Top 10 Real Estate Issues in Not-for-Profit Organizations OCTOBER 3, 2017 MARIE BRILMYER, CPA, MACC DONNA JENKINS, CPA ADAM SCHULTZ, CPA
Introduction Welcome Overview of the Webinar Introduction to Panelists - Adam Schultz, CPA - Marie Brilmyer, CPA, MACC - Donna Jenkins, CPA
Top 10 Real Estate Issues 1. Choosing the Right Location 2. Lease vs. Buy 3. Leasing of Cell Tower Space 4. Valuation of In-Kind Rent 5. Accounting for Internally-Constructed Property 6. Disposal of Long-Lived Assets 7. Impairment 8. Rental Income Subject to UBIT 9. Donated Real Estate and the 990 10. Gift Acceptance Policy
1. Choosing the Right Location
1. Choosing the Right Location Location is important - Many NFP s have a community-based and locally operated quality to them - May play in to the final decision of a donor and beneficiary to say yes - Proximity to resources, labor, and beneficiaries can enhance (or challenge) an NFP s ability to succeed
1. Choosing the Right Location Consider all the financial and non-financial consequences - Access to beneficiaries and markets for products and services - Access to employees, donors, and volunteers - Access to materials and vendors - Competition from other organizations in the area Consider the prestige (or lack thereof) of the surroundings - Is it accessible for the beneficiaries? Are there target beneficiaries in the area? - Will volunteers want to come there? - Will donors want to continue affiliation with the organization?
1. Choosing the Right Location Examples - A not-for-profit organization seeking to attract, train, and deploy volunteers found it difficult to do so in a location without public parking in a crime-riddled area - An organization seeking to meet with and ask doctors to submit medical research articles found it best to have a location near a highway with nice business-like conference rooms - A not-for-profit providing alcohol and drug addiction counseling services found it best to have several locations in and around the communities they wanted to serve
2. Lease vs. Buy
2. Lease vs. Buy Each option has benefits and drawbacks Decision depends on organization s situation - Is the organization stable or growing? - Are funding sources consistent? - Are programs changing / expanding? - Need for customized space or specific location? - How does current space fit with above questions? - Can the organization afford to buy? (consider down payment, renovations, and unexpected repairs)
2. Lease vs. Buy Lease Pros Flexibility (lease what you need) Typically less expensive (short term) No large cash payments No property management Lease Cons Increasing rental rates Less control over operating expenses Re-negotiations at end of lease Uncertainty at end of lease Buy Pros Appreciating asset (build net assets) Greater control over operating expenses Savings (long-term) Less uncertainty Potential revenue from other tenants Buy Cons Up-front capital (or fundraising efforts) Less flexibility Operating responsibilities Long-term debt considerations
2. Lease vs. Buy Current lease accounting - Operating leases payments are expensed (no asset or liability recorded) - Capital leases Asset and liability recorded, asset is depreciated and lease payments reduce liability New lease accounting (effective in 2019) - Operating lease Asset and liability recorded, depreciation of asset and interest expense shown straight-line as lease expense on the statement of operations - Finance lease Similar to capital lease
2. Lease vs. Buy Free cash or other liquid funds Fundraising (capital campaign) Foundation / government grants Long-term debt / bond issuance
3. Leasing of Cell Tower Space
3. Leasing of Cell Tower Space The Wireless Tower Construction industry has seen steady growth with expected continued growth - 3.2% annually from 2011-2016; 5.9% annually expected from 2016-2021 Tower companies will lease/buy land from property owners and in turn lease out the constructed tower to wireless carriers (AT&T, Verizon, Sprint, etc.) With a growing industry and increasing reliance on wireless technology, there will be more opportunity to lease out small parcels of land or space
3. Leasing of Cell Tower Space Common leasing provisions: - Typically lease land ranging from 2,500 10,000 sq. ft. with the right to construct tower - Densely populated areas leasing rooftop space - Two common term structures: - 5-10 year initial term with multiple renewal periods - 40 year easement with buy-out provision for ownership
3. Leasing of Cell Tower Space Common leasing provisions: - Rental payments monthly or annually - Annual or term rental escalations - Lessor potential to negotiate for tower revenue share contingent rental consideration - Ex. $500/mo + 25% of rental revenue from tower - Asset Retirement Obligation for the lessee - Must remove equipment upon termination of lease
3. Leasing of Cell Tower Space Typically structured as operating leases - Accounting is simpler - Lease payments are operational expenses, thus fully deductible for the lessee Rental income will need to be straight-lined in accordance with GAAP - Majority of leases include annual escalations UBIT will need to be considered when entering into an arrangement ASU 2016-02 will need to be considered
4. Valuation of In-Kind Rent
4. Valuation of In-Kind Rent In-Kind Rent Defined - The ability to operate and/or usage rights to a facility at no formal cost to the NFP or at a below market rate - A contribution in the form of use of property - Under ASC 958-605-55-23 the use of property in-kind is classified as a form of contributed assets, rather than a form of contributed services Initial Valuation - Based on fair market rental value in the current marketplace - Determine market price of a similar property using observable inputs such as rental square footage market price, available lease agreement, management estimate based on similar properties in area, etc.
