IRS revokes exemption from homeowners association with member-only facilities

Plain-English summary

The IRS revoked an organization's exemption under IRC § 501(c)(4), effective January 1 of the redacted year. The organization administered covenants, maintained common property, and operated a swimming pool and clubhouse restricted to its members. The IRS concluded that the area was not a qualifying community because it lacked a recognizable relationship to a governmental subdivision and did not have powers such as police protection. The organization therefore did not promote social welfare for the general public, although the IRS noted that it might qualify as a homeowners association under IRC § 528 and file Form 1120-H.

Ruling snapshot

• Question: Did the homeowners association qualify for continued exemption under IRC § 501(c)(4) when its common areas and pool were restricted to members?
• Outcome: Revocation, effective January 1 of the redacted year.
• Key authorities: IRC §§ 501(c)(4) and 528; Treas. Reg. §§ 1.501(c)(4)-1(a)(1)-(2) and 1.501(c)(4)-2; Rev. Ruls. 73-306, 74-99, 80-63, and 80-206; Flat Top Lake Association v. United States, 868 F.2d 108 (4th Cir. 1989).

Full text (IRS public release)

PAE TASENT OF THE TREASURY
CARMAL REVENUE SERVICE

22 N Front St, Room 426 ,

Memphis, TN 38103
Release Number: 201321032
Release Date: 5/24/2013 .. . MAR(052007 ~=«2UJ: 501.0400
Legend: Person to Contact:
ORG = Name of Organization Identification Number:
Date = xx Contact Telephone Number:
ORG In Reply Refer to: TE/GE Review Staff
EIN:
Dear

This is a Final Adverse Determination as to your exempt status under section 501(c)(4)
of the Internal Revenue Code. :

Our adverse determination was made for the following reasons:

ORG failed to establish that they meet the requirement for exemption under IRC 501(c)(4).
Section 1.501(c)(4)-1(a)(1) and (2) of the Treasury Regulations reads in part, "(a) Civic
organizations (1) In general. —A civic league or organization may be exempt as an
organization described in section 501(c)(4) if: (i) It is not organized or operated for profit; and
(ii) It is operated exclusively for the promotion of social welfare. (2) Promotion of social
welfare (i) In general. —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.

As a result of our recent audit of your organization's activities for the period ended December 31,
20xx, it was determined that a substantial part of your activities include the administration and
enforcement of covenants for preserving the appearance of a particular area, the maintenance of
common property, and the operation of pool and clubhouse facilities. Therefore, we are
revoking your organization's exemption from Federal income tax under section 501(c)(4) of the

Internal Revenue Code effective January 1, 20xx.

You are required to file Form 1120-H, U.S. Income Tax Return for Homeowners Associations.
These returns should be filed with the appropriate Service Center for all years beginning after
December 31, 20xx. Form 1120-H must be filed by the 15" day of the third month after the end
of your annual accounting period. A penalty of $20 a day is charged when a return is filed late,
unless there is reasonable cause for the delay. However, the maximum penalty charged cannot
exceed $10,000 or 5 percent of your gross receipts for the year, whichever is less. This penalty

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may also be charged if a return is not complete, so please be sure your return is complete before
you file it. You are required to file Form 1120-H with the appropriate Internal Revenue Campus.

You have the right to contact the office of the Taxpayer Advocate. However, you should
first contact the person whose name and telephone number are shown above since this
person can access your tax information and can help you get answers. You can call 1-
877-777-4778 and ask for Taxpayer Advocate assistance. Or you can contact the
Taxpayer Advocate from the site where the tax deficiency was determined by calling

or writing to: Internal Revenue Service.

Taxpayer Advocate assistance cannot be used as a substitute for established IRS

procedures, formal appeals processes, etc. The Taxpayer Advocate is not able to reverse

legal or technically correct tax determinations, nor extend the time fixed by law that you

have to file a petition in the United States Tax 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.

