Determination 1338045: IRS revokes title-holding company’s exemption for operating commercial facilities

Plain-English summary

The IRS revoked a title-holding company’s exemption under IRC § 501(c)(2). The company held property for a related tax-exempt organization but also controlled a bingo-hall concession stand, bar, catering, cleaning, maintenance, and room-rental operations. The IRS concluded that these services went beyond holding title to property and collecting rent, and that the related organization’s income was not properly reported as unrelated business income. The company had signed Form 6018-A consenting to revocation, effective July 1, 20XX.

Ruling snapshot

• Question: Did the organization continue to qualify for exemption under IRC § 501(c)(2)?
• Outcome: Revocation. The organization operated service businesses beyond the permitted title-holding and rental functions.
• Key authorities: IRC §§ 501(c)(2), 501(c)(25)(G), 511, 512, 514; Treas. Reg. §§ 1.501(c)(2)-1, 1.512(b)-1.

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street
Dallas TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES UIL: 501.02-01
DIVISION

Date: April 9, 2009

Number: 201338045
Release Date: 9/20/2013

LEGEND:
ORG = Name of Organization
ADDRESS = Address of Organization Employer Identification

Year =xx
Person to Contact/ID Number:

Contact Numbers:

CERTIFIED MAIL
Dear

In a determination letter dated October 19xx, you were held to be exempt
from Federal income tax under Internal Revenue Code § 501(c)(2 ).

We have determined you have not operated in accordance with the
provisions of Internal Revenue Code § 501(c)(2 ). We have explained the
basis for our determination in the enclosed report of examination.

On February 24, 20xx you signed Form 6018-A, Consent to Proposed
Action, agreeing to the revocation of your exempt status under section
501(c)( 2) of the Code. Therefore, your exemption from Federal income
tax is revoked effective July 1, 20xx.

You are therefore required to file Form(s) 1120, Federal Corporate Income
Tax Return, for the year(s) ended June 30, 20xx, and 20xx, with the
Ogden Service Center. 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, 1-877-777-4778, and ask for Taxpayer Advocate
Assistance.

If you prefer, you may contact your local Taxpayer Advocate at:

Internal Revenue Service

This is a final adverse determination letter with regard to your status under

IRC § 501(c)(2 ).

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

Sincerely,

Sunita B. Lough
Director, EO Examinations

Enclosures:
Report of Examination
Copy of Form 6018-A

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

Explanation of Items Exhibit
Name of Taxpayer Year/ Period Ended
ORG NUM June 30, 20xx

June 30, 20xx

LEGEND:

ORG = Name of Organization

Num= Identifying Number

RELATED ORG = Name of Related Organization
ADDRESS = Address of Organization

Year = xx

ISSUE:

Whether The ORG, qualifies for tax exemption under Section 501(c)(2) of the Internal
Revenue Code.

FACTS:

The ORG, (hereinafter referred to as the "Organization"), was incorporated in the state on
September 8, 19xx The state record reflected that this corporation was active and a domestic non
profit corporation with the exclusive purpose of holding title to property, collect income there
from, and turn over the entire amount thereof, less expense, to RELATED ORG, a non profit
organization under Internal Revenue Code Section 501(c)(8). In October 19xx, the organization
was granted tax exempt status under section 501(c)(2) of the Internal Revenue Code as a holding
company.

According to our records, the organization filed the most recent Forms 990 for the tax period
ending June 30, 20xx. The organization had filed Forms 941 for all quarters January 01, 20xx
through September 31, 20xx with no balances due.

The organization holds title to two buildings and the property located at ADDRESS

The lease agreement between the organization and the RELATED ORG. entitles the RELATED
ORG to use the property at ADDRESS location, which consists of approximately five acres and a
lodge facility. The premises shall be used for the purpose of having meetings and other functions
. The organization reserved the right to lease the premises to other parties for short terms
provided that said leasing to other parties does not interfere with the functions and uses of the
RELATED ORG. The rent charged was $1 per month, payable in advance on or before the first
day of each month during the term of the lease. A copy of the lease provided stated the terms
commencing on January 1, 19xx and extending through December 31, 20xx. There were no
written current leases provided and the organization stated that they continue on a verbal
commitment. A review of the books and records for the examined periods July 1, 20xx through
June 30, 20xx did not find the full amount of rents paid or collected between the two parties.