4. Valuation of In-Kind Rent Recognition - The FV of the contributed use of the facility would be recognized as both revenue/support and corresponding expense in the period the in-kind rental facility is used - Determination needs to be made if the in-kind rent is for a single period vs. extended period of time Treatment Options - Single Period Recorded as in-kind revenue/expense in the period benefit is received - Extended Period Defaults to unconditional promises to give treatment, receivable and revenue recorded for discounted FV of entire rental term
4. Valuation of In-Kind Rent EXAMPLE: XYZ Foundation receives the free use of 10,000 square feet of premier office space provided by a local corporation. The local corporation has informed XYZ Foundation that it intends to continue providing the space as long as it is available, and although it expects it would be able to give the Foundation 30 days advance notice, it may discontinue providing the space at any time. The local corporation normally rents similar space for $14 - $16 annually per square foot, the going market rate for office space in the area. XYZ Foundation decides to accept this gift the free use of office space to conduct its programming activities. SOLUTION: Since the in-kind term is not a true unconditional promise over a specified time period (right to cancel with notice), XYZ Foundation would record a period revenue/expense for the FV of the in-kind rent between $140,000 - $160,000 in the period it receives such in-kind benefit.
4. Valuation of In-Kind Rent EXAMPLE: Given the same fact pattern, the local corporation has explicitly and unconditionally promises the use of the office space for 5 years, with no intentions of cancelling or amended the rental period until after the original 5 year term is completed. SOLUTION: Recognition would default to promise to give treatment, recognizing the FV of the entire rental term with a receivable and corresponding restricted revenue in current period. - The asset and related restricted revenue should be discounted based on NFP s incremental borrowing rate over the 5 year term - The asset is typically referred to as donated facility use asset - Expense recognition would occur over each period ratably until the asset is relieved at end of 5 year term
4. Valuation of In-Kind Rent Discounted Rent or $1 Lease - NFP would recognize in-kind rent/expense for the difference between amount paid and market rental price - Similar treatment as previous slides if period of time or extended period of time Lack of Observable Inputs - May require consultation of real estate or market expert to determine value
5. Accounting for Internally-Constructed Property
5. Accounting for Internally-Constructed Property Things to Consider - Identifying the Direct and Indirect costs of the project. - Cost accumulation continues during construction and is applied towards a CIP account (Construction-in- Progress). Direct Costs - Costs that can be easily and conveniently traced to a particular cost objective. - Include items such as direct materials (i.e. electrical wiring for a building), salaries for employees directly working on a project (i.e. labor hours), as well as employer paid taxes associated with the direct wages.
5. Accounting for Internally-Constructed Property Indirect Costs - Many different ways to allocate costs to a selfconstructed asset (i.e. allocated based off of labor hours of employees directly involved in construction). - Should be distinguished from G & A costs, as they are considered period costs (expensed in the period they are incurred). - It is advisable to have an internal policy on allocations of indirect costs.
5. Accounting for Internally-Constructed Property Recognition of In-Kind Labor - Donated services and labor are required to be recognized as contributions revenue (and assets and expenses) when certain criteria is met: - The labor or services must create or enhance the internally constructed asset of the entity. - The donated service must require specialized skills, are provided by individuals possessing those skills, and would typically need to have been purchased if not provided by donation. - Examples include architectural services.
