Can Tennessee exempt LLC-owned low-income housing from property tax under the state constitution?

Subject

Opinion No. 12-55, Property Tax Exemption for Low-Income Housing Property, May 21, 2012

Plain-English summary

House Majority Leader Gerald McCormick asked the AG two questions about SB2944/HB2974, a 2012 bill that would have exempted from ad valorem property tax any property of an LLC or limited partnership "wherein there is in effect an 'extended low-income housing commitment' as defined in Section 42 of the Internal Revenue Code." Section 42 is the federal low-income housing tax credit (LIHTC) program, which is generally used by for-profit entities that can monetize the credit. The first question was whether the bill complied with Tenn. Const. art. II, § 28, which limits property tax exemptions to property "held and used for purposes purely religious, charitable, scientific, literary or educational." The second question was a workaround: would it be constitutional if a non-profit held legal title and leased the land to an LLC that used the property to provide LIHTC-financed low-income housing?

The AG said no to both. Article II, § 28 requires that the property be both held and used by a charitable organization for charitable purposes. A for-profit LLC, even one providing valuable low-income housing, is not a charitable organization. Its for-profit status is "fundamentally inconsistent" with the charitable-use exemption. The lease-around structure fails for the same reason: the property is not being used by the non-profit for charitable purposes; the for-profit LLC is using it. The General Assembly does have discretion to grant property tax exemptions to bona fide non-profits that themselves hold and use property to provide low-income housing (and has done so in § 67-5-207 for certain non-profit corporations housing low-income disabled or elderly persons), but it cannot route around the constitutional requirement by extending exemption to for-profit owners or for-profit operators.

Currency note

This opinion was issued in 2012. Subsequent statutory amendments, court decisions, or later AG opinions may have changed the analysis. Treat this page as historical context, not current legal advice. Verify current law before relying on any specific rule, deadline, or remedy mentioned here.

Historical background and statutory framework

Article II, § 28

The Tennessee Constitution authorizes the General Assembly to exempt from taxation property "as may be held and used for purposes purely religious, charitable, scientific, literary or educational." Tenn. Const. art. II, § 28. Both conditions matter: held by an exempt-purpose entity and used for exempt purposes.

Mid-State Baptist Hospital and the "held and used" rule

The Tennessee Supreme Court in Mid-State Baptist Hosp., Inc. v. City of Nashville, 366 S.W.2d 769 (Tenn. 1963), held that the basis for the charitable property-tax exemption is a charitable organization holding and using property for its charitable purposes. Both elements are essential. The court also said that a charitable organization that uses its property for for-profit activities "becomes liable for taxation as any other business establishment." The flip side: a for-profit business that does some charitable things does not turn its property into exempt property.

Why SB2944 fails the first prong

SB2944 would have extended exemption to "[p]roperty of limited liability companies or limited partnerships" with LIHTC commitments. The AG presumed those entities were for-profit, because nonprofit entities do not benefit from § 42 credits (which trade on tax liability). The constitutional exemption was simply not available to that class of owner.

Out-of-state analogues

The opinion drew supporting authority from Rockingham County v. Board of Trustees of Elon College (N.C. 1941): "The fact that a commercial enterprise devotes its entire profits to a charitable or other laudable purpose does not change the character of its business nor the purpose for which it is held." It is still a commercial enterprise. United Brethren Publ'g Establishment v. Shaffer (Ind. App. 1919) said the same in a different setting: an institution claiming exemption "must, itself, be a charitable institution, and not one organized for the purpose of profit, notwithstanding . . . the proceeds or profits of the business are devoted to a most worthy charitable purpose."

The General Assembly's discretion to define "charitable"

Tennessee courts have recognized that "the Tennessee Constitution does not define the term 'charitable,'" which gives the General Assembly some discretion in defining its meaning (Club Sys. of Tenn. v. YMCA of Middle Tenn.). The classic definition from Baptist Hosp. v. City of Nashville (1928) treats charity as a gift "for the benefit of an indefinite number of persons," including by "assisting them to establish themselves for life, or by erecting or maintaining public buildings or works or otherwise lessening the burdens of government." Housing can qualify (American Heritage Apartments v. Bennett; Christian Home for the Aged v. Assessment Appeals Comm'n). Several other states have extended property-tax exemptions to non-profits providing low-income housing (Kansas: In re Mental Health Ass'n; Louisiana: New Orleans Towers Affordable Hous. Corp.; New York: In re Association for Neighborhood Rehabilitation; Texas: Orange County Appraisal Dist. v. Agape Neighborhood Improvement). But in each of those cases, the party claiming exemption was a nonprofit entity.

