Fraternity housing club lost section 501(c)(7) exemption

Plain-English summary

The IRS revoked a fraternity housing corporation's section 501(c)(7) social-club exemption because rental of its fraternity house was its only activity and source of income, with no income from member social activities. The examination report concluded that a club supported by unrelated nonmember rental income rather than membership fees, dues, assessments, and member use of club facilities was operating a business instead of operating exclusively for pleasure, recreation, or other nonprofitable purposes. The revocation was effective from the stated date, and the organization was required to file Form 1120 for the affected year and later years.

Ruling snapshot

• Question: Did a fraternity housing corporation supported entirely by real-property rental income continue to qualify as a section 501(c)(7) social club?
• Outcome: No; the IRS revoked its exemption and required federal corporate income-tax returns.
• Key authorities: IRC §§ 501(c)(7), 512, and 7428; Treas. Reg. § 1.501(c)(7)-1; Rev. Ruls. 58-589 and 68-119; Public Law 94-568

Full text (IRS public release)

Transcriber's note: this document is a nine-page scan containing a final revocation letter, a proposed-revocation letter, and Form 886-A. All page images were checked. Obvious OCR errors in headings, words, punctuation, and section citations were corrected by comparison with the images; form layout was linearized and redacted blank text is identified where needed. Original grammatical and typographical irregularities are preserved. The wording is otherwise verbatim.

DEPARTMENT OF THE TREASURY

Internal Revenue Service

TE/GE EO Examinations
1100 Commerce Street, MC 4920 DAL
Dallas, TX 75242
TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: February 21, 2019

Number: 201925020

Release Date: 6/21/2019 Person to Contact:
Identification Number:

Contact Telephone Number:
UIL: 501.03-00 In Reply Refer to:
EIN:

CERTIFIED MAIL – Return Receipt Requested
Dear [redacted]:

This is a final revocation letter as to your exempt status under section 501(c)(7) of the
Internal Revenue Code. The Internal Revenue Service’s recognition of your organization as
an organization described in section 501(c)(7) is hereby revoked effective August 1, 20XX.

We have made this determination for the following reasons:

Your organization does not meet the criteria in Revenue Ruling 58-589, 1958-2, CB 266.
Although you do not make your social and recreational facilities available to the public, your
organization derives all its income from the rental of real property, and none from social
activities for its members. A club which engages in business, such as renting its real property
is not fulfilling the requirements for exemption under IRC section 501(c)(7).

Public Law 94-568 provides that social clubs are permitted to receive up to 35% of their
gross receipts from sources outside of their membership without losing their tax-exempt
status and that within that 35%, not more than 15% of gross receipts should be derived
from the use of a social club’s facilities or services by the general public.

Your investment income is derived from rental of the fraternity house owned by
[redacted]. Based on information on the Form 990-EZ, this is the only
activity carried on by the fraternity.

As such, you failed to meet the requirements of I.R.C. section 501(c)(7), in that you
failed to establish that you are operated exclusively for an exempt purpose.

You are required to file Federal income tax returns on Form 1120. These returns should be
filed with the appropriate Service Center for the year ending July 31, 20XX, and for all years
thereafter.

-2-

Processing of income tax returns and assessment of any taxes due will not be delayed should
a petition for declaratory judgment be filed under section 7428 of the Internal Revenue
Code.

If you decide to contest this determination in court, you must initiate a suit for declaratory
judgment in the United States Tax Court, the United States Claim Court or the District
Court of the United States for the District of Columbia before the 91st day after the date this
determination was mailed to you. Contact the clerk of the appropriate court for the rules for
initiating suits for declaratory judgment. Please contact the clerk of the respective court for
rules and the appropriate forms regarding filing petitions for declaratory judgment by
referring to the enclosed Publication 892. Please note that the United States Tax Court is the
only one of these courts where a declaratory judgment action can be pursued without the
services of a lawyer. You may write to the courts at the following addresses:

United States Tax Court
400 Second Street, NW
Washington, DC 20217

US Court of Federal Claims
717 Madison Place, NW
Washington, DC 20005

U. S. District Court for the District of Columbia
333 Constitution Ave., N.W.
Washington, DC 20001

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that
can help protect your taxpayer rights. TAS can offer you help if your tax problem is causing
a hardship, or you've tried but haven’t been able to resolve your problem with the IRS. If
you qualify for TAS assistance, which is always free, TAS will do everything possible to help
you. Visit www.taxpayeradvocate.irs.gov or call 1-877-777-4778.

