Other 1318016: IRS revokes a homeowners association's section 501(c)(4) exemption

Plain-English summary

The IRS revoked a homeowners association's exemption under section 501(c)(4). The association restricted access to its common areas to members and guests, and used police assistance, gates, keys, and vehicle stickers to control access. The IRS concluded that these activities served private members rather than the general public or a definable community. The IRS also considered section 528 treatment and found that the association did not meet the required expenditure test for association property. The association therefore had to file Form 1120 returns.

Ruling snapshot

• Question: Whether the association qualified under section 501(c)(4), and whether it qualified as a homeowners association under section 528.
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(4), 528, 6012; Treas. Reg. §§ 1.501(c)(4)-1, 1.528-1, 1.528-2, 1.528-3, 1.528-6, 1.528-8, 1.528-9, 1.6012-2; Rev. Rul. 72-102; Rev. Rul. 74-99.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
TE:GE EO Examinations

1100 Commerce St. 501.04-00
Dallas, Texas 75242

Date: 12/09/2010

Number: 201318016
Release Date: 5/3/2013

LEGEND Taxpayer Identification Number:
ORG - Organization name Form:
XX - Date Address - address Tax Year(s) Ended:

Person to Contact:

Contact Numbers:
ORG Telephone:
ADDRESS Fax:

CERTIFIED MAIL - RETURN RECEIPT REQUESTED
Dear

In a determination letter dated May 30, 20XX, you were held to be exempt from Federal
income tax under section 501(c)(4) of the Internal Revenue Code (the Code).

Based on recent information received, we have determined you have not operated in
accordance with the provisions of section 501(c)(4) of the Code. Accordingly, your
exemption from Federal income tax is revoked effective March 1, 20XX. This is a final
adverse determination letter with regard to your status under section 501(c)(4) of the
Code.

We previously provided you a report of examination explaining why we believe
revocation of your exempt status is necessary. At this time, we informed you of your
right to contact the Taxpayer Advocate, as well as your appeal rights. On June 24,
20XX, you signed Form 6018-A, Consent to Proposed Action, agreeing to the
revocation of your exempt status under section 501(c)(4) of the Code.

You are required to file Federal income tax returns for the tax period(s) shown above. If
you have not yet filed these returns, please file them with the Ogden Service Center
within 60 days from the date of this letter, unless a request for an extension of time is
granted, or unless an examiner's report for income tax liability was issued to you with
other instructions. File returns for later tax years with the appropriate service center
indicated in the instructions of those returns.

You have the right to contact the Office of 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 contact the person whose name and telephone
number are shown at the beginning of this letter.

Sincerely yours,

Nanette M. Downing,
Director, EO Examinations

DRAFT REPORT
ORG
EXHIBIT 1-1

GROSS INCOME TEST NEEDED TO MEET REQUIREMENTS UNDER IRC 528

DATE DUES RCVD
3/6/XX
3/6/XX
3/6/XX
3/8/XX
3/8/XX
3/10/XX
3/15/XX
3/20/XX
3/23/XX
3/28/XX
[illegible]
4/11/XX
5/11/XX
6/18/XX
[illegible]
8/5/XX
8/31/XX
10/4/XX
10/12/XX
10/13/XX
12/12/XX

FEES
TOTAL

[illegible]

Dues/Fees received FY20XX02 $[illegible]

Gross Income $[illegible]

Percent of income from dues [illegible]% Meets
*Must be 60% or more of gross income per IRC 528(c)(1)

DRAFT REPORT
EXHIBIT 1-2

EXPENDITURES TEST NEEDED TO MEET REQUIREMENTS UNDER IRC 528

EXPENSES AMOUNT
Dominion VA Power
Dredging
Insurance
Lawn Maintenance
Maintenance
Accounting & Legal Fees
TOTAL

Expenses for acquisition, construction, management,
maintenance and care of association property.

Total reported expenses - Form 990-EZ, line 17

Percent of income for expenses from the acquisition,
construction, management, maintenance, and care of
association property. Does not meet.
Must be 90% or more of total
expenses for the taxable year per IRC 528(c)(1)(2).

