Warning – dangerous claws: property tax exemption claw-back can impose unexpected expense on not-for-profits

Posted on Sep 5, 2014

By Joe Haberzetle, JD, LLM

Many Washington not-for-profits benefit substantially from the various property tax exemptions provided in state law. Private schools, churches, hospitals, museums and performing arts centers are among the organizations that can be granted exemptions from property taxes on the land and buildings they use, as well as on their personal property such as equipment, furniture, fixtures and exhibits. However, a relatively obscure provision in these laws can lead to harsh results when exempt property is sold or converted to a non-exempt use.

Generally, when exempt property ceases being used for an exempt purpose (or is sold, loaned or rented on an ongoing basis to a non-exempt user), the exemption is lost for future periods. Under the “claw-back” provision, however, the formerly exempt owner/user is also required to pay the property tax that would have been due on the property during the three years immediately preceding the loss of the exemption, as well as interest calculated from the date that such taxes would have originally been due.

To understand the potential impact of this provision, consider a not-for-profit museum that occupies a facility with a fair market value of $2 million. If the museum sells its facility and triggers the claw-back provision, it would likely be faced with a property tax bill of around $75,000! Furthermore, since claw-back is triggered by the change in use (rather than by the sale itself), the property tax bill may be due well before the organization receives the proceeds from the sale of the property, even if the pending sale is what is ultimately causing the recapture.

Fortunately, there are several important exclusions from the claw-back, including the following:

  • Any property that has been exempt from property tax for over ten consecutive years prior to the sale or change in use.
  • Changes of use affecting only part of an exempt property, if they result in less than 51% of the area of the property losing its exempt status.
  • Transfers to another not-for-profit organization or entity that is subsequently granted a property tax exemption on the same property.
  • Property transferred to an agency of state government or to the city or county in which the property is located, and any other transfers achieved through the exercise of the power of eminent domain (or effectuated in anticipation of such exercise).
  • Changes in use resulting from an official action of state or local government disallowing the present use of the property.
  • Changes in use resulting from a natural disaster such as a flood, windstorm or earthquake.
  • Relocation of the exempt activity to another location or site.
  • Cancellation of a lease on leased property, where the exemption had been granted to the lessee.

If a property was exempt for less than three previous years, the claw-back is limited to the actual period for which the exemption was in effect. In addition, periodic, limited use of church property by outside organizations and individuals will not cause the loss of the exemption, as long as such use remains below certain statutorily defined thresholds.

The law imposes a duty on owners of exempt property who have knowledge of a change in the exempt use to notify the Washington Department of Revenue of such change. If the Department determines that the claw-back provision applies, it informs the county treasurer where the property is located, and the treasurer then calculates and collects the back taxes and interest due.

Given the potentially draconian impact of the claw-back provision, owners of exempt properties are encouraged to contact a tax advisor and consider the potential tax impacts carefully prior to selling their property or allowing any use of the property that falls outside of the exempt purpose for which the exemption was originally granted.

© Clark Nuber PS, 2014.  All Rights Reserved

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This article or blog contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.

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