PLR 200451031: Boating club's sale and liquidation preserve its tax exemption

Plain-English summary

A tax exempt boating club planned to sell its property, distribute the remaining assets to members, and dissolve because membership had declined and operating costs had risen. The IRS ruled that the incidental sale would not cause the club to lose its section 501(c)(7) exemption. It also ruled that gain from the sale would not be unrelated business taxable income under section 512. The letter does not decide whether members must pay tax on the amounts they receive when the club dissolves.

Ruling snapshot

• Question: Would the club's sale and liquidation jeopardize its exemption or create unrelated business taxable income?
• Outcome: Approved; neither consequence results on the stated facts.
• Key authorities: IRC §§ 501(c)(7), 512(a)(3); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 58-501.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 200451031
Release Date: 12/17/04
SE:T:EO:RA:T:4

Date: September 21, 2004
Contact Person:

Identification Number:
Uniform Issue List
501.07-02
Contact Number:
512.09-03
(202)

Employer Identification Number:

Legend:

M=
x=

Dear ------------------:

We have considered the ruling request dated December 15, 2003, submitted on behalf of M, a nonprofit organization which is exempt from federal income tax under section 501(c)(7) of the Internal Revenue Code. M requests a ruling that any gain realized by it on the sale of certain property, as described below, will not cause it to lose its tax exempt status and will not be considered unrelated business taxable income under section 512 of the Code.

FACTS:

M was incorporated in ------ under the nonprofit statute of the State in which it conducts its activities. In -------, it received a determination letter from the Service recognizing it as tax exempt under section 501(c)(7) of the Code. The purpose of M, as outlined in its Constitution, has always been “…to promote boating and social recreation, to encourage members to become proficient in navigation and all matters pertaining to seamanship and to advance the cause of boating in its broadest sense.”

M charges dues and annual assessments to its members in order to cover the costs of maintaining its facilities, making any necessary improvements thereon, and for the retirement of debt. M also requires members to meet certain work crew requirements to maintain the club premises. In addition, M states it operates a “Members’ Bar” on the premises for the benefit and enjoyment of its members.

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Despite the foregoing, M has found it increasingly difficult to maintain its existence as its membership has aged, new membership has dwindled (primarily attributed to the various work requirements), and the costs of operation have increased. For these reasons, club members have approved the sale and liquidation of M’s assets to its members, complete cessation of operations, and the dissolution of the corporation. The membership is not considering any improvements to the property to facilitate a sale. Currently, M is in contract to sell the property. LAW:

Section 501(c)(7) of the Code provides for the exemption of clubs organized and operated for pleasure, recreation, and other nonprofitable purposes, substantially all the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

Section 1.501(c)(7)-1(a) of the Income Tax Regulations states that the exemption provided to organizations described in section 501(c)(7) of the Code applies only to clubs which are organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, but does not apply to any club if its net earnings inures to the benefit of any private shareholder. The regulation also states that, in general, this exemption extends to social and recreation clubs, which are supported solely by membership fees, dues, and assessments. However, a club otherwise entitled to exemption will not be disqualified because it raises revenue from members through the use of club facilities or in connection with club activities.

Section 1.501(c)(7)-1(b) of the regulations provides that a club which engages in business, such as making its social and recreational facilities available to the general public or by selling real estate, timber, or other products, is not organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, and is not tax exempt. Solicitation by advertisement or otherwise for public patronage of its facilities is prima facie evidence that the club is engaging in business and is not being operated exclusively for pleasure, recreation, or social purposes. However, an incidental sale of property will not deprive a club of its exemption.

Section 511 of the Code imposes a tax on the unrelated business taxable income (defined in section 512) of organizations exempt from tax under section 501(c) of the Code, including those described in section 501(c)(7).

Section 512(a)(3)(A) of the Code provides, in part, that with respect to an organization described in section 501(c)(7), the term “unrelated business taxable income” means the gross income (excluding any exempt function income), less the deductions allowed by this chapter which are directly connected with the production of the gross income (excluding exempt function income), both computed with certain modifications provided in section 512(b).