Form 886 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG. (EIN) 02/28/20XX
LEGEND
ORG - Organization name EIN - EIN XX - Date Address - address
City - city Treasurer - treasurer RA-1 - RA-1 PROP-1 through PROP-
3 - 18th through 37th PROP

ISSUE:

1. Whether ORG (ORG) is exempt from federal income tax under
   IRC 501(c)(4)?

2. Whether ORG qualifies as an exempt homeowners’ association under IRC 528?

FACTS:
ORG is a homeowners’ association recognized as an exempt organization under IRC 501(c)(4).

Since ORG had not filed an information return for numerous years, it received notice from the
IRS dated 09/XX/XX that its exempt status was inactive or had been terminated. On 05/30/XX
ORG received notice from the IRS that a determination letter was issued in October 19XX that
recognized it as exempt from Federal income tax and that it is currently exempt under section
501(c)(4) of the Internal Revenue Code.

The purposes of ORG, as set forth in its Articles of Incorporation, are:

1. To promote and engage in programs for the recreation, welfare and education of the
   members and their families;

2. To do all acts and things needful and necessary to accomplish the aforesaid; and

3. To buy, hold, receive, sell, lease, mortgage and deal in all property, both personal and real
   that may be deemed necessary to promote our purposes.

Income received by the organization is primarily from dues and fees from members who own
lots within and the ORG community. Expenses for the year include: insurance, lawn care,
maintenance, utilities, publication of its community newsletter, bank fees, picnics & socials,
meeting expenses, accounting and legal fees and charitable contributions.

Review of ORG's books and records identified the following information regarding use of its
common areas:

ORG Handbook & Directory -

• The ORG Handbook & Directory (updated March 20XX) states that the community owns six
pieces of property in ORG. They include “PROP-1,” two parcels of the PROP-2, the PROP-
3 area where Address stops and starts up again, a narrow strip of land at the end of ORG
sign. The Community Association maintains these community areas. (Section 4, page 2)

• ORG properties follow covenants that are a part of your deed and restrict the use of
property for the benefit of the community. (Section 4, page 3)

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

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

• When locked, the gates at the PROP-2, PROP-1 and the lot at the end of Address have
been very effective in discouraging trespassers. For this reason, it would be GREATLY
appreciated if you would lock the gates once you are inside, again when you leave, and any
time you see a gate left open. Keys to the gates are available from the ORG Treasurer. If
your ORG dues are current, there is no charge for the first key. A second key will cost $.
Any additional keys beyond the second will cost $ each.” (Section 4, page 5)

Board Meeting Minutes -

• April 26, 20XX - “Concern has been voiced about trespassing at the PROP-2 and tennis
courts. The neighbor woke up and saw a roaring fire at the boat ramp area, she called the
fire department and the police. Non-residents are using the area. It was suggested that we
will give a key and a list of all the people living here to RA-1, who will have some of his
Officers patrol the area and park in the PROP-2. The Officers will question everyone using
our community property.”

• May 24, 20XX - “Enhancement of security against trespassers on ORG property was
suggested by City County Police as follows:
• Move no-trespassing sign at PROP-2 to more visible location or add additional sign.
• Add no-parking signs along road by tennis court to discourage some trespassers from
parking there and to give police a reason to initiate conversation those parked there.
• Advise all ORG members to obtain and use their ORG bumper sticker to let police know
they are authorized to use ORG properties.”

“To PROP-1” Newsletters -

• “Persons who do not live in ORG have been enjoying the beautiful properties at the PROP-2
and PROP-1. When asked to leave, some do, and others come back - even after dark.
The Board has placed a letter on file with the City District of the City County Police
authorizing them to enter our properties to remove persons not authorized to use them.
The police will call one of the Board members to identify whether the persons are residents
or non-residents. If legal action is necessary, one of the Board members will be available to
testify if needed, but the police are very willing to assist us in this matter.”

• “To assist the police in patrolling our properties, and to avoid embarrassment of our good
residents, please note that it is very important for all residents to have a ORG bumper
sticker on all their vehicles. These are available at no cost, other than being a ORG
member in good standing, from Treasurer, Treasurer. If the police do not see a ORG
sticker on a vehicle parked at or near the PROP-2, tennis court or point, they will assume
there are trespassers involved. Not having the ORG bumper sticker offers the police an
opportunity to open conversation and ultimately determine whether the persons are on the
property legally or not.”

