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Volume 10 - Opinions of Counsel SBRPS No. 88

Opinions of Counsel index

Nonprofit organizations exemption (generally) (leased property - rent limitation: carrying, maintenance and depreciation charges) - Real Property Tax Law, §§ 420-a, 420-b:

A nonprofit organization may lease its property to certain other organizations [e.g., another nonprofit organization] and still receive an exemption pursuant to section 420-a or 420-b of the Real Property Tax Law, provided the rent charged does not exceed the property’s carrying, maintenance, and depreciation charges.

Carrying charges are those charges (exclusive of penalties) necessary to carry or maintain the property without foreclosure.

Maintenance charges include costs to preserve and repair property, but do not include enhancements that increase the value of the property, replacements that suspend deterioration, or changes that appreciably prolong the life of property.

Depreciation is a decline in value of property caused by wear or obsolescence usually measured by a formula which reflects those elements over a given period of useful life of property.

We have been asked whether a nonprofit organization receiving an exemption on property under section 420-a or 420-b of the Real Property Tax Law may still receive the exemption if it leases that property to another entity. It may, provided that (1) the lessee would be eligible to receive one of the particular exemptions specified in the statute if it owned the property and (2) the rental is limited.

Sections 420-a [mandatory class] and 420-b [optional class] both require that title to the property for which exemption is sought be in a nonprofit organization that is organized or conducted exclusively for exempt purposes and that the property be used exclusively for such purposes. The term “exclusively” has been defined in this context as principally or primarily (Association of Bar of City of New York v. Lewisohn, 34 N.Y.2d 143, 313 N.E.2d 30, 356 N.Y.S.2d 555 (1974); see also, Hapletah v. Town of Fallsburg, 79 N.Y.2d 244, 590 N.E.2d 1182, 582 N.Y.S.2d 54 (1992)).

Subdivision two of each section provides that, if property otherwise eligible for exemption is leased or used for nonexempt purposes, it shall be subject to taxation. However, the same subdivisions further provide that the property may still be exempt if it is leased to an organization which is itself eligible for exemption pursuant to certain RPTL sections (including §§ 420-a and 420-b) enumerated in subdivision two, provided “any moneys paid for such use do not exceed the amount of the carrying, maintenance, and depreciation charges of the property or portion thereof.” This limitation on rents was intended to assure that the statute cannot in any way be used to provide a profit for tax exempt corporations (Sisters of St. Joseph v. City of New York, 49 N.Y.2d 429, 403 N.E.2d 150, 426 N.Y.S.2d 444 (1980)).

In order to determine the maximum amount of rent allowed to be collected by the property-owning nonprofit organization, then, it is necessary to add those three categories of expenditures. The terms “carrying charge,” “maintenance charge,” and “depreciation charge” are not defined in the RPTL. However, since it is a rule of statutory construction that words in a statute are to be given their ordinary and usual meaning (McKinney’s Statutes, § 232), judicial interpretations of these terms, although used in other contexts, are helpful.

Carrying charges have been defined as those charges (exclusive of penalties) necessary to carry or maintain the property without foreclosure (Garthley v. Garthley, 20 Misc.2d 620, 194 N.Y.S.2d 557 (Sup.Ct., Nassau Co., 1955)). Expenses included in this definition are mortgage interest, taxes, insurance, repairs, and assessments for garbage disposal, sewer, and water (Garthley v. Garthley, supra; In re Campbell’s Estate, 164 Misc. 640, 299 N.Y.S. 451 (Surr.Ct., N.Y. Co., 1937); In re Cutler’s Estate, 9 Pa. D.&C.2d 238 (Montgomery Co., 1956); Boyland v. Perales, 205 A.D.2d 759, 613 N.Y.S.2d 917 (2d Dept. 1994)). A charge for a managing agent’s assistant who executed leases and supervised repairs and purchases, and an accounting charge for the preparation of operations reports have also been held to be reasonable carrying charges (Application of Metropolitan Life Ins. Co., 174 Misc. 385, 21 N.Y.S.2d 261 (Sup.Ct., Bronx Co., 1940)). However, amortization of mortgage principal for these purposes is not included in carrying charges (In re Cutler’s Estate, supra). Also excluded from carrying charges are corporate franchise taxes (as they are crucial to the corporation’s existence, not to the maintenance of the building), legal expenses in the collection of rent, and penalties and late fees (Application of Central Hanover Bank & Trust Co., 172 Misc. 606, 16 N.Y.S.2d 630 (Sup.Ct., New York Co., 1939)).

Carrying charges must be tangible, not hypothetical in nature. If a nonprofit organization without a mortgage on a piece of property claims that it could have invested the money and taken a mortgage, the hypothetical return on investment is not a carrying charge (Matter of St. Michael’s Protestant Episcopal Church v. Kaplan, N.Y.L.J., Feb. 17, 1977, p. 10, cols. 4-5 (Sup.Ct., New York Co.)).

