e.g., charitable) correlate precisely with a charitable property owner (instead of a religious or educational owner).
Takeaways from FUMC
The Court’s FUMC ruling provides welcome clarity and potent reminders about property tax exemption, as follows.
Key Exemption Elements
Exemption qualification in Illinois (and many other states) is no easy task as a legal matter. The burden of establishing property tax exemption is admittedly high for applicants. As a threshold matter, and as a matter of state constitutional law, all exemptions must be strictly construed against the taxpayer. In applying the law to specific facts, the government is to resolve all debatable questions in favor of taxation. Exemption applicants thus must “clearly and conclusively” prove qualification for this very valuable economic privilege.
Additionally, the subject property must be “exclusively” used for a tax-exempt purpose. This is a fact-specific inquiry. According to Illinois case law interpreting the exemption statute, the term “exclusively” means “primary use,” and therefore may include consideration for time that property is used for exempt purposes, the percentage of property used for exempt purposes, the percentage of total visitors who use property for exempt purposes, and whether nonexempt uses directly and substantially support exempt uses. Some “incidental” (i.e., secondary) non-exempt use may be allowed, but only very little! The FUMC decision addresses these additionally important requirements in significant ways, as explained below.
The exemption qualification also must fit well within one of the specific categories, such as religious, educational, or charitable. Each word is a term of art. Churches and other houses of worship generally qualify for “religious” exemption based on their worship and related religious activities. The term “educational” narrowly connotes a school program with regular faculty, curriculum, student body and classrooms, which offsets government burdens to educate its citizenry. Self-improvement courses, adult education schools and programs that focus on a specific skill set often do not qualify as “educational” for purposes of tax exemption, nor do childcare centers. The FUMC decision provides pivotal clarification regarding exemption categories, which should bring welcome relief to nonprofit property owners that may fit within more than one of these categories, using the example of a religious organization (namely a church) engaged in charitable activities (i.e., the provision of housing on a charitable basis).
Exempt Ownership – Possibly Different From Exempt Usage? Yes!
The Court started its legal analysis with the 1968 Methodist Old Peoples Home v. Korzen case, in which the Illinois Supreme Court set forth the following test of whether an applicant qualifies for charitable exemption:
1. The benefits derived are for an indefinite number of persons;
2. The organization has no capital, capital stock, or shareholders and earns no profits or dividends;
3. The organization derives its funds mainly from public and private charity and holds them in trust for the objects and purposes expressed in its charter;
4. The organization dispenses charity to all who need and apply for it;
5. The organization does not appear to place obstacles of any character in the way of those who need and would avail themselves of the charitable benefits it dispenses; and
6. The organization actually and exclusively uses the property for charitable purposes.
As the FUMC Court recognized, no one factor is controlling; rather the question of exemption qualification must be decided on a case-by-case basis.
But as the Court further observed, the first five factors relate to the nature of the organization, with only the final factor regarding the property’s usage. As the Court noted, “[t]his is where things get murky.” More specifically, the Methodist Old People’s Home decision aims to square the Illinois Constitution’s “use”-oriented exemption language with Illinois charitable exemption statute (35 ILCS 200/15-65(a)), which requires both charitable ownership (“institutions of public charity”) and charitable usage. As the Court explained:
Therein lies the confusion. [Methodist Old People’s Home] purports to define the constitutional boundaries of a use-based charitable exemption, yet it speaks in terms of the hallmarks of a charitable institution. The statute, on the other hand, adds a separate requirement that the property be owned by a charitable institution, but case law seems to look to [Methodist Old People’s Home’s] constitutional use test to determine what constitutes a charitable institution.
Against this backdrop, the Court found it legally proper to apply the Methodist Old People’s Home’s multi-factor charitable test here even though the exemption applicant was a religious organization. The Court’s resulting conclusion is remarkable! As a result of FUMC, no more must an exemption applicant both be exclusively a charitable institution and engage in exclusively charitable usage. Stated differently, the Illinois Constitution’s “exclusive use” language must not be augmented by the Illinois charitable exemption statute, which has been consistently interpreted to preclude charitable exemption for a religious or educational property owner.
Applying the Charitable Factors
The Court then applied the Methodist Old People’s Home’s factors to the Church and its property usage, with important clarifying guidance regarding certain factors.
Financial Aspects
The Court confirmed that the Church easily meets the second and third factors, since it is a nonprofit organization with no stock or shareholders and its revenues come nearly entirely from membership contributions and similar charitable support. While the Church may receive some funds from the housing project, “[t]he record is clear that, far from being profitable, the [housing] project was a money-losing proposition for the Church.” Correspondingly, the Church’s evidence showing that this housing project was a wholly charitable endeavor was quite important, particularly since the DOR’s prior interpretation of related evidence was quite skeptical.