Why the non-profit-shell workaround also fails

The second question posed a structure: a nonprofit holds title and leases the land to an LLC that uses LIHTC credits to provide low-income housing. The AG read Article II, § 28 to require both holding and using by the exempt-purpose entity. In the proposed structure, the non-profit is not using the property to provide low-income housing. The LLC is. And the LLC is for-profit, which disqualifies the use under Mid-State Baptist Hospital and Elon College.

The AG added that even if the non-profit's "ownership" interest could qualify for exemption in isolation, that would not exempt the LLC's leasehold interest in the improvements. Tenn. Code Ann. § 67-5-502(d) assesses as real property any "interest that the lessee may have in and to the improvements erected upon land where the fee, reversion, or remainder therein is exempt to the owner." So the lessee's interest would remain on the tax rolls.

What the General Assembly could do

The AG flagged a constitutional path that does work: grant exemption to bona fide non-profit organizations that themselves hold and use property to provide low-income housing. Section 67-5-207 already does this for certain non-profits housing low-income disabled or elderly persons. The General Assembly could legislatively extend that approach to broader categories of non-profit low-income housing operators.

Common questions

Why can't an LLC qualify even if it's only providing housing to low-income tenants?

Under Article II, § 28 and Tennessee case law, the exemption requires that the property be held by a charitable organization and used for charitable purposes. A for-profit LLC, regardless of how much social good it does, is not a charitable organization. The AG opinion treats this as a constitutional floor that the legislature cannot ignore.

What if the LLC reinvests all of its profits in housing?

The Elon College reasoning the AG cited specifically rejects this argument. "The fact that a commercial enterprise devotes its entire profits to a charitable or other laudable purpose does not change the character of its business nor the purpose for which it is held."

Could a nonprofit hold title and lease the property to an affiliated LLC?

The AG opinion says this also fails Article II, § 28's "held and used" test. The non-profit is holding but not using; the LLC is using but is not a charity. And § 67-5-502(d) keeps the LLC's leasehold interest in the improvements taxable.

Is there any Tennessee property-tax exemption for low-income housing today?

The opinion noted Tenn. Code Ann. § 67-5-207 (a non-profit-corporation exemption for housing low-income disabled or elderly persons) as one example of a constitutional path the legislature has taken. Other exemptions may exist and the section may have been amended since 2012. Anyone planning an affordable-housing project should verify the current law and current case law.

Does federal LIHTC do anything to make a state property tax exemption easier?

No. LIHTC credits are federal income-tax credits. They do not control state property-tax classifications. Article II, § 28 sets the constitutional limits independently of how a project is structured for federal tax purposes.

Could a non-profit qualify even if it uses property managers or third-party operators?

The opinion did not directly address that scenario. The constitutional question turns on use of the property by the non-profit, in a sense recognized by Tennessee charitable-use jurisprudence. A non-profit owner that hires staff or contractors but remains the operator is meaningfully different from one that leases out its land to a separate for-profit operator. Specific facts would matter.

Citations

• Tenn. Const. art. II, § 28
• Tenn. Code Ann. § 67-5-207 (property tax exemption for certain non-profit low-income housing)
• Tenn. Code Ann. § 67-5-502(d) (taxation of lessee's interest in improvements)
• 26 U.S.C. § 42 (federal low-income housing tax credit)
• Mid-State Baptist Hosp., Inc. v. City of Nashville, 366 S.W.2d 769 (Tenn. 1963)
• Rockingham County v. Board of Trustees of Elon Coll., 13 S.E.2d 618 (N.C. 1941)
• United Brethren Publ'g Establishment v. Shaffer, 123 N.E. 697 (Ind. App. 1919)
• Club Sys. of Tenn., Inc. v. YMCA of Middle Tenn., 2005 WL 3479628 (Tenn. Ct. App. Dec. 19, 2005)
• Baptist Hosp. v. City of Nashville, 3 S.W.2d 1059 (Tenn. 1928)
• American Heritage Apartments, Inc. v. Bennett, 2005 WL 1996623 (Tenn. Ct. App. Aug. 18, 2005)
• Christian Home for the Aged, Inc. v. Assessment Appeals Comm'n, 790 S.W.2d 288 (Tenn. Ct. App. 1990)
• In re Mental Health Ass'n, 221 P.3d 580 (Kan. 2009)
• New Orleans Towers Affordable Hous. Corp. v. Kahn, 744 So. 2d 50 (La. Ct. App. 1999)
• In re Association for Neighborhood Rehabilitation, Inc. v. Board of Assessors, 917 N.Y.S.2d 734 (N.Y. App. Div. 2011)
• Orange County Appraisal Dist. v. Agape Neighborhood Improvement, Inc., 57 S.W.3d 597 (Tex. App. 2001)