If you have any questions, please contact the person whose name and telephone number
are shown in the heading of this letter.

Sincerely yours,

Marsha A Ramirez
Director, EO Examinations

DEPARTMENT OF THE TREASURY
Internal Revenue Service
TE/GE EO Examinations
TAX EXEMPT AND 1122 Town and Country Commons, Room 128
GOVERNMENT ENTITIES Chesterfield, MO 63017-8293

DIVISION

November 6, 2006

Legend: Taxpayer Identification Number:
ORG = Name of Organization Form:

Address = Address of ORG Tax Year(s) Ended:

Date = xx 20xx12

Person to Contact/ID Number:

Contact Numbers:
Telephone:

Fax:
ORG

ADDRESS

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 Una greed Issues. If a
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:

Local Taxpayer Advocate

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,

Internal Revenue Agent

Enclosures:
Publication 892
Publication 3498
Form 6018

Report of Examination
Envelope

Letter 3610 (04-2002)
Catalog Number 34801V

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

Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
ORG 20xx12
Legend:
ORG = Name of Org
Date = xx

1. Should the ORG, an organization exempt under Internal Revenue Code section 501(c)(4), continue to be
   exempt since it operates a swimming pool open only to the members of the organization?

FACTS

1. ORG was recognized, on 03/27/19xx, as an organization exempt under IRC 501(c)(4) because it was an
   organization described in IRC 501(c)(3).

2. The organization membership is compelled to belong by fees mandated in a covenant to the member's
   property title.

3. The organization owns and maintains common areas and a swimming pool.

4. The common areas and swimmi pool ate restricted to the organization's members and are not for the use
   and enjoyment of the general public.

5. The organization does not maintain a police (security) force or enact laws or other ordinances normally
   identified with a governmental subdivision or district.

6. The specific area which encompasses the otganization's homeowner's property and common areas does not
   have tts own zip code.

501(c)(4) of the Internal Revenue Code states that civic leagues or organizations not organized for profit but
operated exclusively for the promotion of social welfare, will be recognized as exempt under subsection 501 (a) if no
part of the net earnings of such entity inures to the benefit of any private shareholder or individual.

Section 1.501 (c)(4)-2 of the Income Tax Regulations states that an organization will be regarded as operating
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, because it is operated primarily to bring about civic
betterments and social improvements.

Section 1.501(c)(4)-1(a)(2)(ii) of the regulations provides that an organization is not operated primarily for the
ptomotion of social welfare if its primary activity is operating a social club for the benefit, pleasure, or recreation
of its members.

Rev. Rul. 73-306, 1973-2 C.B. 179 provided that a nonprofit organization formed to protect the rights of tenants in
one rental complex did not benefit the community in general, but rather a select group of individuals. Therefore,
exemption under 501(c)(4) was denied.

REV-RUL, Homeowners association, Preserving appearance and maintaining common ateas, Revenue Ruling
74-99, 1974-1 CB 131, (Jan. 01, 1974)

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 ot
facilities it owns and maintains must be for the use and enjoyment of the general public; Rev. Rul. 72-102 modified.

CC SEOUSSSSISSSSS

Department of the Treasury- Intemal Revenue Service

Form 886A Explanation of Items pohedule BY
Name of Taxpayer Yeat/Period Ended
ORG 20xx12

Rev. Rul. 74-99, 1974-1 C.B. 132 clarified the definition of community as it applies to homeowners associations. A
mere aggregation of homeowners in a real estate subdivision is not a community. It must be a geographical unit
bearing a reasonably recognizable relationship to an area ordinarily identified as a governmental subdivision or a

REV-RUL, Homeowners' associations, Revenue Ruling 80-63, 1980-1 CB 116, J an. 01, 1980)
was issued to discuss, in question and answer format, certain issues raised by Rev. Rul. 74-99,

Question 1:

Does Rev. Rul. 74-99 contemplate that the term "community" for purposes of section 501()(4) of the Code

embraces a minimum area or a certain number of homeowners:

Answer: No. Rev. Rul 74-99 states that it was not possible to formulate a precise definition of the term
"community". The ruling merely indicates what the term is generally understood to mean.

