## Facts

- Rensselaer Polytechnic Institute (RPI) was a tax-exempt educational organization under I.R.C. § 501(c)(3).
- RPI owned and operated a fieldhouse used for (1) exempt student and educational activities and (2) commercial events that generated unrelated business taxable income (UBTI) for fiscal year 1974 under I.R.C. § 511(a)(1).
- The dispute concerned how to allocate indirect fieldhouse expenses—especially depreciation and other fixed costs—between exempt use and unrelated commercial use when computing UBTI under I.R.C. § 512.
- Treasury Regulation § 1.512(a)-1(c) permits allocation of expenses between exempt and unrelated uses on a “reasonable basis” when a facility serves both purposes.
- RPI allocated indirect expenses based on the proportion of hours the fieldhouse was used for exempt versus commercial activities, and allocated idle time proportionally in the same manner.
- The IRS argued that deductions were allowed only for expenses that would not have been incurred absent the unrelated business activity, and objected particularly to depreciation allocated to periods of idle time.
- The Tax Court upheld RPI’s allocation method as reasonable; the Commissioner appealed.

## Issues

1. Whether I.R.C. § 512’s requirement that deductions be “directly connected with” an unrelated trade or business imposes a “but-for” test (expenses would not exist absent the unrelated activity).
2. Whether Treas. Reg. § 1.512(a)-1(c) validly permits allocation of indirect expenses for dual-use facilities on any reasonable basis.
3. Whether allocating depreciation and other fixed costs for idle time proportionally between exempt and unrelated uses is a reasonable method for computing UBTI.

## Decision

- The Second Circuit affirmed the Tax Court’s judgment.
- The court held that Treas. Reg. § 1.512(a)-1(c) is consistent with I.R.C. § 512 and validly permits allocation of indirect expenses on a reasonable basis for dual-use facilities.
- The court rejected the Commissioner’s proposed “but-for” test as an impermissibly restrictive interpretation of “directly connected with.”
- The court upheld RPI’s hour-based allocation, including proportional allocation of idle time, as reasonable and not shown to distort unrelated business income.

## Legal Principles

- Under I.R.C. § 512 and Treas. Reg. § 1.512(a)-1, deductions against UBTI require a proximate and primary relationship to the unrelated business, but this standard does not require proof that the expense would not have been incurred absent the unrelated activity.
- When a facility is used for both exempt and unrelated purposes, indirect expenses (including depreciation and other fixed costs) may be allocated between uses on any reasonable basis. Treas. Reg. § 1.512(a)-1(c).
- Depreciation and similar capacity costs may be treated as joint costs of exempt and unrelated use; allocating such costs, including during idle time, is permissible if the method reasonably reflects the facility’s dual use.
- Reasonableness of an allocation method under the regulation is largely a factual determination; absent error or distortion, courts will not require the IRS’s preferred method.

## Conclusion

The Second Circuit held that a tax-exempt organization operating a dual-use facility may allocate indirect expenses, including depreciation attributable to idle time, between exempt and unrelated uses on any reasonable basis under Treas. Reg. § 1.512(a)-1(c), and it affirmed the Tax Court’s approval of RPI’s time-based allocation in computing UBTI.


Rensselaer Polytechnic Inst. v. Comm’r, 732 F.2d 1058 (2d Cir. 1984)