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 NUM June 30, 20xx
June 30, 20xx

The property located at Different Address is operated as a bingo hall with the organization
holding a valid state hall operator’s license. The commercial lease agreement with the Related
ORG at this location entitles the RELATED Org to use the facility, utilities, tables, and chairs
one day per week for the sole purpose of conducting Bingo, paying $0 per week as rental of the

_ premises and $0 per week for janitorial, maintenance, and supply services. The RELATED ORG
shall have full authority over any and all food and beverage offerings and operate the kitchen,
which is not part of this lease agreement. The bingo hall is rented out to six other non profit
organizations for the remainder of the week under similar lease terms with no provisions
regarding the kitchen operations. The organization acts as the employer for the employees
working at the bingo hall, including the kitchen staff, and at the lodge facilities. They have filed
all employment tax returns and paid all employment taxes from January 1, 20xx to present. The
Related ORG. previously acted as the employer and filed all employment related returns up
through January 31, 20xx.

During review of the operations of the bingo hall, the exam found that the organization was
controlling the concession stand, collecting rents, and providing cleaning and maintenance. The
RELATED ORG is limited in offering services to non members as a member organization and
must use member volunteers to meet the exception for not treating non member income as
unrelated business income. They did not operate the concession stand with volunteer members.
The organization paid employees under their control to operate the concession stand at the bingo
hall seven days a week and also hired a manager to oversee the catering and renting of the hall
facilities. They also controlled the members lounge area and paid a bartender to serve the
members.

The organization is precluded from receiving any unrelated business income from activities other
than collecting rents.

The facilities located at ADDRESS the RELATED ORG’s meeting room and offices, in
addition to the social area advertised as the Room on their website and on the outdoor signage in
front of the building. The Room is available for rent to the general public as well as to members
of the RELATED ORG. They offer services including catering, food, bar, and cleaning. The
room has full kitchen and bar facilities and offers a dance floor area in addition to table and chair
set ups as specified by the renter. The organization has control over the employees and the
operations of the Room, as well as the Open bar area in their meeting room.

The Form 990, Federal tax return, filed for the organization did not properly report income and
expenses from the activities in connection with the bingo hall concessions and the Room rentals
and bar income. The income from the concessions offered seven nights a week were reported in
error on the RELATED ORG tax return for the period ending June 30, 20xx.

The organization reported only rents on the tax return for the period ending June 30, 20xx. They
reported rents and concessions on the tax return for the period ending June 30, 20xx. In both

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 NUM June 30, 20xx

June 30, 20xx

years, the income from the bar connected to the Room and the RELATED ORG meeting room
was not reported on the organization’s tax returns. It was determined that they controlled the bar
operations by providing employees and management over the inventories. The RELATED ORG
cannot engage in unrelated business income from non members without reporting that taxable
income on Form 990-T.

There were no Forms 990-T filed by either the RELATED ORG or the organization.
LAW:

Section 501(c)(2) of the Internal Revenue Code ( the “Code’) provides for the exemption from
federal income tax of corporations organized for the exclusive purpose of holding title to
property, collecting income there from, and turning over the entire amount thereof, less expenses
to an organization which itself is exempt under this section. Rules similar to the rules of
subparagraph (G) of paragraph (25) shall apply for purposes of this paragraph.

Under section 501(c)(25)(G) of the Code an organization shall not be treated as failing to be
described in section 501(c) (2) by reason of the receipt of any otherwise disqualifying income
which is incidentally derived from the holding of real property which does not exceed 10 percent
of the organization's gross income for the taxable year.

Section 1.501(c) (2)-1(a) of the Income Tax Regulations (the “regulations') provides that since
a corporation cannot be exempt under section 501(c) (2) if it engages in any business other than
that of holding title to property and collecting income there from, it generally cannot have
unrelated business taxable income as defined in section 512 other than unrelated business rental
income described in section 514.

Section 511(a) of the Code imposes a tax on the unrelated business taxable income of
organizations described in section 501(c) (2).

Section 512(b) (3) of the Code modifies the definition of unrelated trade or business by
excepting all rents from real property.

Section 1.512(b)-1 of the regulations provides that whether a particular item of income falls
within any of the modifications provided in section 512(b) shall be determined by all the facts
and circumstances of each case.

Under section 1.512(b)-1(c) (2) of the regulations the term rents for purposes of section 512(b)
includes all rents from real property. However, certain rents from, and certain deductions in
connection with, debt-financed property (as defined in section 514(b)) shall be included in
computing unrelated business taxable income.