Question 2:

May a’ homeowners! association, which represents an area that is not a community, qualify for exemption under
section 501(c) (4) of the Code if it restricts the use of its recreational facilities, such as swimming pools, tennis
courts, and picnic areas, to members of the association?

Answer.

No. Rev. Rul. 74-99 points out that the use and enjoyment of the common areas owned and maintained by a homeowners'
association must be extended to members of the general public, as distinguished from controlled use or access

restricted to the members of the association. For purposes of Rev. Rul. 74-99, recreational facilities are included in the
definition of "common areas".

Rev. Rul. 80-206, 1980-2 C.B. 185 provided that a nonprofit organization formed to protect the legal rights of all
€ tenants in a community does qualify as a social welfare otganization.

Flat Top Luxe Association v. United States, 868 F.2d 108 (4th Cir. 1989), the court concluded that a homeowners!
association that encompassed a very large area but restricted use of its facilities to its members does not qualify for
exemption under IRC 501(c) (4). The court went on to conclude that in order to be exempt under IRC 501(c)(4),

the organization must be a community that constitutes an active part of society rather than a private refuge for those
who would live apart.

GOVERNMENT'S POSITION

Civic leagues and organizations not organized for profit, but operated exclusively for the promotion of social welfare
are recognized as exempt under section 501(c)(4) of the Code. An organization will be regarded as operating exclusively
for the promotion of social welfare if it is primarily engaged in promoting the common good and general welfare of
the people in the community (Section 1.501(c) (4)-1(a) (2) (i) of the regulations).

One crucial element for section 501(c) (4) exemption is promotion of social welfare for the people of a community.
The Service granted exempt status to an organization that defended tenants’ rights for a whole community, which is

Form 886- A

Department of the Treasury. - Internal Revenue Service
Page: -2-

‘

s “QOL A

Formroo@rk “Ex " lanati ~ nof Iteme Schedule No. or
10 . .
Name of Taxpayer P Exh i bit
Year/Period Ended
ORG 20xx12

considered an exempt activity. Rev. Rul. 80-206. In comparison, the organization in Rev. Rul. 73-306, was denied

exempt status because it only benefited the tenants in one rental complex. It did not benefit the community in
general, but rather a select group of individuals.

Rev. Rul 74-99 noted that an aggregation of homeowners in a real estate subdivision is not a community. It must also
be a geographical unit bearing a reasonably recognizable relationship to an area ordinarily identified as a
governmental subdivision or district. This organization is not a community as described above since it is not a

recognized governmental subdivision ot district and does not possess the powers or responsibilities (Le., police
protection) generally associated with such entities.

Rev. Rul. 80-63 further provides that an area not considered a community cannot be exempt under 501(0)(4) if it
Opetates a swimming pool for the exclusive use of its homeowner members. Flat T: op Lake Association v. United
States reinforces this ruling by concluding that for an area to be considered a community it must an active part of

society rather than a private refuge for its members.

Considenny all the facts and circumstances and applying the applicable law the ORG is not an organization described in
IRC 501(0)(4) of the Code. However, it may qualify as a homeowners association under section 528 of the Code.

TAXPAYER'S POSITION

eo ization agrees wi e Government's position.
The organization agr th the G: t's p

CONCLUSION
The organization's exemption under section 501(c)(4) of the Code should be revoked for the period beginning

January 1, 20xx and for all subsequent periods. If the organization elects, and is eligible under section 528 of the
Code, it may begin filing Form 1120-H. Otherwise it must file Form 1130.

Fe oom 886-A (Rev. A 8 Department of the Treasury - Internal Revenue Service
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