IRS determination 1151027: IRS denies exemption to a homeowners association

Plain-English summary

The IRS issued a final adverse determination denying a homeowners association exemption under IRC § 501(c)(4). The association maintained a lake portion, a road, and a natural area, but the IRS concluded that the common areas primarily benefited the association's members and their properties rather than the general public. The determination relied on the requirements described in Rev. Rul. 74-99 and related authorities, including the public-use requirement for common areas. The proposed adverse determination became final because the association did not file a protest within 30 days.

Ruling snapshot

• Question: Does the homeowners association qualify for exemption under IRC § 501(c)(4)?
• Outcome: Denied.
• Key authorities: IRC §§ 501, 6110; Treas. Reg. § 1.501(c)(4)-1; Rev. Rul. 74-99; Rev. Rul. 80-63; Flat Top Lake Ass'n v. United States, 868 F.2d 108 (4th Cir. 1989)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Release Number: 201151027 Contact Person:
Release Date: 12/23/2011
Date: September 27, 2011 - Identification Number:
UIL Code: 501.04-00

501.04-07 Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:

Dear

This is our final determination that you do not qualify for exemption from federal income tax as
an organization described in Internal Revenue Code section 501(c)(4). Recently, we sent you a
letter in response to your application that proposed an adverse determination. The letter
explained the facts, law and rationale, and gave you 30 days to file a protest. Since we did not
receive a protest within the requisite 30 days, the proposed adverse determination is now final.

You must file federal income tax returns on the form and for the years listed above within 30
days of this letter, unless you request an extension of time to file.

We will make this letter and our proposed adverse determination letter available for public
inspection under Code section 6110, after deleting certain identifying information. Please read
the enclosed Notice 437, Notice of Intention to Disclose, and review the two attached letters that
show our proposed deletions. If you disagree with our proposed deletions, you should follow
the instructions in Notice 437. If you agree with our deletions, you do not need to take any
further action.

If you have any questions about this letter, please contact the person whose name and
telephone number are shown in the heading of this letter. If you have any questions about your
federal income tax status and responsibilities, please contact IRS Customer Service at

Letter 4040(CG) (11-2005)
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1-800-829-1040 or the IRS Customer Service number for businesses, 1-800-829-4933. The
IRS Customer Service number for people with hearing impairments is 1-800-829-4059.

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure
Notice 437
Redacted Proposed Adverse Determination Letter
Redacted Final Adverse Determination Letter

Letter 4040(CG) (11-2005)
Catalog Number 476352

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION
Date: August 10, 2011 Contact Person:

Identification Number:

Contact Number:

FAX Number:

Employer Identification Number:
LEGEND: UIL:
C = state 501.04-00
Q = date 501.04-07

S = geographic area
t = dollar amount

Dear

We have considered your application for recognition of exemption from federal income
tax under Internal Revenue Code section 501(a). Based on the information provided,
we have concluded that you do not qualify for exemption under Code section 501(c)(4).
The basis for our conclusion is set forth below.

Issues

• Do you qualify for exemption under section 501(c)(4) of the Code? No, for the
  reasons described below.

Letter 4034(CG) (11-2005)
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Facts

You were incorporated in State of C on Q. Your articles of incorporation state the
following purpose:

The corporation is organized exclusively to manage the business and
affairs of the S Subdivision....

You are a homeowners’ association consisting of 15 lots, three of which are common
areas. The three common areas consist of the following:

Lot 12: A portion of a lake that is partially contained within the other lots in your
subdivision.

Lot 14: A road that runs through the subdivision providing members access to
their properties.

Lot 15: A one acre natural land area between the boundary line of properties and
the access road

The remaining 12 lots are owned by nine individuals. You will maintain, repair and
insure the common areas (Lots 12, 14 and 15). To do so, you collect dues and
assessments from members and engage in the following activities:

Pay property taxes for the common areas

Pay attorney fees for filing required biennial reports with the state
Pay insurance premium for $t liability policy for the lake

Build a reserve fund to pay for road maintenance

Collect dues to pay for professional tax assistance

The lots in the subdivision you serve are configured in a U-shaped arrangement. The
access road connects to a highway and winds in front of the lots and is open to the
general public. Only individually owned lots are located along this road.

