FG’s Guide to Long-Term Lease Agreements

DEFINITION

Long-term leases are used primarily when property will remain privately held by a key insider but needs improvements which will be paid for by the exempt organization.

BEST PRACTICE  

If a tax-exempt organization is going to pay for improvements such as, but not limited to, constructing a building, renovating existing structures, or even erecting permanent fencing, the term length of the lease agreement must be sufficiently long enough in time, without the payment of rent, for the organization to realize the value of the investment in the property. This also ensures that there is no inurement and private benefit to the key insider, or their heirs, which maintains ownership of the property.

In order to determine the length of time needed for a long-term agreement, the costs of improvements must be known ahead of such improvements being made. (Please note, if the costs go above the quoted amounts, that could require an amendment to the lease to lengthen the term.) Then, the fair market rental value of the property must also be known.

With both those amounts, you will determine how long the term of the lease must be for the organization to realize the value they are putting into the property.

Let’s look at some examples:

• An animal rescue needs to construct a new barn on property owned by the Board President, where activities are conducted. The cost of the barn will be $850,000. The fair market rental value of the portion of the property used is $1200 per month or $14,400 annually. To see how long the term must be to avoid any inurement to the property owner, we must divide the construction costs by the annual fair market rental value.

$850,000 ÷ $14,400 = 59

In this case, the term of the lease should be at least 59 years.

• Let’s say that same animal rescue has a barn, but it needs improvements due to its age. Renovations will be $300,000 to add features and replace some portions of the building. We’re going to keep the same fair market rental value at $14,400 per year.

$300,000 ÷ 14,400 = 20.8 (round up to 21)

The term of this agreement should be 21 years.

The Board of Directors will need to approve such improvements and ensure that there is not a better location available to secure for conducting the organization’s activities to demonstrate that this is the best arrangement for the organization at the present time. The property owner must recuse themselves from this vote, as well as anyone they may be related to through blood, marriage, or business, following their Conflict-of-Interest policy. Meeting minutes need to detail the discussion, how the length of time was determined and that the interested parties recused themselves from the vote.