When Is a Property Owner Entitled to a Property Tax Exemption? Recent Developments in the Law Portend of Widespread Reconsideration of This Question.

by Reed Smith

[authors: Dusty Elias Kirk, Kyle R. Smith]

Courts in a number of states are reconsidering how to determine whether a property owner, often a nonprofit entity, is entitled to a property tax exemption or other special property tax treatment. More than ever before, state and local governments are questioning the purpose for granting such organizations tax-exempt status and whether that purpose is being advanced.

Pennsylvania is in the forefront of this phenomenon. Recent Pennsylvania court decisions portend a new national trend for state and local governments to successfully challenge the favorable property tax treatment that certain organizations – including not-for-profit hospitals and universities – have historically received. In the past year, Pennsylvania appellate courts have decided three cases involving whether a nonprofit was entitled to an exemption from the obligation to pay real property taxes. These cases illustrate a change in how the question of whether a property is to be granted an exemption as a purely public charity is to be addressed by assessment officials, boards of assessment appeal, and Pennsylvania trial courts in the future.

In Mesivtah Eitz Chaim Of Bobov, Inc. v. Pike County Board of Assessment Appeals, 44 A.3d 3 (Pa. 2012), the Pennsylvania Supreme Court considered the test for deciding whether a not-for-profit religious camp was an “institution of purely public charity” and thus exempt from real property taxes. At issue was whether nonprofit exempt status should be decided under the provision in the Pennsylvania Constitution that permits such exemptions, or under the more liberal definition that the Pennsylvania legislature set forth in the Institution of Purely Public Charities Act in 1997. In Metsivtah, the Pennsylvania Supreme Court analyzed whether the five-prong test that the court announced in Hospital Utilization Project vs. Commonwealth, 487 A.2d 1306 (Pa. 1985) – commonly known as the “HUP test” – still applies, or whether the test set forth in the Institution of Purely Public Charities Act applies.

The property owner in Mesivtah, which operates a religious camp, argued that it did not need to satisfy the HUP test; rather, it needed only to meet the more liberal test set forth in the Institution of Purely Public Charities Act. The Pike County Board of Assessment argued that “the separation of powers doctrine prohibits the General Assembly from intruding upon the judiciary’s function of interpreting and defining the Constitution.” Mesivtah, 44 A.3d at 7. The Pennsylvania Supreme Court ruled that the subject constitutional provision was designed to limit legislative authority to create tax exemptions, and that the court’s development of the five prongs of the HUP test followed the court’s careful review of a long line of case law interpreting this constitutional provision. It held that the HUP test, and not the definition of purely public charity in the Institution of Purely Public Charities Act, is the standard that must be met in order to be entitled to tax exemption under the Pennsylvania Constitution.

On the heels of Metsivtah, the Pennsylvania Commonwealth Court handed down its decision in Camp Hachshara Moshava v. Wayne County Board for the Assessment and Revision Taxes, 47 A.3d 1271 (Pa. Commw. 2012). It also denied an exemption for a religious camp that a nonprofit operated for similar reasons. Following the Supreme Court’s lead, the Commonwealth Court applied the HUP test and affirmed the lower court’s conclusion that a religious camp’s providing assistance to a local volunteer fire department did not meet one of the prongs of the HUP test, which is that the institution seeking the exemption relieve the government of some of its burden. Id. at 1280.

The Commonwealth Court also addressed this issue in In re Appeal of Dunwoody Village, 2012 Pa. Commw. LEXIS 195 (Pa. Commw. 2012). Dunwoody Village, a nonprofit that operates a continuous care retirement community, appealed the trial court’s decision to deny its exemption request. The trial court did so after it applied the five-prong HUP test and without considering the criteria set forth in the Institution of Purely Public Charity Act. Id.

The Dunwoody case is the first Pennsylvania appellate case involving a health care facility’s request for a property tax exemption as a “purely public charity” since the Mesivtah decision. The Commonwealth Court examined each prong of the HUP test and the trial court’s ruling in Dunwoody. It concluded that the property owner failed all five prongs of the HUP test; according to the court, the structure of the property owner’s business was constructed around the requirements and definitions set forth in the Institution of Purely Public Charities Act, but those standards are not to be applied to address the question of whether an institution qualifies for an exemption as a purely public charity. Id. at 36-37. In short, the Pennsylvania Constitution sets the standard for whether an exemption may be granted, and the Pennsylvania Supreme Court placed the Pennsylvania legislature on notice that the court, and not the Legislature, has the sole authority to interpret the Pennsylvania Constitution.

