Other 1318024: IRS proposes revoking a neighborhood organization's exemption

Plain-English summary

The IRS proposed revoking a neighborhood organization's exemption under section 501(c)(4). The organization provided newsletters, directories, community events, and a security patrol for participating property owners. The IRS concluded that these services primarily served the private interests of members rather than promoting social welfare for the community as a whole. The organization was described as similar to a homeowners association under section 528, and the IRS proposed revocation effective January 1, 20XX, with Form 1120-H filings required for specified years and future years.

Ruling snapshot

• Question: Whether the organization continued to qualify for exemption under section 501(c)(4).
• Outcome: Revocation.
• Key authorities: IRC §§ 501(c)(4), 528; Treas. Reg. §§ 1.501(c)(4)-1(a)(2)(i), 1.528-1; Commissioner v. Lake Forest, Inc., 305 F.2d 814 (1962); Rev. Rul. 69-280; Rev. Rul. 77-273.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examination
1100 Commerce Street

TAX EXEMPT AND
GOVERNMENT ENTITIES Dallas, Texas 75242

DIVISION

July 30, 2007

Taxpayer Identification Number:
Number: 201318024

Release Date: 5/3/2013 Form:
Tax Year(s) Ended:
ORG
Address Person to Contact/ID Number:
UIL: 501.04-00 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.

Sincerely,

Marsha A. Ramirez
Director, EO Examinations

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

Form 8 86 A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 12/31/20XX
Legend
ORG = Organization name XX = Date XYZ = State City = city
CO-1 = Company CO-2 = 2" company
ISSUES

Does ORG continue to qualify for tax exempt status under Internal Revenue Code section
501(c)(4)?

FACTS

The ORG (ORG) was incorporated May 21, 19XX in the State of XYZ. The ORG is not gated,
nor does it enforce any covenant for preserving the architecture and appearance of a particular
area.

The Articles of Incorporation shows the purposes for which the ORG was organized as:

e To promote and develop the common good and welfare of the residents within the
community, such community being defined as that certain area of the City of City, known
as the CO-1,

e To promote and develop good fellowship, neighborliness, and civic responsibility among
the members of the corporation including, but not limited to, discussion and collective
pursuit of problems of civic interest.

The By-laws identify the purposes of this ORG to be to preserve, protect, and advance the
interests of the neighborhood in which its members reside, to disseminate information of interest
to those residents, and to promote fellowship among its members.

The By-laws recognize the streets and blocks which make up the member residences which adult
residents reside on. Membership is voluntary for all residents in the area covered by the ORG.
The ORG provides its members with an annual directory, monthly newsletters, participation in
neighborhood events and activities. The ORG has formed a Creek Operations committee to act
as liaison, arrange maintenance and periodic inspection of the creek area behind member’s
homes.

For the tax year ended December 31, 20XX, the ORG provided members with monthly
informative newsletters and an annual telephone directory. The monthly newsletter provides
members with property care tips, crime watch report, advertisements geared toward homeowners
and the ORG agenda. The monthly newsletter is also used to keep members aware of the ORG
events and activities, which promote fellowship and encourage non-member resident owners to
join. The ORG holds a Spring and Fall General Membership meeting, Boot Scootin’ Progressive
Party, Easter Egg Hunt, the 4" of July Parade, Tree Lighting with Santa Claus, and annual
Halloween Party. The ORG requires foods and candy as fee for admittance to the events held,

Form 886-A cev.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 12/31/20XX
Legend
ORG = Organization name XX = Date XYZ = State City = city

CO-1 = Company CO-2 = 2™ company

while other activities may require members to pay for events held off-site. The conducting these
activities and member benefits make up about % of the organization total expenses.

The ORG also offers crime watch patrol open to the ORG members. The ORG has an agreement
with a neighboring homeowner ORG to provide the crime watch patrol. The ORG employs off-
duty police officers in City Police cars to patrol in the designated Crime Watch area. The patrol
officers’ schedule varies, with special emphasis on known peak crime hours. The operation of
the crime watch program makes up about % of the ORG expenses. In 19XX the ORG formed
the CO-2 to address growing crime in the area. As a result the ORG started Crime watch patrol.
The ORG had about 405 participants on the program. The ORG charged $ per month in dues for
the service. Benefits limited to paying participants include:
e Voice mail system — each member has an access code,
e Extra attention to their home while on a trip (such as checking windows and doors for
anything unusual, and removing flyers and hiding newspapers and mail,
e Direct access to patrolling officers and off-duty voice mail message via dedicated cell
phone,
Member alert to recent crime in the area,
e Crimes watch member signage for home exterior.

Officers are available approximately 100 hours a week to address other problems and concerns
such as:
e Medical emergency assistance

e Investigation of suspicious persons
e Investigation of unknown parked vehicles
e “Open garage door” alerts
e Overseeing personal safety for late-night home arrival
e Stopping vandalism in progress.
LAW

Section 501(c)(4) of the Code provides for the exemption from Federal income tax of civic
leagues or organizations not organized for profit but operated exclusively for the promotion of
social welfare and the net earnings of which are devoted exclusively to charitable, educational, or
recreational purposes.