• “In case you haven't noticed, the gate and fence have been replaced at PROP-1 and the
locks at both PROP-1 and boat PROP-2 have been repaired/replaced.”

• “Members of the ORG Association, in good standing, are entitled to ORG Bumper stickers
and keys to the gates at the PROP-2 and PROP-1. These are available from our treasurer,
Treasurer. The first key is free, the second is $ and the third or more are all $ each. The
ORG bumper stickers are free and are important if using the PROP-2 or parking along the
road adjacent to either the PROP-2 or PROP-1 since they identify the vehicle as belonging to
a ORG member. The Board has officially authorized the City County Police to assist in

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

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

the control of non-resident trespassers and the absence of a ORG bumper sticker will
initiate a conversation by the police to determine if the owner should not be using the
property. Vehicles with ORG stickers will not be questioned and will therefore save the
officer's and your time. It is suggested that you obtain stickers for all your vehicles, your
boat and trailer. Please make the effort to obtain the stickers and keys at your earliest
convenience.”

Correspondence -

• In a letter issued to the City County Police Department, City District Station (June 7, 20XX),
the organization “requests assistance, as required, for the removal of illegal trespassers on
ORG Association property. The two properties that attract the most trespassers are the
PROP-2/tennis court area and the beach/picnic area at the east end of Address. We will
continue to ask trespassers to vacate the areas whenever we see them. We have problems
with repeat offenders who return after dark as well as during the day. We have asked all
association members to place an issued blue ‘ORG’ bumper sticker on each of their cars for
identification as residents who may be parked on or near the properties and who are legally
using the properties. Vehicles without the ‘ORG’ sticker can reasonably be suspect as
trespassers. While there are “No Trespassing” and “No Parking” signs at these locations,
some will be moved and others added to make them more visible to all.”

LAW:

IRC 501(c)(4)(A) provides for the recognition of exemption from federal income tax of civic
leagues or organizations not organized for profit, but operated exclusively for the promotion of
social welfare.

IRC 501(c)(4)(B) states that subparagraph (A) shall not apply to an entity unless no part of the
net earnings of such entity inures to the benefit of any private shareholder or individual.

Tax Reg. 1.501(c)(4)-1(a)(1) provides that a civic league or organization may be exempt as an
organization described in section 501(c)(4) if it is not organized or operated for profit and it is
operated exclusively for the promotion of social welfare.

Tax Reg. 1.501(c)(4)-1(a)(2)(i) provides, in part, that 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.

Tax Reg. 1.501(c)(4)-1(a)(2)(ii) states, in part, that an organization is not operated primarily for
the promotion of social welfare if its primary activity is operating a social club for the benefit,
pleasure, or recreation of its members, or is carrying on a business with the general public in a
manner similar to organizations which are operated for profit.

In Rev. Rul. 72-102, 1972-1 CB 149, it is stated that a nonprofit organization formed to
preserve the appearance of a housing development and to maintain streets, sidewalks, and
common areas for use of the residents is exempt under section 501(c)(4). The organization

Form 886-A (rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

described is a membership organization that was formed by a developer and is operated to
administer and enforce covenants for preserving the architecture and appearance of a housing
development, and to own and maintain common green areas, streets, and sidewalks for the use
of all development residents. Prospective home buyers are advised that membership in the
organization is required of all owners of real property within the housing development. The
organization is supported by annual assessments and member contributions. Its activities are
for the common benefit of the whole development rather than for individual residents or the
developer. Further stated, for the purposes of section 501(c)(4) of the Code, a neighborhood,
precinct, subdivision, or housing development may constitute a community.

Rev. Rul. 74-99, 1974-1 CB 131, which modifies Rev. Rul. 72-102, provides that 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 residences, and

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

Revenue Ruling 74-99 also states that Revenue Ruling 72-102 “...was intended only to approve
ownership and maintenance by a homeowners' association of such areas as roadways and
parklands, sidewalks, and street lights, access to, or the use and enjoyment of which is
extended to members of the general public, as distinguished from controlled use or access
restricted to the members of the homeowners' association. ...”

