Debt-Financed Income and Form 990-T

Unrelated debt-financed income (§514)

• Debt-financed property: any property held to produce income (including gain on sale) on which there is acquisition indebtedness at any time during the year, or during the twelve months before a sale — rental real estate, equipment, margin-bought securities, a partnership interest bought with borrowed money.
• Acquisition indebtedness: debt incurred (A) to acquire or improve the property; (B) before, if it would not have been incurred but for the acquisition; (C) after, if but-for and the borrowing was reasonably foreseeable when the property was acquired. Bancroft Laboratory mortgages its lab to replace the working capital it spent remodeling the office building it rents out → acquisition indebtedness (Ex. 4.13). A partner’s share: Board Society borrows $2 million for its $3 million partnership interest; the partnership borrows $15 million for a $24 million office building; Board’s acquisition indebtedness is $2 million plus one-third of $15 million = $7 million (Ex. 4.14). Converting debt-free property to an unrelated use with a loan outstanding creates it; deeds of trust, UCC security interests, pledges and tax liens once due are mortgages.
• The fraction (Reg. §1.514(a)-1): average acquisition indebtedness (principal on the first day of each month the property is held, ÷ months held, a fraction of a month counting as a month) over average adjusted basis (basis on the first and last day of the year held, ÷ 2), not over 100%. Carpenters Guild: $100,000 of rent, $1,000,000 average basis, $500,000 average debt → 50% → $50,000 UDFI (Ex. 4.10). Office building bought July 7 for $510,000 with $300,000 borrowed and $20,000 of principal paid monthly from July 28: debt on the first of July through December sums to $1,500,000 ÷ 6 = $250,000; basis $510,000 and $490,000 → $500,000; 50% (Ex. 4.18). The percentage falls as the loan is paid down.
• Deductions (§514(a)(2)): the same percentage of the expenses directly connected with the property — interest, taxes, management, repairs, and straight-line depreciation only (the exempt-organization limits on §179 and bonus do not apply to UBTI assets generally, but §514 says straight-line). Half the building debt-financed, $10,000 of depreciation → $5,000 (Ex. 4.11); half of $30,000 → $15,000; a quarter of $40,000 → $10,000. [Final Q54, B; SQ 35, A; marked]
• Gain on sale: the taxable fraction is the highest acquisition indebtedness in the twelve months before the sale over the average of basis on the first day of the year of sale and at the sale date. Building bought January 1 for $608,000 with a $288,000 mortgage, sold for $640,000 with basis of $571,010 after $36,990 of depreciation; average basis ($589,505 + $571,010) ÷ 2 = $580,258; $288,000 ÷ $580,258 ≈ 50%; gain $68,990 → $34,495 taxable as long-term gain on Schedule D (Ex. 4.22), with any §1250 recapture ordinary. Losses are computed with the percentage in the loss year and carried over without it (Ex. 4.20: a $20,000 loss at 40% is an $8,000 capital loss carried forward in full); NOLs the same (Ex. 4.12: $20,000 of rent and $25,000 of expenses at 50% → $10,000 of income, $12,500 of deductions, a $2,500 NOL).
• Modifying the debt: a refinancing, extension, renewal or substitution of lender or obligor is the same debt to the extent principal does not increase; new money is a separate debt; payments on a mixed note are allocated pro rata ($60,000 paid on a $600,000 note of which $500,000 was acquisition indebtedness reduces it by $50,000, Ex. 4.15).
• Not acquisition indebtedness: debt incurred in performing the exempt function (a school’s student loans, a hospital’s building bonds used for patient care); charitable gift annuity obligations that meet the §514(c)(5) tests (sole consideration, present value under 90% of the property’s value, lives of one or two people, no minimum or maximum term, not tied to income); the obligation to return collateral on a securities loan; a short sale; real-property debt of a qualified organization — a §401(a) trust, a school under §170(b)(1)(A)(ii), or a (c)(25) title-holding company — if the price is fixed, no payment is contingent on income, the seller is not the lessee, and the property is not leased back to the seller or to a disqualified person (§514(c)(9)); and certain federal financing.
• Gifts and bequests (§514(c)(2)(B)): mortgage debt on property received by bequest or devise is not acquisition indebtedness for 10 years; by gift, likewise, if the mortgage was placed more than five years before the gift and the donor held the property more than five years. Lost if the organization assumes or agrees to pay any of the debt, or pays the donor for the equity.