Lot 12 represents only a portion of the total lake. The remainder of the lake is owned by
individuals who are members of your organization. Although the lake was designed to
control erosion and run-off from surrounding farm ground, it is used primarily for
recreational purposes such as fishing. Except for one individually owned lot, all other
lots in your organization border the lake. There is no public access to the lake. The
topography of the land does not allow public access to the lake as the developer did not
make any provision for access to the lake other than passing through individually owned
lots. Thus, Lot 12 is accessible only to your members and their guests. Further,
allowing public access would increase the liability insurance that you pay with respect to

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Lot 12. Paragraph 18 of your general covenants requires property owners in your
association whose land contains any part of water reservoir to maintain liability
insurance. Paragraph eighteen of your general covenants further provides that property
owners may assign this responsibility to you (the homeowner's association.) The
premium payment for the insurance policy paid in your most recent fiscal year
represents about one-half of your income for that year.

The non-building lot that you maintain could be accessed by the general public,
however, you explained there would be no reason for anyone to access this lot as they
would be risking chigger, tick and mosquito attacks. This lot is a natural area that
serves as a water run-off to the lake.

You do not perform exterior maintenance to private residences. You stated that, upon
dissolution, your assets would be distributed in accordance with state law and that the
balance would be equitably distributed to lot owners of record at that time.

Law

Section 501(c)(4) of the Code provides that civic leagues or organizations not organized
for profit but operated exclusively for the promotion of social welfare, or local
associations of employees, the membership of which is limited to the employees of a
designated person or persons in a particular municipality, and the net earnings of which
are devoted exclusively to charitable, educational, or recreational purposes and no part
of the net earnings of such entity inures to the benefit of any private shareholder or
individual may be exempt from federal income tax.

Treasury Regulation 1.501(c)(4)-1 provides in part that a civic league or organization
may be exempt as an organization described in section 501(c)(4) [26 USCS § 501(c)(4)]
if it is not organized or operated for profit; and it is operated exclusively for the
promotion of social welfare.

An organization is operated exclusively for the promotion of social welfare if it is
primarily engaged in promoting in some way the common good and general welfare of
the people of the community. An organization embraced within this section is one which
is operated primarily for the purpose of bringing about civic betterments and social
improvements. A social welfare organization will qualify for exemption as a charitable
organization if it falls within the definition of charitable set forth in paragraph (d)(2) of §
1.501(c)(3)-1 and is not an action organization as set forth in paragraph (c)(3) of §
1.501(c)(3)-1.

Rev. Rul. 74-99; 1974-1 C.B. 131 - A homeowners association, to qualify for exemption
under section 501 (c) (4) of the Code, (1) must serve a "community" which bears a
reasonable recognizable relationship to an area ordinarily identified as governmental,
(2) it must not conduct activities directed to the exterior maintenance of private

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residences, and (3) the common areas or facilities it owns and maintains must be for the
use and enjoyment of the general public.

Rev. Rul. 80-63, 1980 CB 116 provides additional clarification for Rev. Rul. 74-99,
above. It explains the term “community” does not embrace a minimum area or a certain
number of homeowners. Instead, whether a particular homeowners’ association meets
the requirements of conferring benefits on a community must be determined according
to the facts and circumstances of the individual case. For instance, if the association
owns and maintains common areas and facilities for the use and enjoyment of the
general public as distinguished from areas and facilities whose use and enjoyment is
controlled and restricted to members of the association then it may satisfy the
requirement of serving a community.

Flat Top Lake Ass'n v. United States, (1989 4th Circuit) 868 F.2d 108 The Court held
that a homeowners association did not qualify for exemption under section 501(c)(4) of
the Code when it did not benefit a “community” bearing a recognizable relationship to a
governmental unit and when its common areas or facilities were not for the use and
enjoyment of the general public.

Application of Law

Section 501(c)(4) of the Code provides that civic leagues or organizations not organized
for profit but operated exclusively for the promotion of social welfare may be exempt
from federal income tax. Treasury Regulation 1.501(c)(4)-1 defines social welfare as
primarily engaged in promoting in some way the common good and general welfare of
the people of the community. As you are conducting activities that support only a select
few private residences, you do not promote the common good and general welfare of
the people in the community, but rather promote the interests of the nine property
owners who are members of your association.

Rev. Rul. 80-63 explained that if an association owns and maintains common areas and
facilities for the use and enjoyment of the general public as distinguished from areas
and facilities whose use and enjoyment is controlled and restricted to members of the
association then it may satisfy the requirement of serving a community. This ruling
emphasizes the third criterion outlined in Rev. Rul 74-99, requiring common areas be
operated for the use and enjoyment of the general public. You have three common
areas:

Lot 12 is accessible only to your members and is used primarily for fishing.
Although you explained that this lake was designed to control erosion and collect
water run-off, you did not explain how this provides a community benefit.
Further, even if the lake provided a community benefit by collecting water and
preventing erosion you do not make payments towards the maintenance of the
lake. The only payment you make in connection with the lake is on the premium

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of a liability policy, which according to paragraph 18 of your bylaws, is ultimately
the responsibility of your members. Because Lot 12 is accessible only to your
members, and appears to provide benefits only to their property, you are
operating in the interest of your members rather than providing a community
benefit.