Section 1.501(c)(4)-1(a)(2)(i) of the Regulations states 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

Form 886-Acev.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 12/31/20XX
Legend
ORG = Organization name XX = Date XYZ = State City = city

CO-1 = Company CO-2 = 2"? company

embraced within this section is one which is operated primarily for the purpose of bringing about
civic betterment and social improvements.

Revenue Ruling 77-273, 1977-2 CB 194, A nonprofit organization that provides security
services for residents and property owners of a particular community, who agree to voluntarily
donate money at a specified hourly rate to defray the cost of the services, is carrying on a
business with the general public in a manner similar to organizations operated for profit and does
not qualify for exemption under section 501(c)(4) of the Code.

Revenue Ruling 69-280, 1969-1 C.B. 152 concluded that an organization that provides
maintenance of exterior walls and roofs of members’ homes in a housing development does not
qualify for tax-exempt status under IRC section 501(c)(4). The organization was operating
primarily for the benefit of individual members rather than the community as a whole.

In Commissioner v. Lake Forest, Inc., 305 F.2d 814(1962), it was held that the organization, a
housing cooperative for World War II veterans and others, did not meet the requirements for tax-
exempt status under IRC section 501(c)(4). The court found that the organization was not
operating exclusively for “social welfare” purposes, but as a private economic enterprise. The
court also determined that the organization was organized and operated for the benefit or
convenience of its members by performing services that its members would otherwise have to
provide for themselves.

Section 528(c)(1) defines the term “homeowners ORG” to mean an organization, which is a
residential real estate management ORG organized and operated to provide for the acquisition,
construction, management, maintenance, and care of ORG property. The homeowners ORG
must receive at least 60 percent of its gross income from amounts received as membership dues,
fees, or assessments, and at least 90 percent of its expenditures must be from the acquisition,
construction, management, maintenance, and care of the ORG property on behalf of members of
the ORG.

The taxable income of a homeowners ORG for any taxable year is 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 directly connected with the production of the gross income (excluding
exempt function income).

Under section 528, the term “exempt function income” is any amount received as membership
dues, fees, or assessments from owners of real property in the case of a residential real estate
management ORG. There shall be allowed a specific deduction of $100. No net operating loss
is deducible. |

Form 886-A cev.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 12/31/20XX
Legend
ORG = Organization name XX = Date XYZ = State City = city

CO-1 = Company CO-2 = 2™ company

Section 1.528-1 of the Regulations states to qualify as a homeowners association an organization
must either be a condominium management association or a residential real estate management
association. As a general rule, membership in either a condominium management association or
a residential real estate management association is confined to the developers and the owners of
the units, residences, or lots. Furthermore, membership in either type of association is normally
required as a condition of such ownership. However, if the membership of an organization
consists of other homeowners associations, the owners of units, residences, or lots who are
members of such other homeowners associations will be treated as the members of the
organization for the purposes of the regulations under section 528.

GOVERNMENT?’S POSITION

An organization that limits its service to certain property owners, operated to serve the individual
interest of its members rather than the community as a whole by providing social activities,
security patrol and disseminating information useful to its members, is not a social welfare
organization exempt under section 501(c)(4). A social welfare organization must be operated for
the benefit of the general public by providing a community benefit to qualify for exemption
under section 501(c)(4). Generally, social welfare organization, which operates as an exempt
homeowners association, owns and maintains certain common areas open to the public. The
Treasury Regulations extend tax-exempt status to those exempt homeowners’ associations that
are primarily engaged in promoting 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 betterment and social improvements.

ORG has not shown its activities primarily serve the community rather than the private interest of
its members. The security patrol services the ORG provides to property owners on a regular
basis is similar to organizations operated for profit. The fact that security patrol services are
provided does not satisfy the requirements of the regulations that an organization be primarily
engaged in promoting the common good and general welfare the community.

ORG is similar to the organizations in Revenue Rulings 69-280 and 77-273, because the ORG
activities and services are for the benefit of its members. Most of the ORG member dues are
used for patrol services for private residents. An organization of this type described in the
rulings is essentially a mutual, self-interest type of organization. ORG’s income is used to
provide direct economic benefits to its members and any benefit to the larger community is
minor and incidental. As in Commissioner v. Lake Forest, Inc., ORG’s benefits are neither
intended for the public at large, rather for the private interest of property owners paying for a
particular service.

Form 886-Acrev.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 12/31 /20XX
Legend
ORG = Organization name XX = Date XYZ = State City = city

CO-1 = Company CO-2 = 2™ company

ORG is similar to organizations describe under section 528 of the Code. The activities and
support are of those of a traditional homeowners’ ORG as described in section 528.

TAXPAYER’S POSITION
Unknown
CONCLUSION

Since the benefits provided by the ORG are limited to its members, you are not operated
exclusively for the promotion of social welfare within the meaning of section 501(c)(4) of the
Code.

As a result of our examination of your Form 990 for the period ended December 31, 20XX, we
have determined that your organization no longer qualifies as an exempt homeowners ORG
described in IRC section 501(c)(4). We are proposing that the Corporation’s exempt status be
revoked as of January 1, 20XX. Form 1120-H, U.S. Income Tax Return for Homeowners ORG,
should be filed for the fiscal years ended December 31, 20XX, 20XX and all future years.

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