Community hospital lease furthers charity and avoids debt-financed property treatment

Plain-English summary

A nonprofit association had long operated a small community hospital but faced declining reimbursements, limited capital, and insufficient scale. A state-commissioned study recommended affiliation with a state university's academic medical center so emergency and acute care would remain available in the thinly populated region. The association proposed leasing the hospital premises to the state university for rent limited largely to bond payments and operating liabilities. The agreements required continued core services, an open emergency department, accreditation, teaching opportunities, and operation consistent with the public university's mission, with the association controlling a joint advisory committee. The IRS ruled that the lease furthered the association's charitable purpose of promoting community health. Because substantially all of the property would continue to be used for that exempt purpose, the premises would not be debt-financed property under section 514(b)(1), and lease income could remain within the real-property rent exclusion when determining unrelated business taxable income.

Ruling snapshot

• Question: Does leasing the hospital to a state university further the association's charitable purpose, and is the property's use substantially related enough to avoid debt-financed property treatment?
• Outcome: approved on both issues
• Key authorities: IRC §§ 501(c)(3), 512(b)(3), 513, and 514(b)(1); Rev. Ruls. 69-545, 73-313, and 80-309

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201703005 Third Party Communication: None
Release Date: 1/20/2017 Date of Communication: Not Applicable
Index Number: 501.03-11, 514.06-00
Person To Contact:
-------------------------------------------------------- ------------------------------, ID No. ------------
-------------------------------------------------- -----------------
------------------------ Telephone Number:
----------------------------------- ----------------------
Refer Reply To:
CC:TEGE:EOEG:EO3
PLR-117788-16
Date:
October 19, 2016

Association = --------------------------------------------------------------
Study = -------------------------------------------------------------------------------
------------------
Community Hospital = ----------------------------------------------
State = -------------------------------
State University = ---------------------------------------------
University Hospital = -------------------------------------------
Communities = ------------------------------------------------------------------
X = -----
Y = ----

Dear ----------------:

This letter responds to a letter from Association’s authorized representatives dated May
31, 2016, and subsequent correspondence, on behalf of Association requesting rulings
that (i) leasing Community Hospital’s premises in the manner described below is in
furtherance of Association’s charitable purpose under section 501(c)(3) of the Internal
Revenue Code1; and (ii) the lessee’s use of the leased property is substantially related
to the exercise or performance by Association of its charitable purpose for purposes of
determining whether income under the lease is derived from debt-financed property
under section 514(b)(1).

1
The Internal Revenue Code of 1986, as amended, to which all subsequent “section” references are
made unless otherwise indicated.
PLR-117788-16 2

FACTS

The Internal Revenue Service (“IRS”) has recognized Association as an organization
described in section 501(c)(3) that is not a private foundation under section 509.
Association was organized under State law as a nonprofit corporation and was formed
to “establish, operate, and maintain a hospital for the care and treatment of persons
who are ill, injured, or in need of hospital care” at its current location (“Community
Hospital”), and “to lease or otherwise acquire, hold, mortgage, sell, or otherwise dispose
of any real or personal property . . . and to do all other acts necessary or expedient for
the administration of its affairs and as are incidental to the obtainment of any of its
purposes.” Association’s board of directors is composed of a number of prominent
individuals who live in Community Hospital’s service area (“Communities”). Community
Hospital has an open medical staff, and its emergency department treats all persons,
regardless of their ability to pay. Association owns the Community Hospital building and
various other, related healthcare facilities (the “Premises”). Community Hospital is
subject to tax-exempt bonds used to fund its expansion and modernization.

Association has operated Community Hospital, a small acute care hospital, continuously
for more than X years to provide the best possible health care services to the people in
Communities. However, in recent years, Association has experienced difficulty covering
the costs of operating Community Hospital because of lack of economies of scale, lack
of access to capital, and declining reimbursements.

