Nonprofit charities regularly own or receive donations of real estate. In the real estate world, holding title to property in an isolated limited liability company is so common that many lenders’ and brokers’ template forms refer to “______ LLC,” with the blank for the buyer’s name. Some real estate lenders require loan collateral to be owned by a separate and newly formed limited liability company, to reduce possible claims of past creditors. Until recently, charitable nonprofits faced uncertainty when using the single-member limited liability company (“SMLLC”) structure so common in the for-profit world, because only the parent is granted IRS charitable (tax-exempt) status and Oregon law required the corporate form of ownership to be eligible for property tax exemption. This created concern over whether gifts transferred directly to the SMLLC would be eligible for tax-deductible donations and in many cases resulted in denial of Oregon property tax exemption, based solely on ownership.
For federal income tax and Oregon real property taxes, we now have clear recognition that a SMLLC owned by a 501(c)(3)-recognized nonprofit corporation is covered by the parent’s charitable status. Issues surrounding nonprofit charities forming subsidiary organizations are complicated and differ by state. Nonprofit subsidiary organizations can be created for real estate holding or other purposes (for example, a corporation, a joint venture partnership, or a multimember limited liability company with another charity), depending on the specific circumstances and objectives. Not all subsidiaries, however, are (like the SMLLC) recognized under the parent’s charitable status. The primary goal of an SMLLC subsidiary is to protect the parent organization from contractual and other types of liability by shielding the nonprofit parent organization’s assets from operations at the subsidiary level. A subsidiary properly formed and maintained, with clear separate accounts and capital, but tax reported as part of the parent’s return, can protect the parent organization from potential liability arising from the subsidiary’s activity. Sometimes intentionally taxable subsidiaries are formed to avoid jeopardizing tax-exempt status when an activity or business does not clearly further the nonprofit organization’s charitable purpose, but that is another topic.
While limiting liability is one goal, the tax results must also be acceptable. ORS 307.022 expressly provides, for purposes of the property tax laws of Oregon, that a limited liability company wholly owned by one or more nonprofit corporations is an entity qualifying for an exemption or special assessment if and to the extent that all the nonprofit corporation owners of the limited liability company qualify for the exemption or special assessment. Oregon will also exempt an SMLLC from tax on gain of the sale of the real property when the single member is an exempt charity and federal law exempts the sale. A variety of states have by statute or administrative guidance treated SMLLCs owned by charitable nonprofits as charitable nonprofits, but many others, such as our neighbors in Washington, have not.
At the federal level, after more than a decade of uncertainty, the IRS recognized charitable donations made to the wholly owned and controlled domestic SMLLC of a qualified U.S. charity in 2012. The IRS expressly provided that such an SMLLC qualifies under IRC Section 170 for the charitable income tax deduction. (IRS Notice 2012-52.) Previously, the IRS had cast doubt on that issue by publicly stating that it was not certain that this was the case.
Many charities had used wholly owned LLCs as part of their overall structure, but the 2012 clarification has increased the comfort and number of SMLLC subsidiaries, especially for directly receiving donations of real property to keep the parent entity out of the chain of title. Advisers frequently recommend forming wholly owned SMLLC entities for charities to hold donated real estate or other unknown or risk associated assets. Real estate is a particularly attractive asset to hold in a separate LLC, because that structure can limit the reach of direct liabilities within the subsidiary, including environmental liabilities (think of anything near the Portland Harbor), from reaching other assets owned by the parent charity. With the Notice, this structure became easier to accomplish, because contributions of real property (or other assets) can be made directly to a charity-owned LLC without compromising the donor’s charitable deduction.
The IRS’s recognition of a charity SMLLC does not change other requirements for such contributions, including the need for donors to obtain a “qualified appraisal” (if applicable), the need for the charity to provide a contemporaneous written acknowledgment of the donation (which should include an express reference to the parent charity and an acknowledgment that the SMLLC is a wholly-owned but disregarded entity). The donor must still meet all the other requirements of Section 170. Under the Notice, the parent charity will be considered the donee organization for purposes of the substantiation and disclosure requirements of IRC Sections 170(f) and 6115, and the limitations of IRC Section 170(b) will apply as though the gift were made to the U.S. charity.
Does the SMLLC need a separate EIN? This is the IRS guidance position: not unless the SMLLC will have its own employees or be involved in specific excise tax activities (oil, timber, etc.). So by IRS policy, the parent’s own EIN is recognized as the SMLLC’s EIN for reporting purposes. In practice, however, some financial institutions appear to have internal policies or practices to request a separate EIN for an SMLLC. We have most often been able to explain or show in the SMLLC’s operating agreement the disregarded nature and IRS allowance for use of the parent’s EIN to open subsidiary checking accounts. Sometimes, however, it may be more efficient to file a new IRS SS 4 (application for an EIN), but everyone involved must keep track of this separate EIN, and remember, the SMLLC is not a separate taxpayer.
In closing, considering common industry practice and changes in federal and state laws, formation of wholly owned SMLLCs should be considered by tax-exempt nonprofits, particularly when receiving a real property gift or starting an activity with unusual risk.
This article was previously published in Fall 2014 edition the Oregon State Bar's Nonprofit Organizations Law Section Newsletter.