In Flat Top Lake Association, Inc. Plaintiff v. United States of America, Defendant. 86-2 USTC it
is held that “A homeowners' association was not entitled to exempt status as a civil league or
organization under Code Section 501(c)(4). The association did not provide benefits of a public
welfare nature to the public or a definable community because the association's facilities were
restricted to the use of its members.”

IRC 528 imposes a tax equal to 30% of a homeowners’ association's taxable income tax for
each taxable year.

IRC 528(c)(1) defines, in part, the term “homeowners association” as an organization which is a
residential real estate management association if -

1. Such organization is organized and operated to provide for the acquisition, construction,
   management, maintenance, and care of association property,

2. 60 percent or more of the gross income of such organization for the taxable year
   consists solely of amounts received as membership dues, fees, or assessments from
   owners of residences or residential lots in the case of a residential real estate
   management association,

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

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

3. 90 percent or more of the expenditures of the organization for the taxable year are
   expenditures for the acquisition, construction, management, maintenance, and care of
   association property,

4. No part of the net earnings of such organization inures (other than by acquiring,
   constructing, or providing management, maintenance, and care of association property,
   and other than by a rebate of excess membership dues, fees, or assessments) to the
   benefit of any private shareholder or individual, and

5. Such organization elects (at such time and in such manner as the Secretary by
   regulations prescribes) to have this section apply for the taxable year.

Tax Reg. 1.528-2 provides that in order to qualify it must be organized and operated primarily
for the purposes of carrying on one or more exempt functions of a homeowners’ association.
The exempt functions of a homeowners’ association are the acquisition, construction,
management, maintenance, and care of association property. For example, maintenance of
association property includes the painting and repairing of such property as well as the
gardening and janitorial services associated with its upkeep. Similarly, the term “construction” of
association property includes covenants or other rules for preserving the architectural and
general appearance of the area. The term also includes regulations relating to the location,
color and allowable building materials to be used in all structures.

Tax Reg. 1.528-9 provides that exempt function income consists solely of income attributed to
membership, dues fees or assessments of owners of residential units or lots. Examples of
exempt function income provided include: removing trash, removing snow from public areas,
paying principal and interest on debts incurred for the acquisition of association property,
paying real estate taxes on association property, and maintaining association property.

Tax Reg. 1.528-6 provides examples of qualifying expenditures which may be included in the
computation of the 90% expenditure test. These examples include: paving of streets, street
signs, security personnel, legal fees, upkeep of tennis courts, swimming pools, recreation
rooms, replacement of common buildings, facilities, air conditioning, insurance premiums on
association property, accounting fees, improvement of private property to the extent it is
association property, real estate and personal property taxes imposed on association property
by a state or local government, and both current operating and capital expenditures on
association property. Qualifying expenditures do not include transfers or investments of funds
to be held to meet future costs or excess assessments which are either rebated to members or
applied against the members’ following year’s assessments.

IRC 528(c)(3) states that the term “residential real estate management association” means any
organization meeting the requirements of subparagraph (A) of paragraph (1) with respect to a
subdivision, development, or similar area substantially all the lots or buildings of which may only
be used by individuals for residences.

Tax Reg. §1.528-1(c) provides, in part, that residential real estate management associations
are normally composed of owners of single-family residential units located in a subdivision,
development, or similar area. They are commonly formed to administer and enforce covenants
relating to the architecture and appearance of the real estate development as well as to perform
certain maintenance duties relating to common areas.

Form 886-A (rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -5-

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

IRC 528(c)(5) states, in part, that association property includes property held by the
association, property commonly held by the members of the organization and property within
the organization privately held by the members of the organization.

Tax Reg. §1.528-3(a) also states, in part, that “Association property” includes real and personal
property owned by the organization or owned as tenants in common by the members of the
organization. Such property must be available for the common benefit of all members of the
organization and must be of a nature that tends to enhance the beneficial enjoyment of the
private residences by their owners. If two or more facilities or items of property of a similar
nature are owned by a homeowners association, and if the use of any particular facility or item
is restricted to fewer than all association members, such facilities or items nevertheless will be
considered association property if all association members are treated equitably and have
similar rights with respect to comparable items or facilities. Among the types of property that
ordinarily will be considered association property are swimming pools and tennis courts. On the
other hand, facilities or areas set aside for the use of nonmembers, or in fact used primarily by
nonmembers, are not association property for the purposes of this section. For example,
property owned by an organization for the purpose of leasing it to groups consisting primarily of
nonmembers to be used as a meeting place or a retreat will not be considered association
property.