Some years ago, State undertook an independent review of State’s health care capacity
and resources. To that end, it commissioned a study (the “Study”), which examined the
supply of general hospital and nursing home facilities in State, and recommended
changes that would result in a more coherent, streamlined health care system.
Referring to Community Hospital and certain other independent community hospitals in
the same geographic region, the Study recommended that access to emergency and
acute inpatient care be maintained at each location due to the unique geography and
population distribution of the region and the distance between the region’s hospitals.
The Study recognized, however, that competition for patients in what it characterized as
a “thinly populated” area would cause the continued decline of those hospitals.
Consequently, it recommended that the hospitals develop an affiliation with University
Hospital in order to strengthen the hospitals and to create a healthcare system that
better serves the needs of the region.

University Hospital is an academic medical center and the region’s only tertiary care
center and Level 1 trauma center. University Hospital is a division of State University.
PLR-117788-16 3

State University was created by statute as a corporation within the department of State
that is concerned with public education.2

More recently, Association hired a consulting firm to prepare a demographic and market
assessment of Community Hospital’s service area and to provide a strategic
assessment of Community Hospital’s options, given its financial difficulties. The
consulting firm considered many factors, including Community Hospital’s ability to
spread costs, managed care contracts, access to capital, access to talent, and
organizational fit, and concluded that remaining independent was not a viable option for
Community Hospital.

After careful study and analysis of current and projected future conditions in its service
area and in the field of health care in general, Association concluded that its public
purpose could best be achieved by integrating its Community Hospital operations into
University Hospital under an Integration and Affiliation Agreement (the “IAA”) with State
University (acting through University Hospital) and by entering into other related and
ancillary transactions and arrangements, including a lease agreement (the “Lease”).3

Under the terms of the Lease, Association will lease the Premises and all property,
plant, and fixed equipment located on the Premises to State University (acting through
University Hospital) for a term of Y years (which term is automatically extended for an
additional year on each anniversary of the lease commencement date), unless
terminated sooner due to one of several enumerated events, including termination by
the landlord following a major tenant breach not timely cured. A major tenant breach
includes tenant’s failure to observe or perform any material covenant, condition, or
agreement on its part to be observed or performed under certain sections of the IAA.
Among the covenants and agreements that State University is required to observe or
perform to avoid a major tenant breach are the following:

   Maintain at Community Hospital various listed core medical and surgical
    services, at current levels of access and sophistication;
   Maintain accreditation of Community Hospital by the Joint Commission without
    significant deficiencies;
   Offer opportunities for teaching and research at Community Hospital;

2
While State University is not recognized as an organization described in section 501(c)(3), Association
represents that State University is an integral part of State, such that State University’s income is
generally not subject to federal income tax.
3
The signatories to the IAA and the Lease are State University and Association. However, University
Hospital, which is a division of State University, will operate Community Hospital on the Premises, which
will still be owned by Association.
PLR-117788-16 4

     Use commercially reasonable efforts to strengthen the clinical and academic
      programs offered at Community Hospital;
     Use commercially reasonable efforts to maintain and strengthen Association’s
      current residency program at Community Hospital;
     Ensure that Community Hospital is operated in a manner consistent with the
      mission, vision, values, and tax-exempt status of State University4; in particular,
      the provision of an emergency room meeting State Department of Health
      requirements may not be discontinued or unreasonably limited; and
     Ensure that State University maintains its exemption from U.S. federal income
      taxation.5

Substantially all of the Premises subject to the Lease will be used in furtherance of
Association’s exempt purposes of promoting healthcare.

The rent to be paid under the Lease is limited to Association’s payment obligations
under the tax-exempt bonds and certain other liabilities, utilities, taxes, insurance, and
administrative expenses. Upon payment of all the obligations under the bonds, the rent
will decrease accordingly.

As an integral part of State, State University is governed by a board of trustees, the
majority of the members of which are appointed by State’s governor. The remaining
members of the board of trustees are State University leaders who serve ex-officio.
While the persons who control State University are not the same as the persons who
control Association, the IAA provides for a joint advisory committee made up of
Association and State University designees, the majority of whom are appointed by
Association (the “Joint Advisory Committee”). The Joint Advisory Committee will meet
at least quarterly to advise University Hospital on matters of operational and strategic
importance involving Community Hospital. It will serve a consultative role (and will be
subject and subordinate to State University’s ultimate responsibility and decision-
making authority), but will discuss and may advise University Hospital on any matter
that its participants deem important relating to Community Hospital, including
recruitment, selection, or termination of the senior executive having operational
responsibility for Community Hospital; decisions to expand, reduce, close, or transfer
any core service; creation of any new program, facility, or major expansion at
Community Hospital; review of clinical quality, safety, patient satisfaction and overall
operational performance, and clinical policies and procedures; review of an internal

4
See fn. 2.
5
See fn. 2.
PLR-117788-16 5

community services plan; proposed annual capital and operating budgets of Community
Hospital; and development and review of long-term strategic plans for Community
Hospital.

