IRC 514(b)(1)(A) provides that if substantially all the use of any property is substantially related to the exercise or performance of an organization’s exempt purpose, such property is not treated as "debt-financed property." The term "substantially all" is defined as 85%.

The extent to which property is used for a particular purpose is determined on the basis of all the facts and circumstances. Where appropriate, these may include:

Rev. Rul. 77–47, 1977–1 C.B. 156, provides that buildings, acquired through assumption of outstanding mortgages by an exempt organization that restores, preserves, and exhibits buildings of historical and/or architectural significance, constitute debt-financed property when they are leased at fair rental value for uses that neither bear any relationship to the buildings’ historical or architectural significance nor accommodate viewing by the general public.

If less than 85% of the use of any property is devoted to an organization’s exempt purposes, only that portion of the property which is used in furtherance of the organization’s exempt purposes is not treated as debt-financed property. Regs. 1.514(b)–1(b)(1).

Congress intended that income, under the general definition of unrelated trade or business, be taxable in its entirely. However, without a statutory exception, such income, if derived from debt-financed property, might be taxable only to the extent of the outstanding indebtedness on such property. Consequently, IRC 514(b)(1)(B) provides that property, to the extent it produces income which is unrelated business taxable income under the general definition, is not treated as "debt-financed property." However, any gain on the disposition of such property which is not included in income from an unrelated trade or business by reason of IRC 512(b)(5) is includible as gross income derived from, or on account of, debt-financed property.

IRC 514 does not apply to amounts which are otherwise included in the computation of unrelated business taxable income, such as rents from personal property included under IRC 512(b)(3), or rents and interest from controlled organizations includible under IRC 512(b)(13). See Example (3) of Regs. 1.514(b)–1(b)(3).

IRC 514(b)(1)(C) provides that property, to the extent it produces gross income derived from research activities otherwise excluded from the unrelated trade or business tax by IRC 512 (b)(7), (8), or (9), is not treated as "debt-financed property."

Under IRC 514(b)(1)(D), debt-financed property does not include any property to the extent it produces income from a trade or business which is excepted from the definition of an "unrelated trade or business" by IRC 513 (a)(1), (2), or (3). Thus, property used in connection with the donated merchandise, volunteer labor, or convenience exceptions does not constitute debt-financed property. Regs. 1.514(b)–1(b)(5).

Under IRC 514(b)(2), use of property by a "related organization" is taken into account in determining the extent to which such property is used for a purpose described in IRC 514(b)(1)(A), (C), or (D).

An exempt organization is related to another exempt organization only if:

Property owned by an exempt organization and used by a related exempt organization or by an exempt organization related to such related exempt organization is not treated as "debt-financed property" to the extent such property is used by either of such related exempt organizations in furtherance of their exempt purposes. Furthermore, property is not treated as debt-financed property to the extent such property is used by a related exempt organization for a purpose described in IRC 514(b)(1)(C) or (D). Regs. 1.514(b)–1(c)(2)(i).

An organization exempt under IRC 501(c)(6) subjected a shell building it owned to a mortgage so that it could finance its completion to suit the needs of its tenant. Notwithstanding that the organization had to borrow money and mortgage its property to finance the alterations, the building was not debt-financed under IRC 514, because the organization was furthering its stated purpose of promoting the commercial development of its metropolitan area by encouraging new industries to move to the area. Therefore, the leasing activity was substantially related within the meaning of IRC 514(b)(1)(A)(i) to the organization’s accomplishment of its exempt purpose. Rev. Rul. 81–138, 1981–1 C.B. 358.

Real property is not debt-financed property if it is leased to a medical clinic, and the lease is entered into primarily for the exempt purposes of the lessor. IRC 514(b)(1).

If an individual transfers property to a trust or a fund subject to a contract providing that the income is to be paid to him/her or to the other individuals or both for a period of time not to exceed the life of such individual or individuals in a transaction in which the payments to the individual do not constitute the proceeds of a sale or exchange of the property so transferred and if the remainder interest is payable to an exempt organization described in IRC 501(c)(3), the property is not treated as "debt-financed property" by reason of the life income contract. Regs. 1.514(b)–1(c)(3).

Under IRC 514(d), if debt-financed property is acquired by an exempt organization in a complete or partial liquidation of a corporation in exchange for its stock, the organization’s basis in such property is the same as it would be in the hands of the transferor corporation, increased by the amount of gain recognized to the transferor corporation upon such distribution and by the amount of any gain which is includible, on account of such distribution, in the gross income of the organization as unrelated debt-financed income.

IRC 514(e) provides that where only a portion of property is debt-financed property, proper allocation of the basis, indebtedness, income, and deductions with respect to such property must be made to determine the amount of income or gain derived from such property which is to be treated as unrelated debt-financed income.

The neighborhood land rule does not apply to property 10 years after it is purchased. Further, the rule applies after the first five years only if the organization satisfies the Service that future use of the land for exempt purposes, before the expiration of the 10-year period, is reasonably certain. The organization need not show binding contracts in satisfying this requirement but must have a definite plan detailing a specific improvement and a completion date, and show some affirmative action toward the fulfillment of such plan. At least 90 days prior to the end of the fifth year the organization must forward the necessary information to the Service. Regs. 1.514(b)–1(d)(1)(iii).

If the neighborhood land rule is inapplicable because the acquired land is not in the neighborhood of other land used for exempt purposes or because the organization fails to establish after the first five years that the property will be used for exempt purposes, but the land is eventually used for exempt purposes within the 10-year period, such property is not treated as debt-financed property for any period prior to such conversion. Regs. 1.514(b)–1(d)(2).

The neighborhood land rule applies with respect to any structure on the land when acquired, or to the land occupied by the structure, only so long as the intended future use of the land requires that the structure be demolished or removed in order to use the land for exempt purposes. Thus, during the first five years after acquisition (and for subsequent years if there is a favorable ruling in accordance with IRC 514(b)(3)) improved property is not debt-financed so long as the organization does not abandon its intent to demolish the existing structures and use the land in furtherance of its exempt purpose. Regs. 1.514(b)–1(d)(3)(i) provide that if there is an actual demolition of such structures, the use made of the land need not be the one originally intended as long as it is any use which furthers the exempt purposes of the organization.

In addition to the above limitation, the neighborhood land rule and exceptions thereto do not apply to structures erected on the land after its acquisition nor to property subject to a business lease (as defined in IRC 514(f) immediately before the enactment of the Tax Reform Act of 1976) whether the organization acquired the property subject to the lease or whether it executed the lease subsequent to acquisition.

Where the neighborhood land rule is initially inapplicable but the land is eventually used for exempt purposes, a refund of taxes shall be allowed in accordance with IRC 514(b)(3)(D) and Regs. 1.514(b)–1(d)(4).

The neighborhood land rule also applies to churches or a convention or association of churches but with two differences. First, instead of the 10-year period during which an organization must demonstrate the intent to use acquired property for exempt purposes, a 15-year period applies. Second, there is no requirement that the acquired land be in the neighborhood of other property used by the organization for exempt purposes. Regs. 1.514(b)–1(e).