Hospitals and health care providers around the country often choose to incorporate as nonprofit entities to obtain tax benefits. One of the most sought after benefits is the ability to secure a property tax exemption on land and improvements used to provide health care services.

A little history
Offering property tax exemptions for health care facilities is based on theories and principles that date back to the 19th century. Most hospitals established in that time period cared exclusively for low-income people. And most of their services were provided by nurses, doctors and religious personnel who donated their time.

Because state and local authorities wanted to encourage this type of generosity, they devised a quid pro quo mechanism whereby a hospital could avoid paying property taxes if its property was used to provide health care to indigent persons at no cost. The underlying theory was that the facility would relieve the state and local governments from the obligation of caring for the sick. In return, the community would exempt any property owned by the hospital from the obligation of paying property taxes. The hospital could then take any money saved through the exemption process and reinvest those funds to further its charitable purpose.

Changing industry and rules
Since those early days, the health care industry and the rules governing property tax exemptions for charitable organizations have changed significantly. Hospitals and health care providers have gone from being purely charitable organizations to multibillion-dollar industries that resemble private corporate conglomerates. As the industry has changed, so has the way in which state and local taxing authorities analyze property tax exemptions.

During the past 20 years, local taxing authorities have chipped away at the tax exemptions of many nontraditional hospitals and health care facilities. In fact, many have declined to grant tax-exempt status to hospitals and health care facilities in order to generate much-needed revenue and as a response to complaints brought by for-profit entities.

The result? Hospitals and health care providers are being forced to pay for unbudgeted taxes. And a property owner usually has to pay the tax before challenging the denial. With these changes, how can a hospital or health care entity predict whether its facility will be exempt?

Determining exempt status
State legislatures and courts have created a number of tests to determine whether a hospital or health care facility is being used for its charitable purpose, though the rules are sometimes difficult to apply to nontraditional uses. For example, traditional hospital facilities that provide 24-hour emergency care for paying and indigent persons usually are exempt, but medical office buildings owned by a hospital and rented to physicians who maintain a private practice often are not.

On the spectrum ranging from exempt facilities to nonexempt facilities, there are many uses that do not fall in one category or another, leaving hospital administrators and practitioners alike to draw vague conclusions as to whether their facilities will qualify for an exemption.

The tests used to obtain an exemption vary, but most states require that:

1. The entity applying for the exemption be organized as a nonprofit entity under state laws and that it qualify as a 501(c)(3) entity under federal laws, and
2. The organization meet constitutional, statutory and common law tests.

The second requirement often requires the hospital or health care provider to show that the property is owned, operated and used according to its charitable purpose.

Is it exempt or not? Courts typically view the following types of facilities as exempt: Ambulatory surgery centers providing emergency care to the indigent, Hospitals that provide 24-hour emergency care, Lodging facilities for patients and family members receiving care at a hospital, Parking garages exclusively used by hospital employees, and Sleeping facilities or apartments used by employees. On the other hand, the following facilities typically are not exempt: Ambulatory surgery centers that do not provide emergency care for the indigent, Medical office buildings leased to physicians in private practice, even if affiliated with a hospital, and Fitness or wellness facilities used or operated by a hospital or health care organization.

Defining charitable purpose
Courts throughout the United States have struggled to define whether certain facilities are used pursuant to a charitable purpose. Several have used the following factors to help determine whether a facility should be granted a property tax exemption:

• Has the facility adhered to strict construction of the appropriate constitutional or statutory provision?
• Has the taxpayer proven it deserves an exemption?
• Will granting the exemption give the nonprofit entity an unfair competitive advantage over for-profit entities?
• Does the use or activity involved relieve a governmental burden?
• Does the use or activity provide services to the public without a fee to indigent persons?

Moreover, when granting tax-exempt status, courts look at whether the facility is operating as a private enterprise purely for profit. (See “Is it exempt or not?” above.)

A noble cause
With the climate change in gaining and keeping their tax-exempt status, hospitals and health care facilities must diligently document and prove that their use is primarily for charitable purposes. Have you?

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