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Did You Know that Your Nonprofit Organization is Exempt from Paying Property Taxes?

Scrabble cubes on a paper pad with the letters "tax" in cubes and then the word "exempt" in black marker.

 

It is common knowledge that nonprofit organizations generally do not pay income tax. But did you know that nonprofit organizations that qualify for federal tax-exempt status are, by law, also exempt from paying property taxes? In the State of California, this exemption is known as the Welfare Exemption.

The Welfare Exemption was first adopted by voters as a constitutional amendment in 1944. Legislation in the Revenue and Tax Code (§214) was then enacted to implement the provisions of the amendment. The Welfare Exemption provides that both real (i.e. land and buildings) and business personal property that are used exclusively for religious, hospital, scientific or charitable purposes are eligible for a property tax exemption. Certain educational purposes and activities may also qualify provided that they: benefit the community as a whole; and include the study of relevant information, the dissemination of that information to interested members of the general public, and the participation of such interested members of the general public.

Taking advantage of this valuable exemption is a two-part process. First, the organization must submit a claim form to the State Board of Equalization (BOE) with copies of its IRS 501(c)(3) or Franchise Tax Board 23701(d) letter of determination, its Articles of Incorporation and all amendments certified by the California Secretary of State, and copies of its financial statements for the years the exemption is claimed. If the BOE determines that the organization is eligible for the exemption, it will issue an Organizational Clearance Certificate. The next step is to submit a claim form to the Assessor in the county in which the property is located, along with a copy of the BOE Certification. The county Assessor will then determine whether the use of the property qualifies for the exemption.

It is important to note that not all property held by a nonprofit organization will automatically qualify for the Welfare Exemption. Many factors are taken into consideration. Exempt property must be owned and operated by the qualifying organization, and the property must be used exclusively for qualifying purposes and activities. The property must also be reasonably necessary to accomplish the organization’s qualifying purpose. Exclusive use, however, may include purposes that are incidental to and reasonably necessary for the accomplishment of the charitable purpose. For example, it is not uncommon for a hospital to operate a gift shop on its premises. This would not disqualify the property from the Welfare Exemption. The operation of a thrift shop would. The distinction being that a gift shop is a reasonable ancillary function of a hospital whereas a thrift shop is not generally considered necessary to the fulfillment of a hospital’s purpose.

In addition to the restrictions on use, California law further requires that an organization’s formation documents include a statement that the qualifying property is irrevocably dedicated to one of the four previously mentioned qualifying purposes, and that in the event the organization ceases operations, the qualifying property will be transferred to another fund, foundation, or corporation organized and operated for similar purposes.

Certain transactions such as rental of the qualifying property for meetings by other exempt organizations, leasing to other exempt organizations, fundraising activities, and activities that generate unrelated business taxable income can raise issues of whether a property qualifies for the full exemption, or only a partial exemption. Before initiating these types of transactions, the potential consequences should be discussed with your accounting and/or legal specialists to ensure compliance with the provisions of the Welfare Exemption. As California is widely known to have above average property tax rates, the Welfare Exemption could mean a hefty savings for your organization which in turn means more money for your qualifying purpose!