Related pointer: Make sure all financial information shows as clearly as possible that the exemption applicant is charitable in nature, obtaining all (or nearly all) of revenues from charitable sources.
Available Charitable Resources
The Court then determined that the Church satisfied the first and fourth factors regarding provision of charitable benefits to people in need. Again, the Court disagreed with the DOR, which focused instead on the fact that only a single-family residence was involved here. But as the Court found, the DOR was incorrectly “focused on the scale of the Church’s charitable effort, rather than its nature.” Further, “In focusing intently on the number of people served, the [DOR] essentially assumes that there can be only large charities, not small ones.” Continuing its legal analysis, the Court then instructed that the word “indefinite” may be applied proportionally, as here, to allow for fully charitable activities even though on a smaller scale. Indeed, the subject property itself was fully dedicated to charitable usage - albeit for one needy family at a time.
As the Court somewhat wryly explained:
In other words, the organization set aside the benefits of its charity for an identified group of persons. No authority has been brought to our attention to suggest that charity cannot, as here, be limited to those in need, nor that a charity that cannot physically accommodate all comers is not charitable in nature. Every soup kitchen might at some point run out of soup, and every orphanage may at some point find all of its beds filled; neither situation would diminish the charitable nature of the organization’s activities.
Related pointer: While a charitable exemption applicant should seek to demonstrate as strongly as possible that its benefits are broadly available to those in need, the applicant is not required to serve everyone to an infinite degree. It is more important to show clearly that the subject property is dedicated to exempt usage - and generously so.
The Details Really Matter!
Interestingly enough, the DOR took great issue with the Church’s lease for the housing project, finding that many provisions were commercial in nature: “they were strict and punitive and more closely resembled a traditional lease agreement than a characteristic of a charitable institution.” In the DOR’s view, the lease thus presented obstacles to charitable benefits, contrary to charitable qualification. But the Court disagreed, determining instead that most of the lease provisions criticized by the DOR were “minimal.” The Court extensively reviewed the evidence provided by the Church and found that the lease provisions establishing conditions for property usage were all reasonable or otherwise warranted. Moreover, the lease at issue “advances the overall goal of preparing the tenant to transition to independent housing (likely involving similar lease provisions). The terms of the arrangement remain markedly favorable to the resident of the property.”
Related pointer: The details indeed matter! Keeping the steep hill of exemption paramount, an exemption applicant should carefully develop all property usage details and make sure to effectively and winsomely present such information within the exemption application. Do not expect the DOR to view property usage the same way as the organizational leaders do, and avoid commercial verbiage when possible (e.g., “rent” and “lease”). See our firm’s blog article on third-party facility usage, which provides corresponding cautions.
Secondary Usage
At last, the final factor focuses squarely on usage. Here, as the Court found, the DOR “singularly focused on the tenant’s use of the property as a single-family residence, assuming that this overrides the Church’s charitable act in making the property available to families in need at a greatly reduced cost.” The Court concluded, however, that the DOR’s focus was myopic and misguided. The housing project was thoroughly charitable, namely for “the provision of reduced-cost housing to individuals in need of assistance and assistance in the transition to a more self-sustaining lifestyle.” In other words, the Court determined that the correct focus must be on the Church’s use of the property – for ministry – not on the tenant’s residential use. Again, the Church’s provision of extensive details to demonstrate charitable activities was quite persuasive:
The Church sustains [financial] loss explicitly for the benefit of the family, which learns the skills necessary to move toward housing independence. It is a cramped view of charity to think that only giving a man a fish can constitute charity, while teaching him to fish cannot. It has long been recognized that assisting those in need “ ‘to establish themselves for life’ ” is a charitable activity. Crerar v. Williams, 145 Ill. 625, 643 (1893) (quoting Jackson v. Phillips, 96 Mass. 539, 556 (1867)).
Consistent with Illinois case precedent, the Court concluded that a property may qualify for exemption even though it has a secondary usage – here, as a private residence. In other words, the “exclusive usage” requirement may be satisfied notwithstanding any secondary usage.
Related pointer: The word “exclusively” is a legal term of art for property exemption purpose. While other types of property use thus may be permissible, be very careful! As per the above cautions, an exemption applicant can risk denial of exemption approval through such additional complicating facts. Note too that the Court did not explicitly state at what point a property’s secondary use becomes a primary one, and such question should be avoided, if possible, within the exemption context.
Next Steps
FUMC should bring a sigh of relief for property owners seeking exemption and for attorneys practicing in this legal area. No longer should applicants need to strain to fit one exemption label over all its activities, such as a church that engages in charitable activities. Other comfort may be taken from the Court’s instructions about financial aspects, proportional charitable activities, scope of beneficiaries, and secondary usage. But caution and care remain warranted for successful exemption applications, as well as for preservation of exempt status. Property tax exemption remains an extremely valuable benefit for many nonprofit owners, well worth guarding carefully and effectively.
