Determination 1234029: IRS denies exemption to a conservation farm organization

Plain-English summary

The IRS denied tax-exempt status to an organization that planned to preserve farmland and protect wildlife while continuing to operate the property as a commercial hay farm. The organization’s president owned the farm, and the proposed nonprofit planned to use grant funds to buy or lease land from the president or the president’s for-profit company. The IRS found inurement and private benefit because the arrangement would benefit the president, the family farm, and a paid consultant and consulting company. It also concluded that restricted public access, commercial farming, and the lack of demonstrated ecological significance prevented the organization from meeting the charitable and conservation requirements of section 501(c)(3).

Ruling snapshot

• Question: Whether the proposed farmland conservation and wildlife-preservation activities qualified for exemption under section 501(c)(3).
• Outcome: Denied.
• Key authorities: IRC §§ 170(h)(4), 501(a), 501(c)(3), 6104(c), 6110, and 7428(b)(2); Treas. Reg. §§ 1.501(a)-1(c), 1.501(c)(3)-1(a)(1), 1.501(c)(3)-1(c)(1), 1.501(c)(3)-1(c)(2), 1.501(c)(3)-1(d)(1)(ii), 1.501(c)(3)-1(d)(2), and 1.501(c)(3)-1(e).

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

Number: 201234029 Contact Person:
Release Date: 8/24/2014
Identification Number:

Date: June 1, 2012
Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:
UIL: 501.33-00; 501.32-01; 501.36-00

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)(3). 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.

Because you do not qualify for exemption as an organization described in Code section
501(c)(3), donors may not deduct contributions to you under Code section 170. 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. File the returns in accordance with their
instructions, and do not send them to this office. Failure to file the returns timely may result in a
penalty.

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, follow the
instructions in Notice 437. If you agree with our deletions, you do not need to take any further
action.

In accordance with Code section 6104(c), we will notify the appropriate State officials of our

determination by sending them a copy of this final letter and the proposed adverse letter. You
should contact your State officials if you have any questions about how this determination may
affect your State responsibilities and requirements.

2

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
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

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: May 30, 2012 Contact Person:
Identification Number:

Contact Number:

FAX Number:

Employer Identification Number:

LEGEND: UIL:

B= State 501.33-00
C= Date of Incorporation 501.32-01
D= Name of for-profit Corporation 501.36-00

E= Founder/President

F= Name of Consulting Company
G= Name of Consultant

H = Date of Contract

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)(3). The basis for
our conclusion is set forth below.

Issues

• Do your net earnings inure to the benefit of insiders thus precluding exemption under
section 501(c)(3) of the Code?

Yes, for the reasons stated below.

• Does your operation for commercial purposes cause you to fail the operational test by not
operating exclusively for an exempt purpose under section 501(c)(3) of the Code?

Yes, for the reasons stated below.

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• Do your operations serve the private benefit of consultant G and her consulting company F
which would preclude exemption under section 501(c)(3) of the code?

Yes, for the reasons explained below.

Facts

E, Your President was introduced to G and her company F by a volunteer of F. G provided E
with an overview of the types of grants that were available from the government. E entered into
a contract agreement with consultant G and G’s consulting company named F on H and made a
payment of the amount listed on the contract.

You then incorporated as a non-profit corporation under the laws of B on date C. Your Articles
of Incorporation state your purposes are to be a sponsor of a preservation farm with federal and
local tax exemption.

The contract E entered into with F, itemized services at a cost of more than $16,000 that include
helping to establish you as a corporation and assist in preparing the Form 1023 application for
tax exemption. You also explained that G and G’s consulting company F will help apply for
federal grants after exemption is granted. As per the contract you would be responsible to pay
for any additional expenses not part of the original agreement. You were to provide all
documents or information required by F in a timely manner. F assisted you in the preparation of
all documents and checked them to make sure they were correct. Payments for your expenses
were then made by F.

Your application for exemption explained that you have two goals. The first goal is to transform
a for-profit hay farm, named D and owned by your President, E, into one of improved forage
production with quality vegetation cover eliminating the possibility of ground erosion. Another
goal is to protect high value agricultural land for environmental conservation and preservation of
endangered wildlife.

Your planned activities are to establish a preservation farm area of approximately 500 acres
located within the for-profit hay farm operation, D. The for-profit hay farm, D, is a family
business owned and operated by your President, E. You described the area identified for the
preservation farm as “not accessible to the general public due to either natural barriers, such as
creeks, drainage, and fences,” and that there are signs stating that trespassing is not permitted.
You also indicated there are no pubic paths, trails or roads on it.

