Other 1318023: IRS revokes a private residential association's exemption

Plain-English summary

The IRS revoked a residential association's exemption under section 501(c)(4). The association maintained private roads and common areas, provided security patrols, and served a restricted residential area whose benefits were limited to property owners. The IRS concluded that the association operated for the private benefit of its members rather than for social welfare, and that it also did not qualify under sections 501(c)(7) or 528. The IRS stated that the organization appeared to be properly described under section 277 as a taxable membership organization and required future Form 1120 filings.

Ruling snapshot

• Question: Whether the residential association continued to qualify for tax-exempt status.
• Outcome: Revocation.
• Key authorities: IRC §§ 277, 501(c)(4), 501(c)(7), 528; Treas. Reg. § 1.501(c)(4)-1(a)(2)(i); Flat Top Lake Association, Inc. v. United States, 868 F.2d 108 (1989); Rev. Rul. 72-102; Rev. Rul. 74-99.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

Attn: Mandatory Review, MC 4920 DAL | 50!-04-00
1100 Commerce St.
TAX EXEMPT AND Dallas, TX 75242
GOVERNMENT ENTITIES
DIVISION Date: November 7, 2008
Number: 201318023
Release Date: 5/3/2013
LEGEND
ORG = Organization name XX = Date Address = address
ORG. Employer Identification Number:
ADDRESS Person to Contact/ID Number:
Contact Numbers:
Voice:
Fax:

CERTIFIED MAIL — RETURN RECEIPT REQUESTED
Dear

In a determination letter dated April 19XX, 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 July
1$t 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 that time, we informed you of
your right to contact the Taxpayer Advocate, as well as your appeal rights. On
September 4, 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 have filed taxable returns on Form[s] 1120, U.S. Corporation Income Tax Return,
for the year[s] ended June 30, 20XX, 20XX, and 20XX with us. For future periods, you
are required to file Form 1120 with the appropriate service center indicated in the
instructions for the return.

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, 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,

Vicki L. Hansen
Acting Director,
Exempt Organizations Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service
Exempt Organizations
135 High Street, Stop 250

TAX EXEMPT AND Hartford, CT 06103

GOVERNMENT ENTITIES
DIVISION

August 20, 2008

Taxpayer Identification Number:

ORG
ADDRESS Form:
Tax Year(s) Ended:
re: ORG Person to Contact/ID Number:
Contact Numbers:
Telephone:
Fax:

CERTIFIED MAIL —- RETURN RECEIPT REQUESTED

Dear

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. Ifa
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.

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Sincerely,

Revenue Agent

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.
20XX06

LEGEND
ORG = Organization name XX = Date City = city XYZ = State
FACTS:

ORG was formed in 19XX. ORG encompasses a small area of approximately 550 acres within
the city of City, XYZ. ORG represents approximately 268 households. Its purpose is to take
ownership of private roadways and common areas in a residential development and to provide for
their repair and maintenance. In addition, ORG was to provide police protection and generally
safeguard the health, comfort and safety of residents. ORG was granted exempt status in April of
19XX.

ORG is a membership organization. Local property owners are referred to as members, their
membership is a consequence of property ownership within the City area. Only property owners
are allowed to join, and membership is automatic under provisions of the organization’s By-Laws
and Corporate Charter. Initially organization assessed its members for the funds with which to
carry out its activities, but had no legal authority to enforce its assessments.

Dues are not obligatory, unless there is a provision for them in the deed of the property owner,
and are used chiefly to defray the costs of printing an annual directory and for some smaller
social events. The organization also conducts various holiday programs and recreational activities
for resident members, some of which involve additional charges.

The organization’s primary activity was in the area of public safety and crime prevention. Asa
major part of its efforts in this area, the organization contracted with retired police officers to
provide the community with professionally trained security personnel. They patrol the area and
respond to calls for routine police matters. Access by non-residents is explicitly restricted, and
notice is given that any unauthorized vehicles will be stopped. If security personnel detect the
presence of non-residents in the area, non residents are asked to leave.

The organization’s activities in the City area include removal of deteriorated structures and flora,
and improvement and maintenance of residential area roads, signage, drains, and open spaces.
Signs are posted at various entry points to the area indicating it is private property.

In 19XX, the state of XYZ adopted a statute to allow for the establishment of districts within
municipalities. The City Tax District was formed by area residents. Since association dues or
assessments were not enforceable taxes were needed for purpose the purpose of providing
security services and maintaining Association’s common areas, and to enforce liens against
property owners who failed to pay the assessments. The creation of a Tax District ensured that
all property owners paid their fair share of the expenses of the area.

Form 886-A crev.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.
20XX06

ORG leased its roads and common areas to the Tax District to limit ORG’s liability. The Tax
District and Association entered into a Service Contract. The Service Contract makes ORG
responsible for the duties it always discharged. ORG sub-contracts its responsibilities to other
entities for security and maintenance. Provisions of the annual contract are essentially unchanged
since 19XX.

ORG is reimbursed for the services it provides at cost from the Tax District. ORG does receive
tax return preparation, bookkeeping, and legal services through the Tax District’s budget, but this
is not disclosed on the 990.

The organization’s activities benefit local property owners. Substantially all of its financial
support comes from assessments imposed by the Tax District on the property owners, with a
minimal portion collected from membership dues. Its expenses primarily grow out of its security
patrol contracts, road maintenance activities, and social activities. Legal expenses were
substantially increased during the examination year and subsequent year due to the challenge by a
local resident to the arrangement with the Tax District. ORG later ended its role in security
contracts.