Exceptions to debt-financed property

• 85% exempt use (§514(b)(1)(A)): substantially all the use of the property is substantially related to the exempt purpose, measured by time, by space, or both; below 85%, the exempt-use portion is excepted and the rest is debt-financed. Parkland College’s four-story building: the lower two floors house its computers, the upper two are rented to the public; $6,000 of rent, $2,000 of expenses split equally, $100,000 average basis, $60,000 average debt → allocable debt $30,000 over allocable basis $50,000 = 60%; 60% of $6,000 less 60% of $1,000 = $3,000 UBTI (Ex. 4.21).
• Already taxed: property whose income is already UBTI as a business (but the gain on sale, not otherwise taxed, is debt-financed); property used in a business excluded for volunteers, convenience or donated goods; property producing excluded research income; personal-property rents and controlled-organization payments taxed elsewhere.
• Medical clinic leases (§514(b)(1)(C)): real property leased to a medical clinic where the lease is entered into primarily for the hospital’s exempt purposes — the physicians’ association that provides all outpatient care and trains the residents (Ex. 4.16).
• Life-income arrangements: property in a trust or fund paying income to individuals for life with the remainder to charity is not debt-financed if the payments are not sale proceeds.
• Neighborhood land rule (§514(b)(3)): real property bought with the intention of using it for the exempt purpose within 10 years, in the neighborhood of other exempt-use property — contiguous, or contiguous but for a road, railroad or stream, or within one mile where buying contiguous land is unreasonable (the owners refuse or ask unreasonable prices, Ex. 4.17) — is not debt-financed while the intent to demolish and build holds. After the first five years it applies only if the organization satisfies the IRS that exempt use is reasonably certain — a ruling request at least 90 days before the end of year five with a definite plan, dates and affirmative action. Fail the ruling but actually convert within the 10 years and the actual-use rule refunds the tax, claim filed within one year after the close of the conversion year. Existing structures qualify only while their demolition is intended. Churches: 15 years, and no neighborhood requirement at all. A business lease (over five years) on the land breaks the rule.

Form 990-T: who, when, how

• Who: any exempt organization, IRA, SEP, SIMPLE, Roth, Coverdell ESA, Archer MSA, HSA, §401(a) trust, or private foundation with $1,000 or more of gross income from unrelated business (before expenses), whether or not tax results — the threshold is not indexed. Churches too. Also filed to pay the proxy tax, to claim a refund of backup withholding or the Form 2439 credit, or by an IRA trustee as a composite return for many IRAs in a RIC (Notice 90-18). [Final Q46, C; marked]
• When: 15th day of the 5th month for exempt organizations and foundations; 15th day of the 4th month for employee trusts, IRAs and the other savings accounts (so a Roth IRA’s 990-T is due April 15 and an exempt organization’s May 15 — the exam’s point). Form 8868: six months for corporate filers, three for trusts (which includes IRAs). [SQ 33, A]
• E-filed since 2021; paper only for a pre-2020 amended year or the IRS’s listed exceptions (Ogden, UT 84201-0045). A refund now requires Form 8050 direct deposit updated 2026. Amended: a new 990-T marked “Amended Return” with a statement of changed lines, within three years. Only a (c)(2) title-holding company and its exempt parent may file a consolidated 990-T; otherwise each organization files its own, and related organizations share the controlled-group limits (one §179 limit, for instance). The $1,000 specific deduction is per organization.
• Estimates if expected tax is $500 or more: four installments, Form 990-W worksheet (not filed), EFTPS deposits; the underpayment penalty on Form 2220 (IRS relief for the first year a §1062 election is made) updated 2026. Penalties: §6651 5% a month to 25% for late filing, with a minimum of the smaller of the tax or $535 for returns due in 2026 when over 60 days late (the course had $435); ½% a month for late payment; reasonable cause available. updated 2026
• Public inspection: a (c)(3)’s 990-T filed after August 17, 2006 is public like the 990 (TEOS posts them); other organizations’ 990-Ts are not. [Final Q56, D; marked]
• Accounting: the same year and method as the 990 and the books. Part IV asks about foreign accounts (FinCEN 114), foreign trusts (Forms 3520, 926, 8865), tax-exempt interest, and a change of accounting method (Form 3115 or the Form 1128 reference).