5. Accounting for Internally-Constructed Property Statement of Financial Position - Should stay on the balance sheet as CIP until completion. - No depreciation is applied until completion. - Interest expense is generally capitalized if borrowing money to pay for costs relating to constructing an asset.
6. Disposal of Long-Lived Assets
6. Disposal of Long-Lived Assets NFP strategy many times involves disposing of long-lived assets to generate cash - Sale of real estate As demand for services and the market conditions change, NFP s react and move locations NFP may change its strategy and this may result in - Discontinued operations - Sale of the NFP to another entity, which would include long-lived assets such as real estate, computers, software, and vehicles
6. Disposal of Long-Lived Assets Assets to be Sold - A long-lived asset to be sold should be classified as held for sale in the period in which all of the criteria are met: - Management commits to a plan to sell - The asset is available for immediate sale in its present condition - The entity has initiated an active program to locate a buyer - The sale of assets is probable generally within one year of the asset being held for sale - The asset is being actively marketed for sale at a price that is reasonable relative to its current fair value - Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn
6. Disposal of Long-Lived Assets Measured at the lower of carrying amount or fair value less cost to sell Should NOT be depreciated or amortized An impairment loss should be recorded for any initial or subsequent write-down to fair value less cost to sell A gain should be recorded for any subsequent increase in fair value less cost to sell, but not to exceed the cumulative loss previously recognized for a write-down to fair value less cost to sell
6. Disposal of Long-Lived Assets Present the asset separately on the statement of financial position Property and Equipment - net Building and improvements Furniture and fixtures Vehicles Less: Accumulated depreciation Construction in progress Asset held for sale XXXX XXXX XXXX XXXX XXXX XXXX XXXX Total property and equipment, net XXXX
6. Disposal of Long-Lived Assets Changes to a Plan of Sale - An entity may decide not to sell a long-lived asset and in that case, the asset should be reclassified as held and used - Such asset should be measured at the lower of its carrying amount prior to being held for sale, adjusted for deprecation or the fair value at the date of the decision not to sell
6. Disposal of Long-Lived Assets Assets to be Abandoned - If an entity commits to a plan to abandon an asset before the end of its useful life, the asset s depreciation estimates should be revised to reflected the shortened life
7. Impairment
7. Impairment
7. Impairment Does the carrying amount exceed fair value less selling costs? - If no, no impairment exists - If yes, recognize impairment loss Recognizing impairment loss - Recognize impairment for the excess and reduce the carrying amount accordingly - After this, carrying amount of property should be adjusted up or down for any subsequent changes in fair value
7. Impairment Signs of possible impairment - Significant decrease in the property s market value - Significant amount of physical damage - Significant adverse physical change in the property - Continuing losses for a property used to produce revenue Assessing for impairment - Does the carrying value exceed net future cash flows? - If yes, no impairment exists - If no, recognize impairment loss based on fair value of asset
7. Impairment Property to be disposed of DR Impairment Loss on Real Estate XXXX CR Allowance for Impairment XXXX Property to be held and used DR Impairment Loss on Real Estate XXXX CR Property to be Impaired XXXX - This will become the property s new cost basis
8. Rental Income Subject to UBIT
8. Rental Income Subject to UBIT Rental income from real property is generally excluded from UBIT except in the following situations Property is debt-financed and held to produce income OR Property with acquisition indebtedness during the year or 12 months before disposal - What is acquisition indebtedness? - A debt agreement is entered into when acquiring or improving the property - A debt agreement is entered into before or after acquiring or improving the property and the debt was reasonably foreseeable
8. Rental Income Subject to UBIT What is acquisition indebtedness? - The Organization buys mortgaged property, but does not assume the mortgage; tax planning tip available here! - Prepay a proportionate share of debt and secure releases of liability from creditor and co-owners - Acquire an undivided interest - Entire property remains encumbered - The Organization receives property by bequest - Not considered acquisition indebtedness for first 10 years - The Organization receives the property by gift - Same as Bequest if mortgage on property 5 years prior to gift - Donor held property > 5 years prior to gift - Exceptions do not apply if the Organization assumes or agrees to pay the debt (even if partial) secured by the mortgage