Upon completion of the affiliation transaction, Association will amend its governing
document to provide that Association will be organized and operated to “establish,
operate, and maintain or lease a hospital and related facilities” and “to promote the
health of the people in [Communities] . . . pursuant to a series of agreements providing
for the operation of [Community Hospital] . . . .”

RULINGS REQUESTED

Association has requested the following rulings:

1) The leasing of the Premises to State University pursuant to the Lease, the use of
the Premises by University Hospital, and the performance of Association’s
obligations under the IAA further Association’s exempt purpose under
section 501(c)(3); and
2) The leasing of the Premises to State University pursuant to the Lease, the use of
the Premises by University Hospital, and the performance of Association’s
obligations under the IAA are substantially related to the exercise or performance
of Association’s exempt purposes such that the Premises will not be considered
“debt-financed property” within the meaning of section 514(b)(1)(A).

LAW

Section 501(a) provides generally that an organization described in section 501(c) is
exempt from federal income taxes.

Section 501(c)(3) describes entities that are organized and operated exclusively for
charitable, educational, scientific, and certain other purposes.

Section 1.501(c)(3)-1(c) of the Income Tax Regulations (the “regulations”) provides that
an organization will be regarded as “operated exclusively” for one or more exempt
purposes only if it engages primarily in activities that accomplish one or more of such
exempt purposes specified in section 501(c)(3). An organization will not be so regarded
if more than an insubstantial part of its activities is not in furtherance of an exempt
purpose.

Section 1.501(c)(3)-1(d)(2) of the regulations provides that an organization is not
organized or operated exclusively for one or more exempt purposes unless it serves a
public rather than a private interest.
PLR-117788-16 6

Rev. Rul. 69-545, 1969-2 C.B. 117, states that the promotion of health is a charitable
purpose, and that a nonprofit organization whose purpose and activity are providing
hospital care is promoting health and may, therefore, qualify as organized and operated
in furtherance of charitable purposes if it meets the other requirements of section
501(c)(3). The ruling explains that the promotion of health is one of the purposes in the
general law of charity that is deemed beneficial to the community as a whole even
though the class of beneficiaries eligible to receive a direct benefit from its activities
does not include all members of the community, such as indigent members of the
community, provided that the class is not so small that its relief is not of benefit to the
community. For example, a hospital that operates an emergency room open to all
persons and that provides hospital care for all those persons in the community able to
pay the cost of such care either directly or through third party reimbursement is
promoting the health of a class of persons that is broad enough to benefit the
community. Additional indications that a hospital is operated for the benefit of the public
include the facts that control of the hospital rests with a board of trustees composed of
independent civic leaders, that the hospital maintains an open medical staff, with
privileges available to all qualified physicians, and that members of its active medical
staff have the privilege of leasing available space in its medical building.

Rev. Rul. 73-313, 1973-2 C.B. 174, addresses the question of whether the activity of
providing a medical building and facilities at reasonable rent (but less than what would
be necessary to provide a normal return on the investment in the building and other
facilities) to attract a medical doctor to a community furthered the charitable purposes of
an organization that was formed to promote the health of the community through the
development and improvement of medical facilities and services. The community
represented by the organization was in an isolated rural area where there were no
medical practitioners. To induce a doctor to locate to the community, the organization
erected a building for use as a doctor’s office with funds raised by contributions. Using
the availability of the building at a reasonable rental basis as an inducement, the
organization entered into an arrangement with a doctor to locate in the community, with
the understanding that the doctor would make his services available to the entire
community. In holding that the organization’s activity is charitable within the meaning of
section 501(c)(3), the ruling states that providing a physical facility in the manner
described bears a clear relationship to lessening the health hazards that result from the
absence of a local practitioner, and that the terms of the arrangement, which were
negotiated at arm’s length and in good faith, bear a reasonable relationship to the
promotion and protection of the health of the community. Any personal benefit derived
by the doctor from the use of the building to conduct his private practice does not lessen
PLR-117788-16 7

the public benefit flowing from the organization’s activities or constitute the type of
private interest prohibited by the regulations.