Section 512(a)(3)((B) of the Code defines “exempt function income” to mean the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services in furtherance of the purposes constituting the basis for the exemption of the organization to which income is paid.

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Section 512(a)(3)(D) of the Code provides, in part, that if property used directly in the performance of an exempt function of an organization described in section 501(c)(7) is sold by such organization, and within a period beginning one year before the date of such sale and ending three years after such date, other property is purchased and used by such organization directly in the performance of its exempt function, gain (if any) from such sale shall be recognized only to the extent that such organization’s sales price of the old property exceeds the organization’s cost of purchasing the other property.

Rev. Rul. 58-501, 1958-2 C.B. 262, holds that where a social club described in section 501(c)(7) of the Code finds it impracticable to continue to conduct its exempt activities and, as such, sells its property and liquidates, such sale is incidental to its exempt purposes. The Rev. Rul. states that the club is still to be considered as operated exclusively for pleasure, recreation, and similar purposes up through the date of the sale and distribution of the liquidated assets to its active members. The revenue ruling concludes that profit from the sale by the club of all its property in conjunction with the termination of its activities and liquidation does not deprive the club of the exemption provided by section 501(c)(7) of the Code.

ANALYSIS:

The facts surrounding the proposed sale of M’s assets show that such property has been used to carry out M’s exempt activities, but circumstances have changed, specifically the aging of the club membership, inability to attract a sufficient number of new members, and increased costs of operation. Thus, M now wishes to sell its assets in conjunction with the dissolution of the club. As in the case of the sale of club property by the organization described in Rev. Rul. 58-501, supra, the purpose of the sale of M’s assets is to facilitate the club’s dissolution rather than to make a profit. As noted in section 1.501(c)(7)-1(b) of the regulations, an incidental sale of property will not adversely affect a social club’s tax exempt status. Furthermore, the distribution of liquidated assets to M’s members will not result in the revocation of the club’s tax exempt status. See Rev. Rul. 58-501.

Concerning the unrelated business tax issue, as indicated above, the assets in question were used directly in the performance of M’s exempt function, and the distribution of liquidated assets is directly in the performance of its exempt function, i.e., the dissolution of the club. See Rev. Rul. 58-501, supra. Under these circumstances, although no “other property” will be purchased by M, gain from the sale of the facilities need not be recognized in accordance with section 512(a)(3)(D) of the Code. Income from the sale of this property is not considered unrelated business taxable income pursuant to section 512(a)(3)(A).

RULINGS:

Based on the foregoing, we rule as follows:

1. Any gain which M realizes on the sale of its assets will not cause it to lose its tax exempt
   status under section 501(c)(7) of the Code.

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2. Any gain which M realizes on the sale of its assets will not be treated as unrelated business
   taxable income under section 512 of the Code.

Except as specifically ruled upon, no opinion is expressed concerning the federal income tax consequences of the transactions described above under any other provision of the Code. Specifically, we express no opinion as to whether amounts received by M’s members upon dissolution of M are taxable to such members.

This ruling is based on the understanding that there will be no material changes in the facts upon which it is based. Any changes that may have a bearing upon M’s exempt status should be reported to the Ohio Tax Exempt and Government Entities (TE/GE) Customer Service Office. The mailing address is: Internal Revenue Service, TE/GE Customer Service, P.O. Box 2508, Cincinnati, OH 45201. The telephone number there is 877-829-5500 (a toll free number).

Pursuant to a Power of Attorney on file in this office, we are sending a copy of this letter to your authorized representative.

Because this letter could help resolve any questions about M’s exempt status, it should be kept with M’s permanent records.

If there are any questions about this ruling, please contact the person whose name and telephone number are shown in the heading of this letter.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

Thank you for your cooperation.

Sincerely,

Debra J. Kawecki

Debra J. Kawecki
Manager, Exempt Organizations
Technical Group 4