In a recent decision out of New Jersey, an LLC, itself taxed as a disregarded entity and wholly-owned by a 501(c)(3) corporation, was denied a property tax exemption with respect to improved real property it leased to another charitable organization because the LLC's articles of organization provided that it could engage in any lawful activity permitted an LLC. 1785 Swarthmore, LLC v. Township of Lakewood, No. A-4701-13C 4 (N. J. App. Div. Oct. 28, 2015).
Oorah, Inc., a New Jersey non-profit corporation, was classified by the IRS as a "public charity" under section 501(c)(3). After acquiring a piece of improved real property, Oorah formed 1785 Swarthmore, LLC and re-deeded the property to it. As such, Swarthmore was wholly-owned by a 501(c)(3) corporation; Swarthmore was, for federal income tax purposes, classified as a disregarded entity. Swarthmore's operating agreement provided that its purpose was "for conducting any legal business enterprise." Thereafter, Oorah leased a portion of the property to Lakewood Chedar School. Regardless, after the lease was entered into, Oorah, in its capacity as the sole member of Swarthmore, applied for a property tax exemption with respect to at least that portion of the property being leased to the school. That application would be denied by the municipal tax assessor, reasoning that Swarthmore, being the "organization claiming the exemption," was "not recognized by the State of New Jersey as a nonprofit organization." That denial would be upheld by both the Tax Court and the Court of Appeals.
Under New Jersey law, a property tax exemption is available for property that is:
- "actually owned and exclusively used for [a] tax-exempt purpose";
- the "operation and use of the property is not conducted for profit"; and
- where the property "owner" is "organized exclusively for tax-exempt purpose".
N.J.S.A. § 54:4-3.6.
Even while the court recognized that, under the Internal Revenue Code, Swarthmore's activities as a disregarded entity are treated as those of its parent, under New Jersey law, federal income tax standards do not govern state law as to property tax exemptions. In this case, it was necessary that the landowner be organized for the nonprofit purpose, and:
Swarthmore did not specifically limit its stated purposes to any extent in its Certificate of Formation. In that certificate, as we have already noted, Swarthmore's stated purpose was very broad: "to engage in any activity within the purposes for which Limited Liability Companies may be formed pursuant to the New Jersey Limited Liability Company Act." (emphasis in original). Hence, Swarthmore could have been formed and operated for any number of non-exempt purposes and thus has not satisfied the organizational purpose requirement under the statute.
Slip op. at 21.
The careful crafting of the purpose clause for any business entity is important. For example, the purpose clause can impact upon the scope of the fiduciary duties binding the members/managers of an LLC. This case is another illustration of the need to carefully consider that provision and, often, if not always, forgo the use of the simple "any lawful purpose" formula.
Thanks to Stuart Pachman for the lead on this decision.
Originally published on Kentucky Business Entity Law
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