Source

• Landing page: https://www.tn.gov/attorneygeneral/opinions.html
• Original PDF: https://www.tn.gov/content/dam/tn/attorneygeneral/documents/ops/2012/op12-055.pdf

Original opinion text

May 21, 2012
Opinion No. 12-55
Property Tax Exemption for Low-Income Housing Property

QUESTIONS

1. Is Senate Bill 2944/House Bill 2974, 107th General Assembly, 2nd Sess. (2012) (SB2944), which authorizes real property to be given tax-exempt status when the property is owned by a limited liability company (LLC) or limited partnership and has qualified for low-income housing tax credits to be used for the purpose of providing low-income housing, consistent with Article II, Section 28, of the Tennessee Constitution?

2. Would it be constitutional for real property to be given tax exempt status when an LLC, a limited partnership, or a collection of such business entities forms a non-profit organization for the sole purpose of holding legal title to that real property, and then that non-profit leases the real property back to an LLC that has obtained low-income housing tax credits (per Section 42, Internal Revenue Code of 1986) to apply to that property for the purpose of providing low-income housing?

OPINIONS

1. No, SB2944 violates Article II, Section 28, of the Tennessee Constitution because it purports to extend a property tax exemption to an LLC or limited partnership without regard to whether that entity is charitable in nature. As interpreted by the Tennessee courts, the property tax exemption authorized by Article II, Section 28, requires both that the entity holding the property be a charitable organization and that the entity use the property for the charitable purposes for which it was organized.

2. No, the described scenario does not comply with Article II, Section 28, of the Tennessee Constitution. As a general proposition, the General Assembly has the discretion to determine that a non-profit organization that holds and uses its property to provide low-income housing is entitled to a charitable use exemption for its property. As structured, however, the arrangement envisions that a for-profit LLC will acquire a leasehold interest in the property and use the LLC's tax credits to provide low-income housing. The for-profit entity's operation of its business on the property would disqualify the property for a property tax exemption under Article II, Section 28, regardless of the entity's goal of providing low-income housing to community residents.

ANALYSIS

The Tennessee Constitution authorizes the General Assembly to exempt from taxation such property "as may be held and used for purposes purely religious, charitable, scientific, literary or educational." Tenn. Const. art. II, § 28. The initial question addresses whether this constitutionally authorized exemption would include the real property sought to be exempted from taxation by SB2944. Specifically, SB2944 purports to exempt from ad valorem taxation "[p]roperty of limited liability companies or limited partnerships, wherein there is in effect an 'extended low-income housing commitment,' as defined in Section 42 of the Internal Revenue Code of 1986." We presume that SB2944 refers to for-profit LLCs and limited partnerships because nonprofit entities would not benefit from the tax credits of I.R.C. § 42.

The property tax exemption described in SB2944 does not comply with Article II, Section 28, of the Tennessee Constitution. In order to fit within the Constitution's authorized exemption, property must be both held and used for charitable purposes. No authority exists under Tennessee case law interpreting Article II, Section 28, for extending the authorized exemption to for-profit entities, such as LLCs or limited partnerships. To the contrary, these cases require that the owner of the exempt property be a charitable organization and that the charity use the property for the charitable purposes for which it was organized. See, e.g., Mid-State Baptist Hosp., Inc. v. City of Nashville, 211 Tenn. 599, 607, 366 S.W.2d 769, 773 (1963) (holding the basis for property tax exemption is that a charitable organization hold and use property for its charitable purposes). Both the charitable nature of the organization and that organization's charitable use of the property are essential to the exemption. Id.

A charitable organization that uses its property to conduct for-profit activities "becomes liable for taxation as any other business establishment." Id. at 604, 366 S.W.2d at 772. Conversely, a for-profit business is not entitled to a property tax exemption merely because it uses its property for some charitable purposes. See Rockingham County v. Board of Trustees of Elon Coll., 13 S.E.2d 618, 621 (N.C. 1941) (observing that "[t]he fact that a commercial enterprise devotes its entire profits to a charitable or other laudable purpose does not change the character of its business nor the purpose for which it is held. It is still a commercial enterprise, and is held as such"). See also United Brethren Publ'g Establishment v. Shaffer, 123 N.E. 697, 698 (Ind. App. 1919) (holding that institution claiming tax exemption "must, itself, be a charitable institution, and not one organized for the purpose of profit, notwithstanding the fact that the proceeds or profits of the business are devoted to a most worthy charitable purpose"). It is the entity's nonprofit status, coupled with its charitable use of the property, that creates the exemption.