8. Rental Income Subject to UBIT Exceptions include: The Organization uses > 85% of the property for its exempt purpose The Convenience Exception, Volunteer Exception, or Donated Merchandise Exception applies - Convenience: Carried on by a governmental college or university for the convenience of its members, students, patients, officers or employees. (parking garage) - Volunteer: Substantially all the work is performed for the Organization without compensation. (parking lot) - Donated Merchandise: Consists of selling merchandise, substantially all or which the Organization received as gifts or contributions. (thrift store) Property is leased to a related organization for certain uses
8. Rental Income Subject to UBIT Leases that include both real and personal property Personal property is any property that is depreciable under the IRS Code, including tangible property as defined (note that cell towers are personal property) - Determined by the percentage of rents attributed to personal property compared to the total rent received - If > 10%, then all rents from the lease are excluded - If 10% to 50%, then only rents attributed to the real property are excluded - If < 50%, then all rents from the lease are subject to UBIT
8. Rental Income Subject to UBIT Rental income from a Controlled Corporation - Include in the parent s calculation of UBIT to the extent it would have been taxable otherwise Lease payments that include compensation for services rendered to the Lessee - Subject to UBIT if the services are not customarily rendered - Customarily rendered = furnishing heat, electric and trash removal - Not customarily rendered = hotel rooms, parking lots, warehouses and storage garages Rent that is calculated as a percentage of net income - Considered to have a profits interest or joint venture with the lessee
8. Rental Income Subject to UBIT Calculating Unrelated Debt-Financed Income - Compute using this formula: Average acquisition indebtedness X gross income from property Average adjusted basis - Expenses that are directly connected with the property are deductible - Planning tips: - An NOL can be carried back two years or forward twenty years. Filing a 990-T even if there is no other income to report can help the Organization preserve the loss and claim it in a future year. - Usually the gain from sale of debt-financed property is included in UBIT - If debt is paid off more than 12 months before the sale of property, then the gain is not taxable (although the transaction may still be taxable for other reasons such as depreciation recapture)
9. Donated Real Estate and the 990
9. Donated Real Estate and the 990 Use caution when accepting gifts of real estate - Understand the potential liability Detailed appraisal of the property by a professional is necessary - Appraisal is required for donations greater than $5,000 Donation should be recorded at fair market value (FMV) as of the date of the contribution Organization must return a written acknowledgement to the donor for any gift of $250 or more
10. Gift Acceptance Policy
10. Gift Acceptance Policy Organizations should implement a formal gift acceptance policy that specifies the following: - Type of assets accepted or not accepted - Mission statement does the gift make sense? - Zoning restrictions can the land be used for the desired purpose? - Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) liability for clean up of environmentally damaged sites (Superfund). May hold all those in the chain of title responsible, regardless of material participation by the owner. The third party defense includes protection for innocent landowners, provided they had no reason to know of the existence of hazardous substances and made all "appropriate inquiry into the previous owner and uses of the property consistent with good commercial or customary practice." 42 U.S.C. sec. 9601(35). Before accepting any gift of real estate, it s a good idea to make sure an environmental evaluation has been done!
10. Gift Acceptance Policy What types of restrictions by donor are allowable - Will restricted land use impede the organization s use of the property? - Does the organization have the wherewithal and the desire to hold the land in perpetuity? Selling donated property - If the organization plans to sell the donation, is there a specific time of year that it can be sold? (may not want to accept a gift outside of this time frame) - What are the holding costs (taxes, insurance, maintenance) if the asset cannot be quickly sold? - If selling a donated asset, make sure the donor is aware that the property is being sold as this can sometimes cause tax consequences. (Also file Form 8282 if needed)
Questions? Information presented is not meant to constitute legal, accounting or other professional advice. Any action taken based on information in this presentation should be taken only after a detailed review of the specific facts and circumstances. Information is current as of the date presented.
Contact Information Marie Brilmyer - mbrilmyer@cohencpa.com Donna Jenkins - djenkins@cohencpa.com Adam Schultz - aschultz@cohencpa.com