[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.514(a)-2]

[Page 187-189]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.514(a)-2  Business lease rents and deductions for taxable years 
beginning before January 1, 1970.

    (a) Effective date. This section applies to taxable years beginning 
before January 1, 1970.
    (b) In general--(1) Rents includible in gross income. There shall be 
included with respect to each business lease, as an item of gross income 
derived from an unrelated trade or business, an amount which is the same 
percentage (but not in excess of 100 percent) of the total rents derived 
during the taxable year under such lease as:
    (i) The amount of the business lease indebtedness at the close of 
the taxable year of the lessor tax-exempt organization, with respect to 
the premises covered by such lease, is of
    (ii) The adjusted basis of such premises at the close of such 
taxable year.

For definition of business lease as a lease for a term of more than 5 
years, and for rules for determining the computation of such 5-year term 
in certain specific situations, see Sec. 1.514(f)-1. For definition of 
business lease indebtedness and allocation of business lease 
indebtedness where only a portion of the property is subject to a 
business lease, see Sec. 1.514(g)-1.
    (2) Determination of basis. For purposes of the unrelated business 
income tax the basis (unadjusted) of property is determined under 
section 1012, and the adjusted basis of property is determined under 
section 1011. The determination of the adjusted basis of property is not 
affected by the fact that the organization was exempt from tax for

[[Page 188]]

prior taxable years. Proper adjustment must be made under section 1011 
for the entire period since the acquisition of the property. Thus 
adjustment must be made for depreciation for all taxable years whether 
or not the organization was exempt from tax for any of such years. 
Similarly, for taxable years during which the organization is subject to 
the tax on unrelated business taxable income the fact that only a 
portion of the deduction for depreciation is taken into account under 
paragraph (c)(1) of this section does not affect the amount of the 
adjustment for depreciation.
    (3) Examples. The application of this paragraph may be illustrated 
by the following examples, in each of which it is assumed that the 
taxpayer makes its returns under section 511 on the basis of the 
calendar year, and that the lease is not substantially related to the 
purpose for which the organization is granted exemption from tax.

    Example 1. Assume that a tax-exempt educational organization 
purchased property in 1952 for $600,000, using borrowed funds, and 
leased the building for a period of 20 years. Assume further that the 
adjusted basis of such building at the close of 1954 is $500,000 and 
that, at the close of 1954, $200,000 of the indebtedness incurred to 
acquire the property remains outstanding. Since the amount of the 
outstanding indebtedness is two-fifths of the adjusted basis of the 
building at the close of 1954, two-fifths of the gross rental received 
from the building during 1954 shall be included as an item of gross 
income in computing unrelated business taxable income. If, at the close 
of a subsequent taxable year, the outstanding indebtedness is $100,000 
and the adjusted basis of the building is $400,000, one-fourth of the 
gross rental for such taxable year shall be included as an item of gross 
income in computing unrelated business taxable income for such taxable 
year.
    Example 2. Assume that a tax-exempt organization owns a four-story 
building, that in 1954 it borrows $100,000 which it uses to improve the 
whole building, and that it thereafter in 1954 rents the first and 
second floors of the building under six-year leases at rentals of $4,000 
a year. The third and fourth floors of the building are leased on a 
yearly basis during 1954. Assume, also, that the adjusted basis of the 
real property at the end of 1954 (after reflecting the expenditures for 
improving the building) is $200,000, allocable equally to each of the 
four stories. Under these facts, only one-half of the real property is 
subject to a business lease since only one-half is rented under a lease 
for more than 5 years. See Sec. 1.514(f)-1. The percentage of the rent 
under such lease which is taken into account is determined by the ratio 
which the allocable part of the business lease indebtedness bears to the 
allocable part of the adjusted basis of the real property, that is, the 
ratio which one-half of the $100,000 of business lease indebtedness 
outstanding at the close of 1954, or $50,000, bears to one-half of the 
adjusted basis of the business lease premises at the close of 1954, or 
$100,000. The percentage of rent which is business lease income for 1954 
is, therefore, one-half (the ratio of $50,000 to $100,000) of $8,000, or 
$4,000, and this amount of $4,000 is considered an item of gross income 
derived from an unrelated trade or business.

    (c) Deductions--(1) Deductions allowable against gross income. The 
same percentage is used in determining both the portion of the rent and 
the portion of the deductions taken into account with respect to the 
business lease in computing unrelated business taxable income. Such 
percentage is applicable only to the sum of the following deductions 
allowable under section 161:
    (i) Taxes and other expenses paid or accrued during the taxable year 
upon or with respect to the real property subject to the business lease;
    (ii) Interest paid or accrued during the taxable year on the 
business lease indebtedness;
    (iii) A reasonable allowance for exhaustion, wear and tear 
(including a reasonable allowance for obsolescence) of the real property 
subject to such lease.


Where only a portion of the real property is subject to the business 
lease, there shall be taken into account only those amounts of the 
above-listed deductions which are properly allocable to the premises 
covered by such lease.
    (2) Excess deductions. The deductions allowable under subparagraph 
(1) of this paragraph with respect to a business lease are not limited 
by the amount included in gross income with respect to the rent from 
such lease. Any excess of such deductions over such gross income shall 
be applied against other items of gross income in computing unrelated 
business taxable income taxable under section 511(a).
    (3) Example. The application of this paragraph may be illustrated by 
the following example:


[[Page 189]]


    Example. Assume the same facts as those in example 1 in paragraph 
(b)(3) of this section. Assume, also that for 1954 the organization pays 
taxes of $4,000 on the property, interest of $6,000 on its business 
lease indebtedness, and that the depreciation allowable for 1954 under 
section 167 is $10,000. Under the facts set forth in such example 1 and 
in this example, the deductions to be taken into account for 1954 in 
computing unrelated business taxable income would be two-fifths of the 
total of the deductions of $20,000, that is $8,000.

[T.D. 7229, 37 FR 28145, Dec. 21, 1972]