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The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.
complex, subject to the mortgage on the prop- organization acquires debt-financed property in To be directly connected with debt-financed
erty, for additional stock in its wholly owned a complete or partial liquidation of a corporation property or with the income from it, a deductible
subsidiary. The exchange satisfied all the re- in exchange for its stock, the organization's ba- item must have proximate and primary relation-
quirements of section 351(a). sis in the property is the same as it would be in ship to the property or income. Expenses, de-
The transfer of appreciated debt-financed the hands of the transferor corporation. This ba- preciation, and similar items attributable solely
property from the tax-exempt hospital to its sis is increased by the gain recognized to the to the property qualify for deduction, to the ex-
wholly owned subsidiary in exchange for stock transferor corporation upon the distribution and tent they meet the requirements of an allowable
didn’t result in a gain subject to the tax on unre- by the amount of any gain that, because of the deduction.
lated business income. distribution, is includible in the organization's
gross income as unrelated debt-financed in- For example, if the straight-line depreciation
Gain or loss on disposition of certain come. allowance for an office building is $10,000 a
brownfield property. Gain or loss from the year, an organization can deduct depreciation
qualifying sale, exchange, or other disposition Computation of debt/basis percentage. The of $10,000 if the entire building is debt-financed
of a qualifying brownfield property (as defined in following example shows how to compute the property. However, if only half of the building is
section 512(b)(19)(C)), which was acquired by debt/basis percentage by first determining the debt-financed property, the depreciation al-
the organization after December 31, 2004, is average acquisition indebtedness and average lowed as a deduction is $5,000.
excluded from UBTI and is excepted from the adjusted basis.
debt-financed rules for such property. See sec- Capital losses. If a sale or exchange of
tions 512(b)(19) and 514(b)(1)(E). Example. On July 7, an exempt organiza- debt-financed property results in a capital loss,
tion buys an office building for $510,000 using the loss taken into account in the tax year in
Average acquisition indebtedness. This is $300,000 of borrowed funds. The organization which the loss arises is computed as provided
the average amount of outstanding principal files its return on a calendar year basis. During earlier. See Gain or loss from sale or other dis-
debt during the part of the tax year that the or- the year the only adjustment to basis is $20,000 position of property under Computation of
ganization holds the property. for depreciation. Starting July 28, the organiza- Debt-Financed Income, earlier.
Average acquisition indebtedness is compu- tion pays $20,000 each month on the mortgage If any part of the allowable capital loss isn’t
ted by determining how much principal debt is principal plus interest. The debt/basis percent- taken into account in the current tax year, it may
outstanding on the first day in each calendar age for the year is calculated as follows: be carried back or carried over to another tax
month during the tax year that the organization year as provided in section 1212 , without appli-
holds the property, adding these amounts, and Debt on first day cation of the debt/basis percentage for that
dividing the sum by the number of months dur- of each month year.
ing the year that the organization held the prop- Month property is held
erty. Part of a month is treated as a full month in July 300,000 Example. X, an exempt educational organ-
computing average acquisition indebtedness. August 280,000 ization, owned debt-financed securities that
September 260,000 were capital assets. Last year, X sold the secur-
Indeterminate price. If an organization ac- October 240,000 ities at a loss of $20,000. The debt/basis per-
quires or improves property for an indetermi- November 220,000 centage for computing the loss from the sale of
nate price (that is, neither the price nor the debt December 200,000 the securities is 40%. Thus, X sustained a capi-
is certain), the unadjusted basis and the initial Total $1,500,000 tal loss of $8,000 (40% of $20,000) on the sale
acquisition indebtedness are determined as fol- Average acquisition of the securities. Last year and the preceding 3
lows, unless the organization obtains the IRS's indebtedness: tax years, X had no other capital transactions.
consent to use another method: $1,500,000 ÷ 6 months $ 250,000 Under these circumstances, the $8,000 of capi-
• The unadjusted basis is the fair market tal loss may be carried over to succeeding
value of the property or improvement on Basis years (subject to limitations under section 1212)
the date of acquisition or completion of the As of July 7 510,000 without further application of the debt/basis per-
improvement. As of December 31 490,000 centage.
• The initial acquisition indebtedness is the Total $1,000,000
fair market value of the property or im- NOL. If, after applying the debt/basis percent-
provement on the date of acquisition or Average adjusted basis: age to the income from debt-financed property
completion of the improvement, less any $1,000,000 ÷ 2 $ 500,000
and the deductions directly connected with this
down payment or other initial payment ap- Debt/basis percentage income, the deductions exceed the income, an
plied to the principal debt. organization has an NOL for the tax year. This
$250,000 ÷ $500,000 = 50%
amount may be carried over to other tax years
Average adjusted basis. The average adjus- in the same manner as any other NOL of an or-
ted basis of debt-financed property is the aver- ganization with UBTI. (For a discussion of the
age of the adjusted basis of the property as of Deductions for NOL deduction, see Modifications under De-
the first day and as of the last day that the or- Debt-Financed Property ductions, earlier in this chapter.) However, the
ganization holds the property during the tax debt/basis percentage is not applied in those
year. The deductions allowed for each debt-financed other tax years to determine the deductions that
Determining the average adjusted basis of property are determined by applying the debt/ may be taken in those years.
the debt-financed property isn’t affected if the basis percentage to the sum of allowable de-
organization was exempt from tax for prior tax ductions. Example. Last year, Y, an exempt organi-
years. The basis of the property must be adjus- zation, received $20,000 of rent from a debt-fi-
ted properly for the entire period after the prop- The allowable deductions are those directly nanced building that it owns. Y had no other
erty was acquired. As an example, adjustment connected with the debt-financed property or UBTI for the year. The deductions directly con-
must be made for depreciation during all prior with the income from it (including the divi- nected with this building were property taxes of
tax years whether or not the organization was dends-received deduction), except that: $5,000, interest of $5,000 on the acquisition in-
tax-exempt. If only part of the depreciation al- debtedness, and salary of $15,000 to the build-
lowance may be taken into account in comput- 1. The allowable deductions are subject to ing manager. The debt/basis percentage with
ing the percentage of deductions allowable for the modifications for computation of the respect to the building was 50%. Under these
each debt-financed property, that doesn’t affect UBTI (discussed earlier in this chapter); circumstances, Y must take into account, in
the amount of the depreciation adjustment to and computing its UBTI, $10,000 (50% of $20,000)
use in determining average adjusted basis. 2. The depreciation deduction, if allowable, of income and $12,500 (50% of $25,000) of the
Basis for debt-financed property ac- is computed only by use of the deductions directly connected with that income.
quired in corporate liquidation. If an exempt straight-line method.
Page 20 Chapter 4 Unrelated Business Taxable Income
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