You are governed by members of the E family and by individuals with a business relationship to
the E family hay farm operation. Your President who is also the owner of D will continue to farm
the preservation farmland area as part of the for-profit hay farm operation that includes a total
area of approximately 1000 acres.

Your budgets report you anticipate receiving an estimated $2 million in federal grants and you
have budgeted approximately $300,000 for the cost of the preservation farmland. You
explained that various government agencies have grants available to preserve land. We asked

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if you would lease or purchase the land owned by E that will make up the preservation farm.
You replied that it has not yet been determined and it will depend on the requirements set by the
grantee agency. Your project description reports that your intentions are to purchase 14 lots
owned by either your President E or his for-profit farm, D. The purchase or lease price has not
been determined. Your purchase or lease of the property from E or D will depend on the
availability of grant funds and other government requirements.

You are registered with the merchants’ registry of the treasury department of B as a merchant
conducting the commercial activities of Agriculture and Silviculture. The Farm area has been
used and it is planned to be used in the near future for farming and/or hay production and it is
your intention to preserve it for that purpose.

In addition to applying for government grants on your behalf your consultant, G, contracted a
company to prepare an Environmental Site Assessment for the preservation farmland. The
Environmental Site Assessment report was prepared for the purpose of identifying any areas,
which could be environmentally impacted. This report described adverse environmental
conditions on the preservation farmland area that “may impede or preclude the completion of
any intended sale-purchase transaction”. The report included observations and pictures of
petroleum spills and substandard “structures that are in use or may have been used to store oil,
waste oil, diesel, and or hazardous substances.”

In your response to the Environmental Site Assessment you represented that the environmental
issues were addressed. You paid an independent contractor to clean up the areas in question.
You also explained that your President has contracted with a company for the collection and
disposal of used oil for recycling purposes.

The charges for the environmental study were paid from the Land Concepts (site conditions)
portion of the contract by F. None of the other studies or appraisals etc listed on the contract
with F has been conducted.

Law

Section 170(h)(4) of the Internal Revenue Code. Conservation purpose defined.
(A) In general, For purposes of this subsection the term “conservation purpose” means-

(i) the preservation of land areas for outdoor recreation by, or the education of, the
general public,

(ii) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar
ecosystem,

(iii) the preservation of open space (including farmland and forest land) where such
preservation is-
(1) for the scenic enjoyment of the general public, or
(II) pursuant to a clearly delineated Federal, State, or local governmental

conservation policy, and will yield a significant public benefit, or

(iv) the preservation of a historically important land area or certified historic

structure.

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Section 501(c)(3) of the Code provides for the exemption from federal income tax of
organizations organized and operated exclusively for charitable, educational and other
purposes, provided that no part of the net earnings inure to the benefit of any private
shareholder or individual.

Section 1.501(c)(3)-1(a)(1) of the regulations provides that, in order to be exempt as an
organization described in section 501(c)(3), an organization must be both organized and
operated exclusively for one or more of the purposes specified in such section. If an
organization fails to meet either the organizational test or the operational test, it is not exempt.

Section 1.501(a)-1(c) of the regulations defines “private shareholder or individual” to mean
persons having a personal and private interest in the activities of the organization.

Section 1.501(c)(3)-1(c)(1) of the regulations provides that an organization will be regarded as
“operated exclusively” for one or more exempt purposes only if it engages primarily in activities
that accomplish one or more of such exempt purposes specified in section 501(c)(3). An
organization will not be so regarded if more than an insubstantial part of its activities is not in
furtherance of an exempt purpose.

Section 1.501(c)(3)-1(c)(2) of the regulations provides that an organization is not operated
exclusively for one or more exempt purposes if its net earnings inure in whole or in part to the
benefit of private shareholders or individuals. Section 1.501(a)-1(c) of the regulations defines
“private shareholder or individual” to mean persons having a personal and private interest in the
activities of the organization.

Section 1.501(c)(3)-1(d)(1)(ii) of the regulations provides that an organization is not organized or
operated exclusively for one or more exempt purposes unless it serves a public rather than a
private interest. Thus, to meet the requirements of this subsection, it is necessary for an
organization to establish that it is not organized or operated for the benefit of private interests,
such as designated individuals, the creator or his family, shareholders of the organization, or
persons controlled, directly or indirectly, by such private interests.

Section 1.501(c)(3)-1(d)(2) of the regulations states that the term ‘charitable’ is used in section
501(c)(3) of the Code in its generally accepted legal sense.

Section 1.501(c)(3)-1(e) of the regulations provides that an organization which is organized and
operated for the primary purpose of carrying on an unrelated trade or business is not exempt
under section 501(c)(3) even though its net profits do not inure to the benefit of individual
members of the organization.