Law:

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

Section 1.501(c)(4)-1(a)(2)(i) of the Income Tax Regulations provides 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 for the purpose of bringing
about civic betterments and social improvements.

Rev. Rul. 72-102, 1972-1 C.B. 149, holds that certain nonprofit organizations of a type usually
called homeowners’ associations, which are formed to administer and enforce covenants for
preserving the architecture and appearance of a housing development and to maintain streets,
sidewalks, and other non-residential, non-commercial properties in the development of the type
normally owned and maintained by a municipal government, may qualify for exemption under
section 501(c)(4) of the Code.

Rev. Rul. 74-99, 1974-1 C.B. 131, modified Rev. Rul. 72-102, to make clear that a homeowners’
association of the kind described in Rev. Rul. 72-102 must, in addition to otherwise qualifying
for exemption under section 501(c)(4) of the Code, satisfy the following requirements: (1) It
must engage in activities that confer benefit on a community comprising a geographical unit
which bears a reasonably recognizable relationship to an area ordinarily identified as a

Form 886-A crev.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.
20XX06

governmental subdivision or a unit or district thereof; (2) It must not conduct activities directed
to the exterior maintenance of private residences; and (3) It owns and maintains only common
areas or facilities such 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 and is not restricted to
members of the homeowners’ association.

Section 7-324 of the Connecticut General Statutes states in pertinent part that a “district” means
any fire district, sewer district, fire and sewer district, lighting district, village, beach or
improvement association and any other district or association, except a school district, wholly
within a town and having the power to make appropriations or to levy taxes. Section 7-326 of the
Connecticut General Statutes states in pertinent part that voters may establish a district for any or
all of a number of purposes, including to extinguish fires, to light streets, to plant and care for
shade and ornamental trees, to construct and maintain roads, sidewalks, crosswalks, drains and
sewers, and to appoint and employ watchmen or police officers, among other things.

Flat Top Lake Association, Inc., v. U.S., 868 F.2d 108, involved an organization’s tax exempt
status pursuant to IRC Section 501(c)(4). In the Flat Top Lake case the

“Association acquired approximately 2,200 acres of land. It constructed a 230
acre artificial lake. The land surrounding the lake front was subdivided into lots
and sold. Access to the property was provided by a two-lane road constructed by
the Association. The road is not a public highway and bears a sign at the entrance
to the development stating “Flat Top Lake Association, Private Property,
Members Only.” There are 375 lots in the Flat Top Lake development owned by
members...

The Association performs “tasks of quasi-governmental nature” for the
Association members and others. Those tasks include year-round water and
sanitation services, snow removal from common areas, police protection, road and
equipment maintenance and maintenance of the dam and other common areas.
The Association is working with local authorities in considering construction of a
sewage treatment plant. Further, it has promulgated a disaster relief plan in the
event of failure of the dam, and it supplies a backup water supply to the nearby
City of Beckley, a city of some 19,000 population.”

The court concluded that the Flat Top Lake Association did not qualify for exempt status under
section 501(c)(4) because it did not represent a community as the term is described in the
published precedent. The area served did not bear a reasonably recognizable relationship to an
area ordinarily identified as a governmental subdivision or a unit or district. The court further
held that the benefits of the organization were limited to its members and benefits were not
enjoyed by the general public. The exclusionary nature of the organization where benefits were
limited to members indicated that the organization was not organized for social welfare but for

Form 886-A crev.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.
20X X06

the private benefit of its members.
Government’s Position:

Rev. Rul. 74-99, 1974-1 C.B. 131, is a key published precedent concerning ORG’s right to
continued exemption. The ruling cites the following requirements: (1) the organization must
engage in activities that confer benefit on a community comprising a geographical unit which
bears a reasonably recognizable relationship to an area ordinarily identified as a governmental
subdivision or a unit or district thereof; (2) the organization must not conduct activities directed
to the exterior maintenance of private residences; and (3) it owns and maintains only common
areas or facilities such 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 and is not restricted to
members of the homeowners’ association.

The Flat Top Lake Association, Inc., v. U.S., 868 F.2d 108, confirmed the criteria in the revenue
ruling. Even though the Flat Top Lake Association performed many more quasi governmental
activities than ORG the court still ruled that the organization did not qualify for exemption
because its size was not reasonably recognizable as a governmental subdivision and the benefits
provided served the organization’s members.

ORG serves a members only area. Security personnel expel all those who are determined to be
non-residents of the City area without regard to their activities, such as fishing, bicycling, or
enjoying the local park. Further, non-residents are warned away and informed the roadways and
common areas maintained in the course of the organization’s activities are private property and
not for public use. Benefits of the maintenance are restricted to property owners.

As stated in the Flat Top Lake case, although it is unquestionably their right to do so, when a
group of citizens elects to separate themselves from society and to establish an entity that solely
advances their own private interests, no potential for general social advancement is implicated.
The requirements expressed in Rev. Rul. 74-99 have not been met.

Taxpayer’s Position:

The organization’s position has not been made known.

Conclusion:

Since the organization’s activities serve the private benefit of its members, it is not operated for

the promotion of social welfare. Accordingly, it does not qualify for exemption from Federal
income tax under section 501(c)(4) of the Code.

Further, since ORG is not organized for pleasure, recreation, or other non-profitable purposes, it
does not qualify for exemption from Federal income tax under section 501(c)(7) of the Code.

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

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. ot
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG.
20XX06

Similarly, since the organization’s revenues are not primarily from member assessments, it does
not qualify as a Homeowner’s Association under section 528 of the Code.

ORG appears to be properly described by IRC 277 as a membership organization which is not
exempt from taxation.

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