IS YOUR PROPERTY TAX EXEMPT? DON’T BET ON IT
Pennsylvania may be at the forefront of a national trend that has seen local governments remove or modify the favorable property tax treatment for nonprofits, particularly hospitals and universities. Municipalities and school districts are always on the hunt for additional tax revenue, and successfully challenging an exemption is one way to achieve that goal.
Exemption law is rooted in the Pennsylvania Constitution, which permits the exemption of “institutions of purely public charity,” Pa. Const. Art. VIII, §2(a)(v). However, there is no statute defining a “purely public charity.” Hospital Utilization Project v. Commonwealth first laid out the Pennsylvania Supreme Court’s vision of a clear standard, requiring that an exempt entity must: 1) advance a charitable purpose; 2) gratuitously provide a substantial portion of its services; 3) benefit a substantial and indefinite class of persons who are legitimate subjects of charity; 4) relieve the government of some of its burden; and 5) operate free from private profit motive (“HUP Test”).
In 1997, the passage of the “Institutions of Purely Public Charity Act” (“Charity Act”), resulted in the adoption of the HUP Test and the creation of additional eligibility tests. While the Charity Act was intended to reduce confusion, the courts interpreted the Charity Act as adding a second layer of criteria, i.e., an organization must satisfy the HUP test and the Charity Act test. A tough nut to crack.
Litigation ensued. In one case, a court revoked the tax exemption of a Jewish summer camp on the grounds that it did not relieve the government of some of its burden. In another case, a court considered the exemption claim of a wholly-owned subsidiary of a Section 501(c)(3) charitable trust. The Trust’s sole purpose was to own, operate and maintain a historic property. The Chester County Board of Assessment denied a full exemption but granted a 72% exemption because that portion of the property was leased to other nonprofits. On appeal, the Commonwealth Court remanded the case to the trial court to determine whether each of the five prongs of the HUP test had been satisfied.
So once granted, is a tax exemption ever safe from challenge? The answer is no. Local taxing authorities have very little, if anything, to lose by challenging an exemption. The property owner must also understand that even though the challenge was initiated by the taxing authority, the burden of proving entitlement to an exemption remains with the property owner.
If you must defend a challenge in court, do not assume that the initial grant of an exemption by the county board will hold much weight. When it comes to the burden of proof, a court may be far more exacting. An organization loses if it is unable to meet just one element of the HUP test. Problems often arise due to a sale. If the property becomes a revenue source from the payment of rent, or if a tenant receives the benefits of the owner’s charity, the exemption may be lost.
Charitable organizations should keep the following principles in mind when structuring lease arrangements: (1) the tenant should share in the owner/charity’s mission and use the property in furtherance of that mission; (2) the overall leasing arrangement should not be profitable, i.e., rent that is at or below market rates; (3) the owner/charity should be responsible for building maintenance and improvements; and (4) the owner/charity should continue to occupy a portion of the leased property and should maintain its right to continued possession and control. Exempt status generally cannot be granted on the basis that the tenant, rather than the owner, is an institution of purely public charity.
Nonprofit entities must understand the importance of the HUP Test and required burden of proof. A property owner must have well-drafted documents and present strong testimony to push back against increased scrutiny from local taxing jurisdictions.
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