Determination 1306027: IRS revokes a social club’s section 501(c)(7) exemption over rental income

Plain-English summary

The IRS issued a final adverse determination that a social club did not qualify for exemption under section 501(c)(7). The club received a substantial portion of its income from renting part of its property to nonmembers, and it used that income to reduce the amounts members needed to contribute. The IRS concluded that the rental activity was regular and substantial, exceeded the applicable nonmember income limits, and caused net earnings to inure to members. The club was required to file federal income tax returns for the listed years unless it requested an extension.

Ruling snapshot

• Question: Did the social club qualify for exemption under IRC § 501(c)(7)?
• Outcome: Revocation
• Key authorities: IRC § 501(c)(7); Treas. Reg. § 1.501(c)(7)-1; Rev. Rul. 58-589; Rev. Rul. 69-220

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201306027 Contact Person:
Release Date: 2/8/2013

Identification Number:
Date: November 15, 2012

Contact Number:

Employer Identification Number:
Form Required To Be Filed:

Tax Years:
501.07-00; 501.07-03; 501.07-06

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)(7). 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)
Catalog Number 476352

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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,

Holly O. Paz
Director, Exempt Organizations
Rulings and Agreements

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: September 26, 2012 Contact Person:
identification Number:
Contact Number:
FAX Number:
Employer Identification Number:

LEGEND: VIL:

B = date 501.07-00

C = date 501.07-03

D = state 501.07-06

F = date

G = name

H = nationality
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)(7).
The basis for our conclusion is set forth below.

issues

Does your nonmember income exceed the 15/35% test, thereby failing you under IRC
501(c)(7), and do you fail to meet facts and circumstances showing substantially all of
your activities are for pleasure, recreational and other nonprofit purposes? Yes, for the
reasons described below.

Facts

You were formed as a corporation in D on F. Your Articles of Incorporation state you will
promote and further the interests of the members of the G family of H nationality living in
D, by aiding in developing the fraternal spirit between the members of the family and to
assist the said members by social and educational means to be worthy citizens and
residents of the United States.

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You were previously granted exemption under 501(c)(7) of the Code. Your exemption
was revoked on B, due to not filing tax returns, and you submitted an application for
reinstatement on C.

You are dedicated to the mutual benefits of the G family members, providing a place for
members to bond, support, socialize and learn from each other's experiences. To do so,
you conduct functions such as monthly luncheons for your members to come together
and discuss whatever is on the monthly agenda. This includes lunar new year
celebrations, parent day and holiday luncheons, and hold an annual spring banquet.
You hold a scholarship luncheon and provide awards to encourage the children of your
members to study hard.

In addition to the above activities, you aim to perpetuate the customs and traditions of
the old country through your functions. You participate with other agencies and
organizations and in community affairs to assist the public and serve similar objectives,
and help newly arrived immigrants assimilate into the country.

Membership is open to anyone over the age of 18 whose family name is characterized
by a certain character of the H language. You have one class of membership.

You bought a building over 30 years ago, which was then renovated. Your members,
who felt having some rental income would decrease donations required to support your
operations, subsidized both the purchase and renovation. This facility is used partially
for your functions, and the remainder is rented out. The tenants living on the rented
portions of your property do not interfere with your use of the property other than the
stated purpose of being tenants.

Your income is from member contributions and rental income. Over a recent three-year
operating period, of your total income, you averaged %, %,and %, respectively,
from tenant rental income. Over that same period, you listed no membership dues or
assessments. You have stated the rental income helps decrease donations members
must make. Your expenses are split roughly between your exempt function activities
and rental expenses such as taxes, insurance and utilities.

Law

Section 1.501(c)(7)-1(a) of the Regulations states that the exemption provided by
section 501(a) of the Code for an organization 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 any part
of its net earnings inure to the benefit of any private shareholder. 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.

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Section 1.501(c)(7)-1(b) of the Regulations states 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 exempt
under section 501(a) of the Code. 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.

Rev. Rul. 58-589, 1958-2 C.B. 266 sets forth the criteria for exemption under section
501(c)(7) of the Code, and provides that a club may lose its exemption if it makes its
facilities available to the general public. A club will not be denied exemption merely
because it receives income from the general public provided such participation is
incidental to and in furtherance of its general club purposes. To retain exemption a club
must not enter into outside activities with the purpose of deriving profit. If such income
producing activities are other than incidental, trivial or nonrecurrent, it will be considered
that they are designed to produce income and will defeat exemption.

Rev. Rul. 69-220, 1969-1 C.B. 154, held a social club that receives a substantial portion of
its income from the rental of property and uses such income to defray operating expenses
and to improve and expand its facilities is not exempt under section 501(c)(7) of the Code.
The club purchased an office building, part of which is leased to commercial tenants.
operating expenses of the building, including the part used as a clubhouse. The club uses
the net income from the rental operation to make capital improvements and to expand the
facilities offered to its members. This club is not exempt from federal income tax under
section 501(c)(7) of the Code because it is regularly engaged in a business ordinarily
carried on for profit and because net income from the activity is inuring to the members of
the club.

The Committee Reports for Public Law 94-568, HR 1144, provides under 501(c)(7) that
social clubs be operated substantially for pleasure, recreation and other nonprofit
purposes. An organization may receive up to 35% of its gross receipts from a
combination of investment income and nonmember receipts, as long as nonmember
receipts do not represent more than 15% of total receipts

Application of Law

Per Section 1.501(c)(7)-1(a) of the Regulations, substantially all of your activities are not
for pleasure, recreation, or other nonprofit purposes. Further, portions of your net
earnings inure to members, disqualifying you from exemption under IRC 501(c)(7).

Per Section 1.501(c)(7)-1(b) of the Regulations, when a club engages in business it is
not organized and operated exclusively for pleasure, recreation and other nonprofit
purposes. As described in Rev. Rul. 58-589, although a club may receive some income

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from the general public, your facility rental activities are more than incidental and,
therefore, preclude exemption under section 501(c)(7) of the Code.

Rev. Rul. 69-220 held a social club that receives a substantial portion of its income from
the rental of property and uses such income to defray operating expenses is not exempt
under section 501(c)(7). Your property rental activity is conducted with the purpose to
generate income, decreasing the amounts needed to be contributed by your members.
This rental income is supporting your operations, and as it is decreasing the obligations
of funds required to be paid by your members, it is inuring to their benefit.

A substantial portion of your income is generated from business done with the general
public. By receiving, on average, around % of your revenue from nonmembers, you
fail the membership income tests set forth by the Committee Reports on Public Law
94-568. You do not meet the facts and circumstances exception for this income test as
your property rental activity is regular and substantial.

Conclusion

Based on the facts provided above, we hold that you do not meet the requirements for
tax exemption under Section 501(c)(7) of the Code. On average, % of your income is
generated from rental activities to nonmembers, failing the income test under 501(c)(7).
As a result, you are not operating substantially for pleasure, recreational or other non
profit purposes. Further, your net income inures to your members. Accordingly, you do
not meet the requirements for exemption under Section 501(c)(7) 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 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.

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.

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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.

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,

Holly O. Paz
Director, Exempt Organizations
Rulings & Agreements
Enclosure
Publication 892