Form 990-T core form, line by line (2025 form)

• Heading: name, EIN, the exemption section from the letter, book value of all assets, the group exemption number, the §529A ABLE and trust checkboxes, whether a 401(a)/408 trust, the number of Schedules A attached, whether a subsidiary in an affiliated group, the organization type (corporation, trust, other), and the books-and-records contact.
• Part I, total UBTI: line 1 the sum of the positive Schedule A Part II line 18 amounts (negative silos are ignored); line 2 reserved; line 3 total; line 4 charitable contributions actually paid to §170(c) organizations plus carryovers — corporations 10% of UBTI before the deduction and before NOL and capital-loss carrybacks (the course’s 25% was 2021 only), and from 2026 only the amount above the new 1% floor check; trusts 50% / 30% as for individuals; line 5 total before NOL; line 6 pre-2018 NOL carryovers, not over line 1 (post-2017 NOLs are on each Schedule A); line 7 subtotal; line 8 the $1,000 specific deduction — one per organization regardless of the number of businesses, except a diocese, religious order province or convention of churches gets one per non-incorporated parish or unit that regularly runs an unrelated business, each limited to that unit’s unrelated gross income, with a statement; line 9 the §199A QBI deduction for trusts (Form 8995), computed silo by silo with loss silos omitted; line 10 total deductions; line 11 UBTI. [Final Q55, D; Q60, A; marked] updated 2026
• Part II, tax: line 1 corporations — line 11 × 21%; line 2 trusts — the §1(e) rate schedule (37% above $16,000 for 2026 check), or Schedule D (Form 1041) for capital gains and qualified dividends; line 3 the §6033(e)(2) proxy tax at 21% on lobbying and political spending not disclosed in dues notices ((c)(4), (5), (6) only; Rev. Proc. 98-19 exceptions); line 4 other — §1291 PFIC deferred tax (Form 8621) and partnership push-out adjustments (Forms 8986 and 8978); line 5 AMT for trusts (Schedule I, Form 1041); line 6 the §501(r) noncompliant-facility income tax for hospitals; line 7 total. [Final Q58, B; marked]
• Part III, tax and payments: foreign tax credit (Form 1118 or 1116), other credits (Form 3800 general business credit, Form 8801), the §1062 farmland-sale installment (new lines 5b and 6k, Form 1062) added 2026, total tax; estimated payments, withholding, backup withholding, the Form 2439 credit, §1341; overpayment and the Form 8050 refund.
• Part IV statements (foreign accounts, foreign trusts, tax-exempt interest, method change). Part V supplemental information. Signature by an officer; an unpaid preparer or a regular employee does not sign the preparer line.