Rev. Rul. 80-309, 1980-2 C.B. 183, addresses the question of whether a nonprofit
organization that was created to construct, maintain, and operate or lease a public
hospital is operated exclusively for charitable purposes. The organization’s articles of
incorporation state that the organization’s purpose is to provide a public hospital and
related facilities for city V and its surrounding communities. The articles also provide
that all of the organization’s assets will be transferred, without consideration, to city V
when all indebtedness has been paid. City V has agreed to accept title at such time.
After construction of the hospital and related facilities, the organization’s only activity
has been to lease them to an association exempt under section 501(c)(3). The lessee
operates the hospital and facilities and pays as consideration an amount sufficient only
to retire the organization’s indebtedness incurred to finance them and cover the
organization’s administrative expenses. Trustees of the lessee association make up the
lessor organization’s entire board of directors. Citing Restatement (Second), Trusts,
secs. 368, 372, and IV Scott on Trusts (3d ed. 1967), secs. 368, 372, for the proposition
that the promotion of health is considered a charitable purpose under the general law of
charity, the ruling concludes that the organization, by building a public hospital and
related facilities and leasing them to an exempt charitable association that operates the
facilities for an amount sufficient only to retire indebtedness and cover necessary
operating expenses, is furthering the charitable purpose of promoting the health of the
community.

In B.S.W. Group, Inc., v. Comm’r, 70 T.C. 352 (1978), an organization formed for the
purpose of providing consulting services to tax-exempt organizations and not-for-profit
organizations (some of which might not be tax-exempt) in the area of rural-related policy
and program development, sought a declaratory judgment from the Tax Court after the
IRS determined that the organization did not qualify as an organization described in
section 501(c)(3). Holding that the IRS had not erred in its determination, the Tax Court
said that it is the purpose toward which an organization’s activities are directed, and not
the nature of the activities themselves, that is ultimately dispositive of the organization’s
right to be classified as a section 501(c)(3) organization. With respect to this petitioner,
the court said that the critical enquiry was whether petitioner’s primary purpose for
engaging in its sole activity, providing consulting services, was an exempt purpose, or
whether its primary purpose was the nonexempt one of operating a commercial
business producing net profits. Finding that petitioner’s sole activity constituted a
consulting business of the sort that is ordinarily carried on by commercial ventures
organized for profit, and observing that competition with commercial firms is strong
PLR-117788-16 8

evidence of the predominance of a nonexempt commercial purpose, the Tax Court
concluded that petitioner’s conduct of a business with an apparently commercial
character weighed heavily against exemption. Furthermore, after noting that it did not
appear that petitioner ever planned to charge a fee less than cost, the court said the fact
that petitioner’s fees may be lower than those charged by other firms is not enough to
prove that petitioner’s purposes are primarily exempt.

Section 511(a) imposes a tax on the unrelated business taxable income of
organizations described in section 501(c)(3).

Section 512(a)(1) defines the term “unrelated business taxable income” as the gross
income derived by any organization from any unrelated trade or business regularly
carried on by it, less the allowable deductions that are directly connected with the
carrying on of such trade or business, both computed with the modifications provided in
section 512(b).

Section 512(b)(3)(A) excludes from the term “unrelated business taxable income” all
rents from real property and all rents from personal property leased with such real
property if the rents attributable to such personal property are an incidental amount of
the total rents received and accrued under the lease, determined at the time the
personal property is placed in service.

Section 512(b)(4) provides that, notwithstanding paragraph (3), above, in the case of
debt-financed property (as defined in section 514), there generally shall be included, as
an item of gross income derived from an unrelated trade or business, the amount
ascertained under section 514(a)(1), and there shall be allowed, as a deduction, the
amount ascertained under section 514(a)(2).