Thus, property that is owned and used by an LLC or limited partnership, as contemplated by SB2944, is not being held and used for a charitable purpose within the meaning of Article II, Section 28. The entity's for-profit status is fundamentally inconsistent with the charitable use exemption, even if some of the entity's activities serve the greater good of the community, such as by providing housing to low-income residents.

The second question concerns the constitutionality of legislation that would grant a property tax exemption to property owned and held by a non-profit organization that then leases the property to an LLC that provides low-income housing to community residents using low-income housing tax credits under Section 42 of the Internal Revenue Code. Tennessee courts have recognized that "the Tennessee Constitution does not define the term 'charitable,'" and "[t]his fact necessarily allows the Legislature some discretion in determining the meaning of the term." Club Sys. of Tenn., Inc. v. YMCA of Middle Tenn., No. M2004-01966-COA-R3-CV, 2005 WL 3479628, at *7 (Tenn. Ct. App. Dec. 19, 2005). The term "charity" has been defined as

a gift, to be applied consistently with existing laws, for the benefit of an indefinite number of persons, either by bringing their hearts under the influence of education or religion, by relieving their bodies from disease, suffering or constraint, by assisting them to establish themselves for life, or by erecting or maintaining public buildings or works or otherwise lessening the burdens of government.

Id. (quoting Baptist Hosp. v. City of Nashville, 156 Tenn. 589, 592, 3 S.W.2d 1059, 1060 (1928)).

Accordingly, in its discretion, the General Assembly could grant a property tax exemption to non-profit organizations that hold and use property for the purpose of providing low-income housing to community residents. The General Assembly reasonably could conclude that the provision of low-income housing assists residents to establish themselves for life and otherwise lessens the burdens of government. In fact, the General Assembly already has created a property tax exemption for certain non-profit corporations that use their property to provide permanent housing for low-income persons with disabilities and low-income elderly persons. See Tenn. Code Ann. § 67-5-207. Moreover, Tennessee courts have held that housing may qualify as a charitable purpose. American Heritage Apartments, Inc. v. Bennett, No. M2003-02595-COA-R3-CV, 2005 WL 1996623, at *5 (Tenn. Ct. App. Aug. 18, 2005) (citing Christian Home for the Aged, Inc. v. Assessment Appeals Comm'n, 790 S.W.2d 288 (Tenn. Ct. App. 1990)). A number of other states likewise have granted property tax exemptions for certain organizations that provide low-income housing. See, e.g., In re Mental Health Ass'n, 221 P.3d 580 (Kan. 2009); New Orleans Towers Affordable Hous. Corp. v. Kahn, 744 So. 2d 50 (La. Ct. App. 1999); In re Association for Neighborhood Rehabilitation, Inc. v. Board of Assessors, 917 N.Y.S.2d 734 (N.Y. App. Div. 2011); Orange County Appraisal Dist. v. Agape Neighborhood Improvement, Inc., 57 S.W.3d 597 (Tex. App. 2001).

In the scenario described in your request, however, the non-profit organization does not hold and use its property for the purpose of providing low-income housing. Instead, the non-profit organization leases the land to an LLC that, in turn, provides low-income housing to community residents using low-income housing tax credits under Section 42 of the Internal Revenue Code. Inasmuch as the LLC using the tax credits is a for-profit entity, this scenario fails to meet the Constitution's requirement that the land be both held and used for charitable purposes. See Tenn. Const. art. II, § 28. Although the LLC is providing a valuable service to the community, it is doing so on a for-profit basis, which would disqualify its use of the property as charitable. Moreover, even if the non-profit organization's property could qualify for exempt status, this would not relieve the for-profit LLC from taxation on its leasehold interest in the property. See Tenn. Code Ann. § 67-5-502(d) (assessing as real property any "interest that the lessee may have in and to the improvements erected upon land where the fee, reversion, or remainder therein is exempt to the owner").

ROBERT E. COOPER, JR.
Attorney General and Reporter

WILLIAM E. YOUNG
Solicitor General

MARY ELLEN KNACK
Senior Counsel

Requested by:
The Honorable Gerald McCormick
House Majority Leader
18A Legislative Plaza
Nashville, Tennessee 37243-0126