Other 200728048: IRS proposes revoking a homeowners' club's social club exemption

Plain-English summary

A subdivision club offered recreational activities and facilities to its members and had been recognized as a tax-exempt social club. The IRS examination report found that the club also enforced restrictive covenants affecting the housing development. It concluded that this activity disqualified the club from exemption under section 501(c)(7). The report also rejected section 501(c)(4) exemption because the clubhouse and pool were open only to members, rather than the general public. The accompanying letter proposed adverse action and explained the club's appeal options and how the proposed action could become final.

Ruling snapshot

• Question: Did the homeowners' club continue to qualify for exemption as a social club?
• Outcome: Revocation proposed: the examination report found that exemption no longer applied.
• Key authorities: IRC §§ 501(c)(7), 501(c)(4); Rev. Rul. 75-494

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TEGE:EO:Examinations

1100 Commerce Street

Dallas, TX 75242

TAX EXEMPT AND GOVERNMENT ENTITIES DIVISION

Release Number: 200728048 January 1, 2007
Release Date: 7/13/2007

Taxpayer Identification Number:

UIL: 501.07-01
Form:
990
ORG Tax Year(s) Ended:

Person to Contact/ID Number:

Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL – RETURN RECEIPT REQUESTED

Dear Sir or Madam:

We have enclosed a copy of our report of examination explaining why we believe an adjustment of your organization's exempt status is necessary.

If you do not agree with our position you may appeal your case. The enclosed Publication 3498, The Examination Process, explains how to appeal an Internal Revenue Service (IRS) decision. Publication 3498 also includes information on your rights as a taxpayer and the IRS collection process.

If you request a conference, we will forward your written statement of protest to the Appeals Office and they will contact you. For your convenience, an envelope is enclosed.

If you and Appeals do not agree on some or all of the issues after your Appeals conference, or if you do not request an Appeals conference, you may file suit in United States Tax Court, the United States Court of Federal Claims, or United States District Court, after satisfying procedural and jurisdictional requirements as described in Publication 3498.

Letter 3610 (04-2002)
Catalog Number 34801V

You may also request that we refer this matter for technical advice as explained in Publication 892, Exempt Organization Appeal Procedures for Unagreed Issues. If a determination letter is issued to you based on technical advice, no further administrative appeal is available to you within the IRS on the issue that was the subject of the technical advice.

If you accept our findings, please sign and return the enclosed Form 6018, Consent to Proposed Adverse Action. We will then send you a final letter modifying or revoking exempt status. If we do not hear from you within 30 days from the date of this letter, we will process your case on the basis of the recommendations shown in the report of examination and this letter will become final. In that event, you will be required to file Federal income tax returns for the tax period(s) shown above. File these returns with the Ogden Service Center within 60 days from the date of this letter, unless a request for an extension of time is granted. File returns for later tax years with the appropriate service center indicated in the instructions for those returns.

You have the right to contact the office of the Taxpayer Advocate. Taxpayer Advocate assistance is not a substitute for established IRS procedures, such as the formal appeals process. The Taxpayer Advocate cannot reverse a legally correct tax determination, or extend the time fixed by law that you have to file a petition in a United States court. The Taxpayer Advocate can, however, see that a tax matter that may not have been resolved through normal channels gets prompt and proper handling. You may call toll-free 1-877-777-4778 and ask for Taxpayer Advocate Assistance. If you prefer, you may contact your local Taxpayer Advocate at:

If you have any questions, please call the contact person at the telephone number shown in the heading of this letter. If you write, please provide a telephone number and the most convenient time to call if we need to contact you.

Letter 3610 (04-2002)
Catalog Number 34801V

Thank you for your cooperation.

Sincerely,

Marsha A. Ramirez
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG / Num May 31, 20XX LEGEND: ORG = Name of Organization Num = EIN SUB = Name of Subdivision XYZ = State Name ISSUE

Does ORG continue to qualify for tax exempt status under section 501(c)(7) of the Internal Revenue Code (IRC) of 1986?

FACTS

ORG (Club) was incorporated in the State of XYZ on December 17, 19WW. The Articles of Incorporation state that “The general nature and objective of the corporation shall be to organize entertainment, recreation and community activities in the subdivision known as SUB in County, XYZ, and to engage in activities designed toward the civic and community betterment of said SUB.” Membership in the Club is limited to residents of the subdivision of SUB.

The Club was granted exemption as an organization described in IRC section 501(c)(7) in August of 19VV. The Club filed another application for exemption in October. Their application was returned and they were provided a letter stating the Club was already exempt.

The Club’s affairs are managed by the Board of Trustees. The Board is comprised of not more than 15 Officers and Trustees. The Club’s Bylaws state in Article 2 - Requirements For Membership that “a condition of membership in the ORG shall be that a declaration of restrictive covenants be recorded against the property of the prospective member obligating the present owners and their successors in the title to belong to the ORG and pay the annual assessments for Club membership.”