Section 513(a) defines the term “unrelated trade or business” as any trade or business
the conduct of which is not substantially related (aside from the need of such
organization for income or funds or the use it makes of the profits derived) to the
exercise or performance by such organization of its charitable, educational, or other
purpose or function constituting the basis for its exemption under section 501.

Section 1.513-1(d)(1) of the regulations provides that gross income derives from
“unrelated trade or business” within the meaning of section 513(a) if the conduct of the
trade or business which produces the income is not substantially related (other than
through the production of funds) to the purposes for which exemption is granted. The
presence of this requirement necessitates an examination of the relationship between
the business activities that generate the particular income in question – the activities,
PLR-117788-16 9

that is, of producing or distributing the goods or performing the services involved – and
the accomplishment of the organization’s exempt purposes.

Section 1.513-1(d)(2) of the regulations provides that a trade or business is “related” to
exempt purposes, in the relevant sense, only where the conduct of the business
activities has causal relationship to the achievement of exempt purposes (other than
through the production of income); and it is “substantially related,” for purposes of
section 513, only if the causal relationship is a substantial one. Thus, for the conduct of
trade or business from which a particular amount of gross income is derived to be
substantially related to purposes for which exemption is granted, the production or
distribution of the goods or the performance of the services from which the gross
income is derived must contribute importantly to the accomplishment of those purposes.
Whether activities productive of gross income contribute importantly to the
accomplishment of any purpose for which an organization is granted exemption
depends in each case upon the facts and circumstances involved.

In computing under section 512 the unrelated business taxable income for any taxable
year, section 514(a) generally includes as an item of gross income derived from an
unrelated trade or business certain amounts with respect to debt-financed property.

Section 514(b)(1) defines the term “debt-financed property” as any property that is held
to produce income and with respect to which there is an acquisition indebtedness (as
defined in section 514(c)) at any time during the taxable year, except that such term
does not include—

          (A)(i) any property substantially all the use of which is substantially related
   (aside from the need of the organization for income or funds) to the exercise or
   performance by such organization of its charitable, educational, or other purpose
   or function constituting the basis for its exemption under section 501 … or (ii) any
   property to which clause (i) does not apply, to the extent that its use is so
   substantially related.

Section 1.514(b)-1(a) of the regulations defines the term “debt-financed property” as
any property that is held to produce income (e.g., rental real estate) and with respect to
which there is acquisition indebtedness at any time during the taxable year.

Section 1.514(b)-1(b)(1)(i) of the regulations provides that to the extent that the use of
any property is substantially related (aside from the need of the organization for income
or funds or the use it makes of the profits derived) to the exercise or performance by an
organization of its charitable, educational, or other purpose or function constituting its
PLR-117788-16 10

basis for exemption under section 501, such property shall not be treated as debt-
financed property.

Section 1.514(b)-1(b)(1)(ii) of the regulations provides that if substantially all of any
property is used in a manner described in section 1.514(b)-1(b)(1)(i), such property shall
not be treated as debt-financed property. In general, the preceding sentence shall
apply if 85 percent or more of the use of such property is devoted to the organization’s
exempt purpose. The extent to which property is used for a particular purpose shall be
determined on the basis of all the facts and circumstances.

Section 514(c)(1) defines the term “acquisition indebtedness” with respect to any debt-
financed property to include the unpaid amount of the indebtedness incurred by the
organization in acquiring or improving such property.

ANALYSIS

Whether leasing the Premises to State University furthers Association’s exempt
purposes.

The leasing of real property is a trade or business commonly carried on for profit by
commercial ventures. In B.S.W. Group, Inc. v. Comm’r, the Tax Court held that the
conduct of a trade or business of a commercial character generally does not further
charitable purposes, even if the trade or business provides goods or services at cost
and solely to section 501(c)(3) organizations. Nevertheless, the court said that it is the
purpose toward which the activities are directed, and not the nature of the activities
themselves, that determines whether the activities further exempt purposes.

