Texas School Property Tax Exemption

The Freeman Law Insights blogs regarding the Religious Organization Property Tax Exemption (Section 11.20 of the Texas Tax Code) and the Charitable Organization Property Tax Exemption (Section 11.18 of the Texas Tax Code) have garnered much interest from and have provided significant support to the consuming public in need of help in those property tax areas. So, I thought I would add to the property tax exemption repertoire with this informational piece on the Schools Property Tax Exemption under Section 11.21 of the Texas Tax Code.

The Lens.

For starters, the analysis on this subject must be viewed from this lens: The law does not favor tax exemptions; all doubts are resolved against the granting of an exemption, and the taxpayer is bound to strictly prove the facts necessary to create the exemption.

General Rule.

To enjoy the exemption, Section 11.21 requires the following: (A) the school must be operated exclusively by the person that owns the property; (B) the buildings and tangible personal property must be used “exclusively” for “educational functions;” and (C) the buildings and tangible personal property must be “reasonably necessary for the operation of the school.” However, there is an “incidental use” exception that is discussed in detail below.

The Owner.

The owner of the property must meet all five of the requirements to qualify as a “school,” and the “school” must be operated exclusively by the person that owns the property. To qualify as a “school” for these purposes, the owner must:

1. be organized and operated primarily for the purpose of engaging in educational functions;
2. normally maintain a regular faculty and curriculum and normally have a regularly organized body of students in attendance at the place where its educational functions are carried on;
3. be operated in a way that does not result in accrual of distributable profits, realization of private gain resulting from payment of compensation in excess of a reasonable allowance for salary or other compensation for services rendered, or realization of any other form of private gain and, if the organization is a corporation, be organized as a nonprofit corporation as defined by the Texas Non-Profit Corporation Act;
4. use its assets in performing the organization’s educational functions or the educational functions of another educational organization; and
5. by charter, bylaw, or other regulation adopted by the organization to govern its affairs direct that on discontinuance of the organization by dissolution or otherwise the assets are to be transferred to this state, the United States, or an educational, charitable, religious, or other similar organization that is qualified as a charitable organization under Section 501(c)(3), Internal Revenue Code of 1954, as amended.

Notably, one of the five requirements is that the organization must be organized and operated primarily for the purpose of engaging in educational functions, thus, leaving open the possibility that the organization may engage in some activities other than “educational functions” and still meet the definition of a “school.” That “loosened” requirement to qualify as a school, however, may not necessarily apply to the use of property that enjoys an exemption under Section 11.21.

“Incidental Use” Exception.

Under Section 11.21(b), use of exempt tangible property for functions other than educational functions does not result in loss of an exemption authorized by Section 11.21 if those other functions are incidental to use of the property for educational functions and benefit the students or faculty of the school. Section 11.21 contains no correlating “incidental use” provision specific to real property or buildings. Whether the Texas Legislature intended the phrase “tangible property” in Section 11.21(b) to include real property and buildings is not indicated in the statute, and the judicial opinions on this subject are sparse and non-specific. However, based on the opinions that do exist, the courts appear to apply the “incidental use” exception to real property and buildings, both being property that is “tangible.”

A most conservative approach is for a “school” owner to not allow any third-party user to use the property, even if that use is dedicated to “educational functions.” See Odyssey 2020 Acad., Inc. v. Galveston Cent. Appraisal Dist., 624 S.W.3d 535, 552–53 (Tex. 2021) (citing Smith v. Feather, 149 Tex. 402, 234 S.W.2d 418, 421 (1950) and Red v. Morris, 72 Tex. 554, 10 S.W. 681, 682 (1889) for the proposition that lack of ownership by even one of the people who used property as school destroyed exemption, but also finding that “[t]he LLCs lease the property to Odyssey for profit and are not involved in operating the school. Under these circumstances, our cases are clear that Odyssey [the lessee] cannot claim the constitutional exemption for school buildings and furniture.”).

The Odyssey opinion cited above addressed the Section 11.21 issue arguably in dicta since the Odyssey 2020 Academy apparently (and according to the Odyssey opinion) did not specifically raise the Section 11.21 exemption as a basis for the exemption on petition for review. Furthermore, the express language used in the statute states that the school must be operated by the person that owns the property and that the property must be used “exclusively” for “educational functions.” Essentially, the Odyssey opinion and the express words used in the statute do not dovetail neatly, with the statute seemingly providing a broader application of the exemption. Nonetheless, the above-referenced unfavorable verbiage from the Texas Supreme Court’s opinion in Odyssey exists.

At least one Texas appellate court opinion indicated that if there is substantial, non-educational use of property, the property cannot be exempt under Section 11.21. Indeed, the courts give the strong impression that an insubstantial or incidental use of exempt real property for other-than-educational functions may not destroy the exemption.

The above-referenced Odyssey opinion could give any “school” pause from allowing anyone other than the property owner from engaging in any activity on property that is exempt under Section 11.21. That would certainly be a most conservative and risk-averse approach.

There is a dearth of Texas judicial opinions that provide any meaningful guidance about how much use of property – real or tangible – that is exempt under Section 11.21 for other than “educational functions” may be permitted without destroying the exemption. However, it is pretty clear that leasing exempt property for a person’s personal or for-profit benefit will likely jeopardize, if not destroy, the exemption.

Bottom line, to enjoy the exemption, the property cannot be simply convenient in connection with that portion of the property which is used for school or educational functions. Rather, for the property to enjoy the exemption, the property must be (1) operated by the qualified “school” owner and (2) used “exclusively” for formal instruction or otherwise “educational functions.” Any non-educational uses must be merely incidental to use of the property for educational functions, and those incidental, non-educational uses must benefit the students or faculty of the school.

Facility Use Agreements are Advisable.

To preserve the exemption under Section 11.21, the “school” owner should require each third-party user to sign a facility use agreement (with however much detail or terms desired) that, among other things: (1) identifies the organizational status of the user; (2) identifies the “education” or “educational functions” that the user intends to advance through use of the property, whether real or tangible, and (3) includes affirmation that the user’s use will be exclusively to advance that education.

The agreement form could also require that the user identify the number and/or demographic of the “students” that are expected to be educated by the use identified. This data point would be primarily for the owner’s internal and/or marketing purposes. However, this data could be impactful in any later-required renewal application for or challenge to the exemption under Section 11.21.

The agreement could also require that the user be appropriately qualified. The Section 11.21 exemption’s focus is on the type of use, rather than the type of user, but requiring the user to be organized as a tax-exempt organization under section 501 or as an instrument of local, state, or federal government will help preserve the Section 11.21 exemption as well as the school’s exemption from federal income tax under section 501(c)(3) of the Internal Revenue Code.

For an in-depth look at federal tax matters relative to engaging in a trade or business that is or is not “substantially related” to an exempt purpose, see the Freeman Law Insights blog three-part series on unrelated business income tax issues located here: https://freemanlaw.com/tax-exemption-and-unrelated-business-income-rules-ubit-substantially-related-part-3-of-3/.

Any uses of a school’s property that do not advance “educational functions” will jeopardize the owner’s exemption. At a maximum, only “incidental,” non-educational uses are permitted, and those uses must benefit the students or faculty of the school. The school should always be in a position to affirm that any non-educational uses by third parties are (1) incidental – accompanying, secondary, minor, or subordinate – to the school’s operation of the school for educational functions; and (2) the non-educational uses benefit the students or faculty of the school.

School’s out. Salud.