Lot 14 is open to the general public, but there would be no reason for the general
public to access this road except to visit the homes of your members.
Accordingly, the road serves as a benefit to your members only.

Lot 15 serves no general purposes, albeit accessible to anyone publicly. In fact,
you explained that accessing this lot may cause physical harm in the form of
insect bites. The primary purpose of Lot 15 is to serve as a water run-off, which
protects the homes of your members.

Although two of these areas are, by definition, open to the public no individuals outside
of your members would derive any benefit from the use of or have any reason to enter
these two lots. The lake for which you carry liability insurance is restricted from pubic
access. Persons accessing the lake must receive permission from your members who
restrict and control access to the lake. The use and/or enjoyment of the only public
common areas within your association’s property are under the control and restriction of
your members. Because all of your common areas have no use or enjoyment to the
general public, you do not bestow a community benefit and thus do not qualify for
exemption under section 501(c)(4) of the Code.

The Court in Flat Top Lake Ass'n v. United States held that the criteria set forth in Rev.
Rul. 74-99 must be met in order for a homeowners association to qualify for exemption
under section 501(c)(4) of the Code. Based on the details presented herein you do not
meet the criteria set forth in Rev. Rul. 74-99 and therefore do not qualify as a
homeowners association exempt under 501(c)(4).

Conclusion

Because you operate primarily for the benefit of your members and not for the social
welfare or common good of the community in general, you do not qualify for exemption
under section 501(c)(4) of the Code.

You have the right to file a protest if you believe this determination is incorrect. To
protest, you must submit a statement of your views and fully explain your reasoning.
You must submit the statement, signed by one of your officers, within 30 days from the
date of this letter.

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We will consider your statement and decide if that information affects our determination.
If your statement does not provide a basis to reconsider our determination, we will
forward your case to our Appeals Office. You can find more information about the role
of the Appeals Office in Publication 892, Exempt Organization Appeal Procedures for
Unagreed Issues.

Types of information that should be included in your appeal can be found on page 2 of
Publication 892, under the heading “Regional Office Appeal’. These items include:

. The organization’s name, address, and employer identification number;
A statement that the organization wants to appeal the determination;
The date and symbols on the determination letter;
A statement of facts supporting the organization’s position in any contested
factual issue;
A statement outlining the law or other authority the organization is relying on; and
A statement as to whether a hearing is desired.

The statement of facts (item 4) must be declared true under penalties of perjury. This
may be done by adding to the appeal the following signed declaration:

“Under penalties of perjury, I declare that I have examined the statement of facts _
presented in this appeal and in any accompanying schedules and statements and, to
the best of my knowledge and belief, they are true, correct, and complete.”

Your appeal will be considered incomplete without this statement.

If an organization’s representative submits the appeal, a substitute declaration must be
included stating that the representative prepared the appeal and accompanying
documents; and whether the representative knows personally that the statements of
facts contained in the appeal and accompanying documents are true and correct.

An attorney, certified public accountant, or an individual enrolled to practice before the
Internal Revenue Service may represent you during the appeal process. To be
represented during the appeal process, you must file a proper power of attorney, Form
2848, Power of Attorney and Declaration of Representative, if you have not already
done so. For more information about representation, see Publication 947, Practice
Before the IRS and Power of Attorney. All forms and publications mentioned in this
letter can be found at www.irs.gov, Forms and Publications.

If you do not intend to protest this determination, you do not need to take any further
action. If we do not hear from you within 30 days, we will issue a final adverse
determination letter to you. That letter will provide information about filing tax returns
and other matters.

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Please send your protest statement, Form 2848 and any supporting documents to the
applicable address:

Mail to: Deliver to:
Internal Revenue Service Internal Revenue Service
EO Determinations Quality Assurance EO Determinations Quality Assurance
Room 7-008 550 Main Street, Room 7-008
P.O. Box 2508 Cincinnati, OH 45202

Cincinnati, OH 45201
You may also fax your statement using the fax number shown in the heading of this
letter. If you fax your statement, please call the person identified in the heading of this
letter to confirm that he or she received your fax.

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

Sincerely,

Lois G. Lerner
Director, Exempt Organizations

Enclosure, Publication 892

Letter 4034(CG) (11-2005)
Catalog Number 47628K