For a definition of maintenance charges, the court in Direen Operating Corp. v. State Tax Commission, 46 A.D.2d 191, 361 N.Y.S.2d 736 (3d Dept., 1974), examined a dictionary definition of “maintenance” and a provision of the Tax Law for assistance. Thus it noted that: “Ballentine’s Law Dictionary (3d ed., 1969) refers to maintenance as ‘[M]aking repairs and otherwise keeping premises or instrumentalities in good condition’” (361 N.Y.S.2d at 738). {1}  The court also cited section 1105(c)(5) of the Tax Law which states that sales tax shall be collected on services for the “[m]aintaining, servicing, or repairing [of] real property, property, or land . . .  as distinguished from adding to or improving such real property, property, or land, by a capital improvement. . . .” Section 1101(b)(9) of the Tax Law defines a capital improvement as:

(i) An addition or alteration to real property which: (A) Substantially adds to the value of the real property, or appreciably prolongs the useful life of the real property; and (B) Becomes part of the real property or is permanently affixed to the real property so that removal would cause material damage to the property or article itself; and (C) Is intended to become a permanent installation.

Case law agrees that maintenance charges include costs to maintain and repair property and do not include enhancements that increase the value of the property, replacements that suspend deterioration, and changes that appreciably prolong the life of property (Stewart Supply Company, Inc., T.C. Memo 1963-62; see also, Moss v. Commissioner of Internal Revenue, 831 F.2d 833 (9th Cir., 1987)). Repairs made simultaneously to capital improvements are considered to combine with the improvements in increasing the value or prolonging the life of the property, and are not considered maintenance charges (id.).

Examples of enhancements ruled not to be repairs are costs for legal defenses and plan approval (Centerville Tract No. 2 Maintenance Corporation v. Casalena, No. 86A-MR-12 (Del.Super. New Castle Co., 1987)), replacement of a side of a building, the installation of a new roof, and restorations of portions of a building damaged by fire (Stewart Supply Company, Inc., supra). Section 1101(b)(9)(iii) of the Tax Law adds that an installation of an original floor covering (including carpet padding) in a new construction, a new addition to existing construction, or a total reconstruction of an existing construction is a capital improvement and not a repair. Other floor covering installations are not considered capital improvements and can be included as maintenance costs.

“Depreciation” is defined in Black’s Law Dictionary [hereafter Black’s] as “[a] decline in value of property caused by wear or obsolescence and is usually measured by a set formula which reflects these elements over a given period of useful life of property” (5 Black’s, 397). The Court of Appeals has stated, “We suppose that judicial notice may be taken of the fact that in the conduct of many industrial enterprises there is a constant deterioration of the plant which is not made good by ordinary repairs which, of course, operates continually to lessen the value of the tangible property which it affects” (People ex rel. Jamaica Water Supply Co. v. Tax Commissioners, 196 N.Y. 39, 57, 39 N.E. 581 (1901); see also, In re Davies’ Estate, 197 Misc. 827, 96 N.Y.S.2d 191 (Surr.Ct., New York Co., 1950)). Because of the numerous methods of depreciation, we cannot specify any particular method of determining depreciation for purposes of section 420-a(2). {2}

If the rent exceeds the carrying, maintenance, and depreciation charges, then the property is no longer entitled to an exemption. This includes a situation in which the amount of rent paid on a sublease exceeds the three charges where the owning body has control over the ability of a tenant to sublease, as the courts have determined that section 420-a(2) was intended to close any loopholes that could be used to allow a nonprofit organization or association to profit from land ownership (Sisters of St. Joseph v. City of New York, supra).

February 3, 1982
Revised August 30, 1999

{1}  We note that Black’s Law Dictionary defines maintenance (of an asset) as, “Expenditures undertaken to preserve an asset’s service potential for its originally-intended life; these expenditures are treated as period expenses or product costs. Contrast with Improvement. See also Maintain; Repair.” (Black’s Law Dictionary 860 (5th ed. 1979; emphasis in original).

{2}  The United States General Services Administration’s (GSA) Office of Management & Budget (OMB) Circular A-122 (Attachment No. B., Subsection 11 (1998)), concerned specifically with the subject of cost determination and depreciation practices for some nonprofit entities, provides that cost determination for depreciation purposes must be based on acquisition cost. Cost basis must be reduced by improvements paid by others, and the rate of depreciation is limited to two percent per year for buildings and six and two-thirds percent for equipment. Where cost records have not been maintained, a reasonable estimate of the original cost may be used. Note, however, that this is only one of several methods of depreciation, and an accountant should be consulted concerning the appropriateness of the methodology used, the GSA circular, and any federal income taxation provisions or regulations which may offer some guidance in this area (e.g., 26 U.S.C.S. §§ 167, 168).