The Building and Grounds Committee is responsible for the repair and maintenance of the Clubhouse, buildings, and grounds owned by the Club. The House Committee supervises the use of the facilities and equipment of the Clubhouse. The Swimming Pool Committee is responsible for the maintenance and upkeep of the pool and enforcement of the pool regulations. The swimming pool, Clubhouse, and common areas are not open to the general public.

The Club conducts various activities for the pleasure and enjoyment of their members, including: aerobics, arts and crafts, bowling outings, bridge, coffee hours, golf outings, poker, scrap booking, line dancing, to name a few. The Club publishes a newsletter, the ORG Bulletin, to inform members of upcoming or proposed events and to address any concerns voiced by residents. The newsletters are distributed to the members.

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service Page: -1-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG / Num May 31, 20XX

Most of the Club’s receipts have been from membership dues and interest. The Club also announced in the June 20YY newsletter that the Club had successfully prevailed in two long- term Deed Restriction violations law suits. The Club would be reimbursed for all legal and court expenses they had incurred in their protection of the covenant restrictions.

LAW

Internal Revenue Code section 501(c)(7) exempts from federal income tax those organizations or clubs “organized for pleasure, recreation, and other nonprofitable purposes, substantially all of 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 regulations further states that “this exemption [under IRC § 501(c)(7)] 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.”

Revenue Ruling 75-494, 1975-2 C.B. 214 concludes that: “club providing social and recreational facilities, whose membership is limited to homeowners of a housing development, will be precluded from qualifying for exemption under section 501(c)(7) of the Code by owning and maintaining residential streets, enforcing restrictive covenants, or providing residential fire and police protection and trash collection service.”

Revenue Ruling 69-280, 1969-1 C.B. 152 concluded that an organization that provides maintenance of exterior walls and roofs of members’ homes in a housing development does not qualify for tax-exempt status under IRC section 501(c)(4). The organization was operating primarily for the benefit of individual members rather than the community as a whole.

Revenue Ruling 74-99, 1974-1 C.B.131 concluded that an organization must, in order to qualify for exemption under section 501(c)(4) of the Code, “serve a ‘community’ which bears a reasonably recognizable relationship to an area ordinarily identified as governmental, not conduct activities directed to the exterior maintenance of private residences, and the common areas or facilities it owns and maintains must be for the use and enjoyment of the general public.”

In Commissioner v. Lake Forest, Inc., 305 F. 2d 814(1962), it was held that the organization, a housing cooperative for World War II veterans and others, did not meet the requirements for tax- exempt status under IRC section 501(c)(4). The court found that the organization was not operating exclusively for “social welfare” purposes, but as a private economic enterprise. The court also determined that the organization was organized and operated for the benefit or

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service Page: -2-

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG / Num May 31, 20XX

convenience of its members by performing services that its members would otherwise have to provide for themselves,

GOVERNMENT’S POSITION

Based upon the applicable law and facts, ORG no longer meets the requirements for recognition of exemption under IRC section 501(c)(7) or any other section of the Code. This is because the Club administers and enforces covenants for preserving the architectural integrity and appearance of the housing development, contrary to Revenue Ruling 75-494. In addition, the Club cannot qualify for exemption under section 501(c)(4) of the Code, because the housing development’s clubhouse and swimming pool are open only to your members and not to the general public.

TAXPAYER’S POSITION

The Club applied for and was granted tax-exempt status in 19WW. The organization was unaware of who completed that application for exemption and when that application was filed. Because the Club wanted to be compliant, the organization filed another application in 20VV. The Service returned the organization’s check and sent a letter to the organization referencing the exempt status granted in 19WW. The officers of the organization were not told they were no longer a social club, but were instead a homeowners’ association. During the examination the Revenue Agent solicited delinquent Forms 990 and 990-T for the years ending May 31, 20WW, 20XX, and 20YY. The organization paid the unrelated trade or business tax, failure to pay penalties, delinquency penalties and interest. The organization has subsequently filed Forms 990 and 990-T for the year ending May 31, 20ZZ.

The organization is not seeking a determination of whether or not they meet the requirements for section 7805(b) relief. The organization is requesting that the revocation’s effective date be June 1, 20TT and that all monies paid (a total of $9,760.67) be applied to any balance due when the Forms 1120-H are filed.

CONCLUSION

As a result of our examination of your Form 990 for the period ended May 31, 20XX, we have determined that your organization no longer qualifies as an exempt social club described in IRC section 501(c)(7) as of June 1, 20TT. Since you will no longer be an exempt organization, you will be required to file Federal income tax returns on Form 1120-H, U. S. Income Tax Return for

Form 886-A (Rev. 4-68) Department of the Treasury - Internal Revenue Service

Page: -3-

Schedule No. or

Form 886A Department of the Treasury - Internal Revenue Service Explanation of Items Exhibit Name of Taxpayer Year/Period Ended ORG / Num May 31, 20XX

Homeowners Associations. Forms 1120-H were solicited and received for the years ended May 31, 20XX, 20YY, 20PP and 20ZZ.

Form 886-A (Rev. 4-68)

Department of the Treasury - Internal Revenue Service
Page: -4-