Rev. Rul. 80-309 provides an example of an instance in which an unusual set of facts
supported a conclusion that, in rare circumstances, the activity of leasing a hospital
facility to an association that is exempt under section 501(c)(3) is directed to the
furtherance of charitable purposes. That revenue ruling held that a nonprofit
organization was operating exclusively for charitable purposes when it leased a hospital
facility to a section 501(c)(3) association where: (i) the lessee association paid as
consideration an amount sufficient only to retire the indebtedness incurred to finance
the hospital facility and meet necessary operating expenses; (ii) lessor and lessee were
under common control; and (iii) title to the facility would be transferred to the
municipality once all indebtedness had been paid.

Association was organized for the purpose of maintaining an acute care hospital so as
to ensure the highest quality of healthcare services for Communities. Having operated
Community Hospital, a small acute care hospital, continuously for more than X years,
PLR-117788-16 11

and acting on the recommendation of the State-commissioned Study that Association
develop an affiliation with University Hospital to strengthen Community Hospital and to
create a healthcare system that better serves the needs of the region, Association now
proposes to lease the Premises to State University, which is an integral part of State
that is organized and operated for educational purposes. The leasing of the Premises
to State University (acting through University Hospital) will not cause Community
Hospital to be operated other than in a manner that will continue to benefit the public
and serve the public interest. In entering into the Lease, State University covenants to
maintain the core services already rendered by Community Hospital, including
emergency room services open to the entire community. In addition, State University
covenants to maintain Community Hospital’s accreditation by the Joint Commission; to
operate Community Hospital in a manner consistent with State University’s mission,
vision, values, and tax-exempt status; and to maintain State University’s exemption from
U.S. federal income taxation.6 If State University breaches its covenants, Association
can terminate the Lease. The rent under the Lease will be in an amount sufficient only
to satisfy Association’s obligations under instruments pertaining to tax-exempt bonds,
the proceeds of which were used to expand and modernize Community Hospital, and to
pay other liabilities and expenses incurred, or to be incurred, by Association on behalf of
Community Hospital. Once the obligations under the bonds are satisfied, the rental
amount will decrease accordingly. Finally, although the persons who control State
University are not the same persons who control Association, Association controls the
Joint Advisory Committee that will advise University Hospital on the operation of, and
strategic planning for, Community Hospital.

Consequently, as in Rev. Rul. 80-309, in which an unusual set of facts resulted in a
conclusion that the leasing of a hospital facility to a section 501(c)(3) organization was
in furtherance of charitable purposes, the particular facts of this case – specifically, the
Study’s recommendation that Community Hospital affiliate with University Hospital in
order to gain access to tertiary care services and the other benefits inherent in a
relationship with an academic medical center, Association’s determination that affiliation
with State University would be the best way to maintain and enhance health care and
hospital services for the residents of Communities, State University’s status as an
integral part of State organized and operated for educational purposes, State
University’s commitments under the IAA, and Association’s control of the Joint Advisory
Committee – lead to a conclusion that the leasing of the Premises to State University,
acting through University Hospital, will further Association’s charitable purpose of

6
See fn. 2.
PLR-117788-16 12

promoting health by maintaining a hospital at its current location. Thus, under the
particular facts of this case, the proposed lease structure will be used to accomplish the
same purposes previously carried out directly by Association.

Rev. Rul. 73-313 provides another example of an instance in which an unusual factual
situation – the absence of medical providers in an isolated rural community – resulted in
the conclusion that the activity of leasing property – in this case, the leasing of a
medical office under terms that would induce a private physician to set up a practice in
the community and make his services available to the entire community – was directed
to the furtherance of a charitable purpose, namely the purpose of promoting the health
of the residents of the community by lessening the health hazards resulting from the
absence of a local medical practitioner.

Similarly, the Study noted that Community Hospital serves a thinly populated area in
which access to emergency and acute inpatient care must be maintained. The IAA and
accompanying Lease will enable Community Hospital to share resources with University
Hospital, a tertiary academic medical center, which will give members of Communities
access to a broader and more efficient network of emergency services, healthcare
providers, medical specialists, specialty medical care, and clinical trials. The affiliation
also will guarantee the long-term financial stability of Community Hospital. Therefore,
by leasing the Premises to State University, Association will be furthering a charitable
purpose, namely the purpose of promoting the health of the residents of an isolated,
thinly populated area by lessening the health hazards that would result should, in the
absence of the affiliation, Community Hospital be forced to discontinue core services or
to close entirely.