Rev. Rul. 67-292, 1967-2 C.B. 184. An organization formed for the purpose of developing a
sanctuary for wild birds and animals for the education of the public may be exempt from Federal
income tax as an educational organization under section 501(c)(3) of the Internal Revenue
Code of 1954.

Rev. Rul. 76-204, 1976-1 C.B. 152. A nonprofit organization formed for the purpose of
preserving the natural environment by acquiring by gift or purchase, ecologically significant

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undeveloped land, and either maintaining the land itself with limited pubic access or transferring
the land to a government conservation agency by outright gift or being reimbursed by the
agency for its cost, qualifies for exemption.

Rev. Rul. 78-384, 1978-2 C.B. 174. A nonprofit organization that owns farmland and restricts its
use to farming or other uses the organization deems ecologically, suitable, but is not operated
for the purpose of preserving ecologically significant land and does not otherwise establish that
it serves a charitable purpose, does not qualify for exemption under section 501(c)(3). Rev. Rul.
76-204 is distinguished.

In Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279, (1945), the
Supreme Court held that the presence of a single non-exempt purpose, if substantial in nature,

will destroy a claim for exemption regardless of the number or importance of truly exempt
purposes.

In Old Dominion Box Co. v. United States, 477 F. 2d 340 (4th Cir. 1973), cert. denied 413 U.S.
910 (1973). The Fourth Circuit held that operating for the benefit of private parties constitutes a
substantial nonexempt purpose.

In Federation Pharmacy Services Inc v Commissioner, 72 T.C. 687 (1979), aff'd, 625 F.2d 804
(8th Cir. 1980) the court held that, while selling prescription pharmaceuticals to elderly persons
at a discount promotes health, the pharmacy did not qualify for recognition of exemption under
section 501(c)(3) of the Code. Because the pharmacy operated for a substantial commercial
purpose, it did not qualify for exemption.

In Airlie Foundation vs. Internal Revenue Service 283 F.Supp.2d 58 (D.D.C., 2003), the court
found that the defendant IRS was correct in denying plaintiff's application for recognition as a
section 501(c)(3) entity. Because plaintiff operates its conference center in a manner consistent
with that of a commercial business, it does not meet the requirements of Code Section 501(c)(3)
and is therefore not entitled to tax exempt status.

Application of Law
Inurement

You do not qualify for exemption under section 501(c)(3) of the Internal Revenue Code because
your net earnings inure to the benefit of your insider, E. Specifically, you were created by E who
paid a consultant, G, and G's consulting company, F, to help you incorporate and look for
federal grant funds that you could apply for. Once federal funding is obtained, the grant funds
would be used to provide the capital needed to purchase or lease and improve or maintain land
owned by E or his for-profit D. This constitutes inurement of earnings to E, and precludes
exemption under section 501(c) (3) of the Code and 1.501(c)(3)-1(c)(2) of the regulations.

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E has used and will continue to use the farmland to operate the E family for-profit farm operation
known as D. Therefore you are operated for the private benefit of the for-profit company D, the
E family and individuals with a business relationship to the E family hay farm operation.
Therefore you are also not described in section 501(c)(3) and 1.501(c)(3)-1(d)(1)(ii) of the
regulations.

Private benefit

You also fail to meet the provisions of section 1.501(c)(3)-1(d)(1)(ii) of the regulations as your
operations serve the private interests of G and her consulting company F. You have paid over
$16,000 to F and G for services. This amount is non-refundable. However barring the
assistance with this application and the one payment for the environmental site assessment
none of these services have been provided. F and G will be paid additional amounts on an
hourly basis for future services to be provided. Amounts were paid to F towards application
fees to the IRS that were higher than the actual fee amount remitted. F will provide technical
help to you to apply for federal and private funds. Based on the copy of the one report provided
it can be seen that the report is prepared for F and G.

F and G will provide assistance to you to apply for federal and private funds. You have
advanced a considerable amount of money to G to help you with this process. The fact that
you have used F & G to assist you with the filing of your application for a fee does not
necessarily indicate that you have operated for their private benefit. However the list of
expenses for payment of fees above the actual cost, and the payment of services listed that
were never provided and the possibility of utilizing F and G to raise funds for you indicate private
benefit is accruing to F and G. In addition F and G were not selected by a bidding process but
by recommendation of a volunteer of F. Your operating for the benefit of private parties also
constitutes a substantial nonexempt purpose and therefore you are similar to the organization in
Old Dominion Box Co. V. United States, supra.