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 NUM June 30, 20xx

June 30, 20xx

Section 1.512(b)-1(c)(5) of the regulations provides that payments for the use or occupancy of
rooms and other space where services are also rendered to the occupant, such as for the use or
occupancy or rooms or other quarters in hotels, boarding houses, or apartment houses furnishing
hotel services, or in tourist camps or tourist homes, motor courts or motels or for the use or
occupancy of space in parking lots, warehouses, or storage garages, does not constitute rent from
real property. Generally, services are considered rendered to the occupant if they are primarily for
his convenience and are other than usually or customarily rendered in connection with the rental
of rooms or other space for occupancy only. The supplying of maid service, for example,
constitutes such service; whereas the furnishing of heat and light, the cleaning of public
entrances, exits, stairways and lobbies, the collection of trash, etc. are not considered as services
rendered to the occupant.

Section 514(b)(1) of the Code defines debt-financed as any property which is held to produce
income and with respect to which there is an acquisition indebtedness at any time during the
taxable year, except that such term does not include property where substantially all of the use is
related to the charitable, educational or other purpose of the organization under section 501.

Rev. Rul. 69-381, 1969-2 C.B. 113 held that income from the rental of offices to the general
public did not preclude exemption from federal income tax under section 501(c)(2) of the Code
where the title holding corporation did not render substantial services to the tenants other than
the normal maintenance of the building and grounds. The general public tenants were not related
in any way to the title holding company or the charitable organization for which it holds title.

Reg. 1.501(c)(2)-1(b) states that a corporation described in section 501(c)(2) cannot
accumulate income and retain exemption, but it must turn over the entire amount of such income,
less expenses, to an organization which is itself exempt under section 501(a).

Although neither the Code nor the Regulations specify the actual timing of remittance, an IRC
501(c)(2) organization should turn over its net income to its parent as soon as practicable, but at
least annually.

GOVERNMENT'S POSITION:

Section 501(c)(2) of the Internal Revenue Code ( the “Code’) provides for the exemption from
federal income tax of corporations organized for the exclusive purpose of holding title to
property, collecting income there from, and turning over the entire amount thereof, less expenses
to an organization which itself is exempt under this section.

The operation of the bingo hall concession stand and the services provided at the Room do not
meet the exclusive purposes of holding title to property and collecting rents. These activities are

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 NUM June 30, 20xx
June 30, 20xx

under the control of the organization acting as the employer providing employees to provide
services beyond those allowed as rental activity.

The rental of the bingo hall and the Room to the general public included other substantial
services by offering concessions, bar, and food services for their convenience. The rental
agreements were not available to determine if these services are separately stated in the rental fee
charged. Therefore, the proper rental income cannot be determined. The services provided are not
part of the rental activity and should be considered separate activities and subject to taxation.

The services provided income over % of the total gross income from the general public which
does not meet the tax exempt purposes of a fraternal organization operated primarily for
members and their charitable purposes. As a Section 501(c)(2) subsidiary organization, the
organization’s exempt purposes are to collect rents and support the RELATED ORGs exempt
purposes.

The organization is required to turn over any excess accumulated amounts to them. They have
not had any excess funds to turn over due to losses incurred in operating the hall .

The regulations provide that an organization cannot have unrelated business income other than
income which is treated as unrelated because of the application of IRC 512(a)(3)(C); or debt-
financed income which is treated as unrelated because of IRC 514; or certain interest, annuities,
royalties, or rents which are treated as unrelated because of IRC 512(b)(3)(B)(i) or (13); and
certain rents from personal property leased with real property which are treated as unrelated
because of IRC 512(b)(3)(B)(i) or because of failure to meet the “incidental amount” exception
in IRC 512(b)(3)(A)(ii).

The rental income does meet the exception under Section 514 and would have been treated as
debt financed income if the organization continued to meet Section 501(c)(2).

The income from the service activities do not meet any of the exceptions provided and are
taxable. None of the income was treated as unrelated business income and no Form 990-T was
filed.

As a result, we have determined that the organization no longer qualify for exemption under
section 501(c)(2).

Therefore, we propose to revoke the organization’s exempt status under section 501(c)(2) of the
Internal Revenue Code effective July 1, 20xx.

CONCLUSION:

It is the government’s position that the organization failed to operate properly to be

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 NUM June 30, 20xx
June 30, 20xx

recognized as exempt from federal income tax under 501(c)(2) of the Internal Revenue Code.

Accordingly, the organization's exempt status is revoked effective July 1, 20xx.

As a taxable entity the organization will be required to file Form 1120 returns for the tax
periods after July 1, 20xx.

Form 886-A (Rev.4-68)

Department of the Treasury - Internal Revenue Service

Page: -6-