These recent Pennsylvania decisions reflect a new national trend for state and local governments to remove or modify the favorable treatment that tax exempt organizations, especially hospitals and universities, receive with respect to property tax relief. More than we have seen in the past, state and local governments are questioning the true tax-exempt purpose of tax-exempt organizations, and whether or not that purpose is being fulfilled.

For example, the Kentucky Supreme Court recently ruled that a private, nonprofit entity that acquired and marketed property in order to attract new business did not qualify for an exemption from paying real property taxes. Hancock v. Prestonsburg Industrial Corporation, 2010-SC-000376-DG (decided April 26, 2012). The Prestonsburg Industrial Corporation (“PIC”), a nonprofit founded in 1968 with the mission of attracting industrial development to Prestonburg, Kentucky, had not paid real property taxes on the real property that it acquired, improved and marketed to potential businesses since its inception.

In 2001, PIC purchased a 100-acre parcel from the City of Prestonsburg for such purposes, and the Floyd County assessor’s office sought to tax it. Apparently, no similar efforts to tax PIC’s property had previously occurred. PIC claimed an exemption under the Kentucky Constitution, but the Revenue Cabinet denied the exemption request. The Kentucky Board of Tax Appeals affirmed the Revenue Cabinet’s decision. On appeal, the Floyd Circuit Court disagreed and granted the exemption, finding that PIC was a charitable organization and was exempt under section 170 of the Constitution. The Kentucky Court of Appeals agreed with the Floyd Circuit Court finding that PIC was a purely charitable organization whose activities “reasonably bettered mankind.” On appeal, the Kentucky Supreme Court reversed, finding that PIC’s efforts to increase commercial activity and add jobs was not “pure public charity” because such benefits were only incidental, the primary benefit being the promotion of PIC’s members’ business interests. The Kentucky Supreme Court determined that PIC was not entitled to a tax exemption because it was neither a governmental agency nor was it a purely public charity exempt from taxation under the Kentucky Constitution.

A similar issue recently reached the Illinois Supreme Court in Provena Covenant Medical Center v. Dept. of Revenue, 925 N.E. 2d 1131 (Ill. 2010), where the court upheld the revocation of a charitable property tax exemption because the hospital in question did not prove that a sufficient level of charitable medical care was being provided.

In June of this year, the governor of Illinois signed Public Act 97-688 into law, attempting to resolve this issue and creating a new type of property tax exemption specifically designed for hospitals. The law adds a new section to the Illinois Property Tax Code dealing specifically with property tax exemptions for hospitals. Prior to the addition of this section, hospitals were only eligible for exemptions if they could demonstrate that they were “institutions of public charity.” The new section 15-86 of the Property Tax Code provides a bright line calculation to determine eligibility for the exemption. Essentially, if the total value of a hospital’s charitable services or activities meets or exceeds the hospital’s estimated property tax liability, the hospital may claim the exemption.

This law is similar to Pennsylvania’s Institution of Purely Public Charity Act, which the Pennsylvania Supreme Court recently ruled cannot trump the Pennsylvania Constitution or the Pennsylvania Supreme Court’s interpretation of it. It remains to be seen if this Illinois Act 97-688 will survive a constitutional challenge. The Illinois judiciary may well conclude that this statute impinges upon the judicial function of interpreting the scope of the Illinois Constitution, much like the Pennsylvania Supreme Court did in Metsivtah.

Today’s continued economic uncertainty is prompting action by state and local governments as they work to secure necessary income while faced with budget and revenue concerns. A growing number of state and local governments, including Pennsylvania, are looking to nonprofit institutions as potential sources for revenue. While it is still unclear how these recent changes in the law will affect exempt status of nonprofits, continued future exemption from taxation should not be assumed. Charitable organizations with exemptions from property taxes may need to reapply for exempt status, and, as a consequence of these recent developments in the law, some nonprofits may lose their exempt status.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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