In Rev. Rul. 73-313, furthermore, the leasing of property to a medical provider for
reasonable rent under terms that were negotiated at arm’s length and in good faith did
not cause an arrangement that otherwise served a public interest to be construed as
serving an impermissible private interest. Similarly, the leasing of the Premises to State
University will not cause the affiliation between Association and State University –
which, as discussed above, otherwise serves a public interest – to serve impermissible
private interests. As previously noted, the lessee, State University, is an integral part of
State with the mission of providing educational services to the people of State. As such,
it owes a singular duty to, and is charged with unique responsibilities toward, the
residents of State. Therefore, the leasing of the Premises to State University, as
provided under the IAA and the Lease, will not redound to the benefit of private
interests, but will continue to accrue to the benefit of the people of State and the
residents of Communities and the surrounding region.
PLR-117788-16 13

Whether the use of the Premises by University Hospital under the Lease is substantially
related to the exercise or performance by Association of its exempt purpose.

The Premises are the subject of tax-exempt bond financing, the proceeds of which were
used to expand and modernize the Premises. Therefore, the Premises would be
considered debt-financed property under section 514(a), and a percentage of any
payments derived under the Lease that would otherwise be excluded as rents under
section 512(b)(3)(A) would be includible in Association’s unrelated debt-financed
income unless University Hospital’s use of the Premises under the Lease is
substantially related to the exercise or performance by Association of its charitable
purpose.

Association’s charitable purpose is to establish and maintain a hospital at its current
location. Under the terms of the IAA and the accompanying Lease, State University
(acting through University Hospital) is required to use the Premises to maintain
Community Hospital and to continue providing healthcare services to the public served
by Association. Substantially all of the Premises will be used for this purpose.
Consequently, the use of the Premises by State University (acting through University
Hospital) is substantially related to the exercise or performance by Association of its
charitable purpose, and the Premises are not considered debt-financed property within
the meaning of section 514(b)(1) for purposes of determining whether any part of the
income derived under the Lease is excludible from Association’s unrelated business
taxable income under section 512(b)(3).

RULINGS

Based solely on the facts and representations submitted by Association, we rule as
follows:

 1) The leasing of the Premises to State University as provided in the Lease will
    further Association’s charitable purpose under section 501(c)(3); and
 2) The use of the Premises by State University (acting through University
    Hospital) will be substantially related to the exercise or performance by
    Association of its charitable purpose. Therefore, the Premises will not be
    considered debt-financed property within the meaning of section 514(b)(1) for
    purposes of determining whether any part of the income derived under the
    Lease will be excludible from Association’s unrelated business taxable income
    under section 512(b)(3).

PLR-117788-16 14

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of Association (accompanied by a penalty of perjury
statement executed by an individual with authority to bind Association) and upon the
understanding that there will be no material changes in the facts. This office has not
verified any of the material submitted in support of the request for rulings, and such
material is subject to verification on examination. The Associate office will revoke or
modify a letter ruling and apply the revocation retroactively if there has been a
misstatement or omission of controlling facts; if the facts at the time of the transaction
are materially different from the controlling facts on which the ruling was based; or, in
the case of a transaction involving a continuing action or series of actions, if the
controlling facts change during the course of the transaction. See Rev. Proc. 2016-1,
section 11.05.

No ruling is granted as to whether Association qualifies as an organization described in
section 501(c) and/or section 509(a)(1), (2), or (3), and, except as expressly provided
above, no opinion is expressed or implied concerning the federal income tax
consequences of any other aspects of any transaction or item of income described in
this letter ruling. In addition, no ruling is granted regarding whether Association satisfies
or is required to satisfy the requirements of section 501(r).

This letter ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representatives.

                                   Sincerely,



                                   Mike Repass
                                   Senior Technician Reviewer
                                   Exempt Organizations Branch 3
                                   (Tax Exempt & Government Entities)

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