Failure to Meet the Operational Test

It is generally recognized that efforts to preserve and protect the natural environment for the
benefit of the public serve a charitable purpose under section 501(c)(3) of the Internal Revenue
Code and section 1.501(c)(3)-1(d)(2) of the regulations. However, your operations are not
intended for the benefit of or enjoyment of the general public. In fact access to the public is
restricted. You will continue to operate a for-profit hay farm on the property. You have not
established that you will use the land for a conservation or charitable purpose as described in
IRC Section 170(h)(4). In fact your goals are to improve forage production, eliminate ground
erosion, and operate a commercial hay farm. Therefore you are not operated exclusively for
exempt purposes as described in sections 1.501(c)(3)-1(a)(1) and 1.501(c)(3)-1(c)(1). Since you
are operating for the substantial nonexempt purpose of operating a for-profit hay farm you are
also like the organization in Better Business Bureau v. United States, supra.

Your primary purpose is to carry on a for-profit hay farm on the property. Therefore you are
carrying on an unrelated trade or business as described in Section 1.501(c)(3)-1(e) and
therefore are not exempt under section 501(c)(3) of the Code.

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You also plan to preserve land to protect wildlife, but unlike Rev. Rul. 67-292 you are not
operating for educational purposes. The land you plan to preserve is farmland that is used for
hay production. The preservation area is also not accessible to the general public with natural
and other barriers and no public paths, trails and signs stating that trespassing is not permitted.
Therefore you are not like the organization in Revenue Ruling 67-292.

From the information provided the land is not ecologically significant undeveloped land but is
farmland that is owned by E and D and used for commercial hay production. In addition the
land has no public access. Therefore, you are unlike the organization described in the
previously cited Revenue Ruling 76-204. In addition, the Environmental Site Assessment
described adverse environmental conditions that may preclude the sale or transfer of the area
designated as a preservation farm.

You are more like the organization described in the above cited Revenue Ruling 78-384 which
did not qualify for exemption because you are not operated for the purpose of preserving
ecologically significant land but for the preservation of farm land for hay farming purposes which
is not a charitable purpose.

You are similar to the organizations in Federation Pharmacy Services Inc and Airlie Foundation.
Your president owns the land and the for-profit company that operates a commercial hay farm
on this land. The farm area has been used and it is planned to be used for farming and hay
production only. Therefore your operations are similar to that of a commercial business and you
do not qualify under section 501(c)(3).

Applicant’s Position

The continuous construction around your area has brought to your attention the need to
conserve, protect and maintain lands to benefit wildlife and their habitat. You are especially
concerned with the endangered and migratory birds in your area. You claim that by preventing
the extinction and extermination of the habitat, the public will benefit as well as the wildlife.

Although the Environmental Site Assessment reported various environmental issues, you claim
that the only concern was on an oil barrel that had a light leak. The issue was limited to a very
small area and you have eliminated the problem. As far as you know, there are no other
complaints on this matter.

Service Response to Applicant’s Position

Because you plan to conserve, protect and maintain ordinary farm land owned by your
President, E, you are not operating for a public purpose. Further there is no indication that the
land is ecologically significant. In addition there are severe restrictions to public access such
as no trespassing signs and other natural barriers on the property. Therefore, your activities do
not further an exempt purpose. The Environmental Assessment substantiates the fact that the
property is being used to operate a hay farm which is a commercial for-profit operation that does
not qualify as an exempt activity described in section 501(c)(3) of the Code.

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Conclusion
Based on the above facts and law, we conclude that:

• The use of your funds to purchase the land from E and his family and D the for-profit hay
farm owned by E constitute inurement to E and his family and cause you to fail the
operational test for exemption under section 501(c)(3) of the Code.

• The continued operations of the for-profit hay farm and other such activities on the property
constitute a commercial activity and therefore cause you to fail the operational test for
exemption under section 501(c)(3) of the Code.

• The arrangements with F and G, the payment of advances including for services not
performed provide private benefit to F and G which precludes exemption under section
501(c )(3) of the Code.

Accordingly, we conclude you do not qualify for exemption under section 501(c)(3) 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. We will
consider your statement and decide if the 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”. The statement of facts (item 4)
must be accompanied by the following declaration:

“Under penalties of perjury, I declare that | 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.”

The declaration must be signed by an officer or trustee of the organization who has personal
knowledge of the facts.

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. If you want representation

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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. You can find more
information about representation in 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 file a protest within 30 days, you will not be able to file a suit for declaratory
judgment in court because the Internal Revenue Service (IRS) will consider the failure to appeal
as a failure to exhaust available administrative remedies. Code section 7428(b)(2) provides, in
part, that a declaratory judgment or decree shall not be issued in any proceeding unless the Tax
Court, the United States Court of Federal Claims, or the District Court of the United States for
the District of Columbia determines that the organization involved has exhausted all of the
administrative remedies available to it within the IRS.

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. That
letter will provide information about filing tax returns and other matters.

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 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

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