IRC 528(d), for purposes of this section, defines a homeowners’ association's taxable income
of any organization for any taxable year as an amount equal to the excess (if any) of the gross
income for the taxable year (excluding any exempt function income), over the deductions
allowed by this chapter which are directly connected with the production of the gross income
(excluding exempt function income), computed with modifications which include a specific
deduction of $100 and disallowance of net operating loss deductions allowed under section
172, and part VIII of subchapter B (relating to special deductions for corporations).

IRC 528(d)(3) states, in part, that the term “exempt function income” means any amount
received as membership dues, fees, or assessments from owners of real property in the case of
a residential real estate management association.

Tax Reg. §1.528-8(a) states that an organization wishing to be treated as a homeowners
association under section 528 for a taxable year must elect to be so treated by filing a properly
completed Form 1120-H (or such other form as the Secretary may prescribe). A separate
election must be made for each taxable year.

Tax Reg. §1.528-8(e) states that if an organization is notified after the close of a taxable year
that its exemption for such taxable year under section 501(a) is being revoked retroactively, it
may make a timely election under section 528 for such taxable year. Notwithstanding any other
provisions of this section, such an election will be considered timely if it is made within 6 months
after the date of revocation. The preceding sentence shall apply to revocations made after April
18, 1980. If the revocation was made on or before April 18, 1980, the election will be
considered timely if it is made before the expiration of the period for filing a claim for credit or
refund for the taxable year for which it is to apply.

Form 886-A (rev. 4-68) Department of the Treasury - Internal Revenue Service
Page: -6-

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

Tax Reg. §1.528-8(e)(f) states that an election to be treated as an organization described in
section 528 is binding on the organization for the taxable year and may not be revoked without
the consent of the Commissioner.

Tax Reg. 1.6012-2(a) states that a corporation in existence during any portion of a taxable year
is required to file Form 1120 return.

TAXPAYER'S POSITION:

POSITION #1:
To be determined
POSITION #2:
To be determined

GOVERNMENT'S POSITION:

POSITION #1:

The limitation on access to common areas maintained by ORG solely to its membership
involves primarily the exercise of private property rights for private benefit and is therefore
inconsistent with community benefit. Since your recreational areas are not open for the use
and enjoyment of the general public and are carried on for the limited benefit of your members
and their guests, you are, therefore, operating for the private benefit of your members, and not
for the benefit of the general welfare of a community. Therefore, you do not qualify for
exemption from Federal income tax as an organization described in section 501(c)(4) of the
Code.

POSITION #2:

Since ORG does not qualify for exemption under IRC 501(c)(4), consideration for qualification
as a non-exempt homeowners’ association under IRC 528 was made. In order to meet
requirements under this code section, an organization must meet five requirements, two of
which include: [redacted] or more of the organization’s gross income for the taxable year must
consist solely of amounts received as membership dues, fees, or assessments and [redacted] or
more of expenditures for the taxable year are for the acquisition, construction, management,
maintenance, and care of association property. In the tax period ending February 20XX, ORG
received [redacted] of its income from membership dues and fees and thus meets the income
requirement. However, only [redacted] of ORG’s expenses were used for the acquisition,
construction, management, maintenance, and care of its properties. As a result, ORG does not
meet the requirements under IRC 528 for the taxable fiscal year ending February 20XX. (Refer
to Exhibits 1-1 and 1-2 attached).

CONCLUSION:

POSITION #1:

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

Page: -7-

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

Name of Taxpayer Year/Period Ended

ORG. (EIN) 02/28/20XX

Beginning with fiscal year ending February 29, 20XX, ORG shall be revoked as an organization
exempt from income tax under IRC 501(c)(4), social welfare and civic league organizations.

POSITION #2:
ORG does not qualify as a homeowner's association under IRC 528 because it does not meet

the [redacted] expenditure requirements as set forth under IRC 528(c)(1). Therefore, ORG will
be required to file Form 1120, U.S. Corporation Income Tax Return.

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

Page: -8-