Schedule A (Form 990-T), one per business

• Heading: the two-digit NAICS business code (Item C), the sequence number of this Schedule A (Item D), and the description (Item E). If the total of all Schedules A Part I line 13 column (A) is $10,000 or less, only the headings, Part I lines 1–13 (direct entry), Part II lines 15–18 and the signature are needed; above $10,000 every applicable part. [Final Q61, D; marked]
• Part I, income (columns income, expenses, net): line 1a–c gross receipts less returns; 2 cost of goods sold (Part III); 3 gross profit; 4a capital gain net income (Schedule D of 1120 or 1041, including the debt-financed fraction of gains); 4b Form 4797 gain (recapture only for periods the organization was taxable); 4c trust capital loss deduction; 5 income from partnerships and S corporations (with a statement of the share of gross income and deductions); 6 rent income (Part IV — the 10%/50% personal-property rule and the services and profits tests); 7 unrelated debt-financed income (Part V — the fraction); 8 interest, annuities, royalties and rents from controlled organizations (Part VI — the §512(b)(13) excess); 9 investment income of (c)(7), (9) and (17) organizations (Part VII); 10 exploited exempt activity income other than advertising (Part VIII); 11 advertising income (Part IX); 12 other income — personal-property-only rents, bad-debt recoveries, Form 8925 employer-owned life insurance, (c)(19) insurance income not set aside; 13 total.
• Part II, deductions not taken elsewhere: 1 officer, director and trustee compensation (Part X) allocated to this business only; 2 other salaries; 3 repairs; 4 bad debts; 5 interest (§163 tracing under Temp. Reg. §1.163-8T, no deduction for interest carrying tax-exempt bonds, §267 related-party and §7872 rules); 6 taxes and licenses (not federal income tax); 7 depreciation and §179 (Form 4562 — full §179, bonus and MACRS are available for UBTI assets; §514 property straight-line); 8 less depreciation claimed in cost of goods sold; 9 depletion; 10 contributions to deferred compensation plans (Form 5500 series still required); 11 employee benefit programs; 12 excess exempt expenses (Part VIII); 13 excess readership costs (Part IX); 14 other deductions with a statement (amortization yes, fines and penalties no); 15 total; 16 UBTI before NOL; 17 the post-2017 NOL of this business — no carryback, indefinite carryforward, 80% of line 16; 18 UBTI of this business, carried to the core form Part I line 1 if positive. [Final Q55 topic]
• Parts III–XI: cost of goods sold (Form 1125-A style, §263A); rent income with the personal-property percentage and the redetermination rule; debt-financed income with the fraction per property; controlled-organization income (exempt and nonexempt subsidiaries separately, the §482 excess); (c)(7)/(9)/(17) investment income and set-asides; exploited exempt activity (two or more businesses exploiting the same activity are one here); periodical advertising with the four-case rule; officer compensation by percentage of time; supplemental information.
• §469 passive losses apply to “affected” exempt organizations — trusts, IRAs and (c) corporations more than 50% owned by five or fewer foundations, pension trusts or SUB trusts — so a rental loss in one silo may be suspended twice over. §267 bars deducting accrued amounts to a related cash-basis person, and a (c)(3) controlled by an individual or family is related to them for this purpose (§267(b)(9)).

Study questions 33–37

• A private foundation’s 990-T is due the 15th day of the 5th month; employee trusts, IRAs and Archer MSAs are due the 15th day of the 4th month. [SQ 33, A; Final Q46, C]
• Rent from personal property that is not incidental to a real-property lease is UBTI; mailing-list rentals among charities, real-property rents and passive income are not. [SQ 34, B]
• Straight-line depreciation of $40,000 on a building one-quarter debt-financed: $10,000. [SQ 35, A; Final Q54, B]
• With more than one unrelated business the net incomes are combined for tax but a loss in one never offsets another; each business has its own Schedule A. [SQ 36, C; Final Q61, D]
• The bingo exclusion is available to a church, not to a social club, a political organization or a homeowners’ association. [SQ 37, A]

Private reference, not client advice. Notes taken from a continuing-education course, Form 990: A Practical Guide (Thomson Reuters Checkpoint Learning, 12 hours, 2022 edition written on 2021 law and the 2021 forms). Figures and rules brought current to 2026 in October 2026 (P.L. 119-21, Rev. Proc. 2025-32, T.D. 9933, T.D. 9898, the 2025 form instructions). Items tagged check are to be confirmed against primary sources before they are relied on.