SAN FRANCISCO-Special considerations come into play when nonprofit organizations want or need to engage in real estate transactions. With very few exceptions, nonprofits have a focus on something entirely unrelated to real property. Whether their mission is educational in nature, is health related, is directed to social issues, or addresses other needs, the typical nonprofit's real estate dealings are ancillary to its purpose. Thus, in such dealings, the nonprofit staff members are usually on unfamiliar terrain. While this is also true of many for-profit enterprises, the nonprofit's tolerance for risk and appetite for creative or alternative deal structures may be set much lower than would be the case for a business whose core mission is generating profits.

As the economy recovers from the Great Recession, the opportunities for nonprofit organizations to generate revenue from real estate holdings is rising, dramatically so in some markets. The cleanest disposition approach, of course, is to sell land or convey it by means of a long-term ground lease. Investment activities of this type generally produce income that is not subject to income tax and pose no threat to the tax exempt status of the nonprofit entity. On the other end of the spectrum is the possibility of transferring land by contribution to a joint venture, in which the nonprofit will possess an ownership interest. This scenario would likely be utilized where the contributed land is to be developed for residential, commercial or mixed uses. With land prices escalating rapidly in many metropolitan markets, land sellers are increasingly presented with the option to realize potentially greater value from their owned land by assuming the risks inherent in property redevelopment. And therein lies the rub, particularly for a nonprofit with goals wholly unrelated to land or its development.

The risk associated with real estate development needs to be carefully considered by the nonprofit, particularly where the nonprofit is partnering with a for-profit company that will take the lead with regard to, and control key decisions relating to, the endeavor. Such an arrangement can magnify the risks inherent in the activity. Moreover, the extent or nature of the activity, or the control position of the for-profit JV partner, could jeopardize the nonprofit's tax exempt status. If the real estate loses its character as investment property (for example, it is redeveloped and held for sale to customers in the ordinary course of a business), income may be subjected to tax on unrelated business income (“UBI”). Too much UBI could also pose a threat to the nonprofit's exempt status. Nonprofits deploying real estate venture strategies may also be surprised by tax issues arising from unrelated debt-financed income, which can be problematic if unanticipated and available structuring tools are not used.

In most situations nonprofits would do well to conduct their real estate transacting in conventional and straightforward ways. The lure of venturing as a means of generating funds other than through performing the nonprofit's core services or through fundraising may well not be worth the either the financial risk or the risk to the organization's tax status.

Marv Pearlstein, Partner at Manatt, Phelps & Phillips represents some of the most successful and active real estate development companies and financial institutions in their acquisition, disposition, development, construction, financing, leasing and management of real property. He has substantial experience in representing these clients in every major real estate product area, including multifamily, office, commercial, industrial and hospitality. The views expressed in this column are the author's own.

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