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

Sincerely yours,

Maria Hooke

Director, EO Examinations
Enclosure:
Publication 892


Date:
September 12, 2018
Taxpayer Identification Number:

Department of the Treasury
Internal Revenue Service
IRS Tax Exempt and Government Entities

Exempt Organizations Examinations
Form:

Tax Year(s) Ended:
Person to Contact:

Employee ID:

Telephone:

Fax:
Manager’s Contact Information:

Employee ID:
Telephone:
Response Due Date:

CERTIFIED MAIL — Return Receipt Requested
Dear [redacted]:

Why you're receiving this letter

We enclosed a copy of our audit report, Form 886-A, Explanation of Items, explaining that we
propose to revoke your tax-exempt status as an organization described in Internal Revenue
Code (IRC) Section 501(c)(7).

If you agree

If you haven't already, please sign the enclosed Form 6018, Consent to Proposed Action, and
return it to the contact person shown at the top of this letter. We'll issue a final adverse letter

determining that you aren't an organization described in IRC Section 501(c)(7) for the periods
above.

If you disagree

1. Request a meeting or telephone conference with the manager shown at the top of this
letter.

2. Send any information you want us to consider.

3. File a protest with the IRS Appeals Office. If you request a meeting with the manager or
send additional information as stated in 1 and 2, above, you'll still be able to file a protest
with IRS Appeals Office after the meeting or after we consider the information.

The IRS Appeals Office is independent of the Exempt Organizations division and
resolves most disputes informally. If you file a protest, the auditing agent may ask you to
sign a consent to extend the period of limitations for assessing tax. This is to allow the
IRS Appeals Office enough time to consider your case. For your protest to be valid, it
must contain certain specific information, including a statement of the facts, applicable
law, and arguments in support of your position. For specific information needed for a

Letter 3618 (Rev. 9-2017)
Catalog Number 34809F


valid protest, refer to Publication 892, How to Appeal an IRS Determination on Tax-
Exempt Status.

Fast Track Mediation (FTM) referred to in Publication 3498, The Examination Process,
generally doesn't apply now that we’ve issued this letter.

4. Request technical advice from the Office of Associate Chief Counsel (Tax Exempt
Government Entities) if you feel the issue hasn’t been addressed in published precedent
or has been treated inconsistently by the IRS.

If you're considering requesting technical advice, contact the person shown at the top of
this letter. If you disagree with the technical advice decision, you will be able to appeal
to the IRS Appeals Office, as explained above. A decision made in a technical advice
memorandum, however, generally is final and binding on Appeals.

If we don't hear from you
If you don't respond to this proposal within 30 calendar days from the date of this letter, we'll
issue a final adverse determination letter.

Contacting the Taxpayer Advocate Office is a taxpayer right

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that can
help protect your taxpayer rights. TAS can offer you help if your tax problem is causing a
hardship, or you've tried but haven't been able to resolve your problem with the IRS. If you
qualify for TAS assistance, which is always free, TAS will do everything possible to help you.
Visit www.taxpayeradvocate.irs.gov or call 877-777-4778.

For additional information
You can get any of the forms and publications mentioned in this letter by visiting our website at
www.irs.gov/forms-pubs or by calling 800-TAX-FORM (800-829-3676).

If you have questions, you can contact the person shown at the top of this letter.

Sincerely,

Maria Hooke
Director, Exempt Organizations
Examinations

Enclosures:
Form 886-A
Form 6018

2 Letter 3618 (Rev. 9-2017)
Catalog Number 34809F


Schedule number or exhibit
Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS
Name of taxpayer Tax identification Number Year/Period ended
July 31, 20XX
ISSUE
Whether [redacted] continues to qualify for exemption under

Internal Revenue Code (IRC) §501(c)(7)

FACTS
[redacted], hereinafter referred to as [redacted], is a

corporation organized in the state of [redacted] that was granted exemption under IRC §501(c)(7) in
March 19XX. The club’s fiscal year ends on the last day of July.

[Redacted] purposes as stated in its Articles of Incorporation is as follows:

The particular objects for which this corporation is formed are to promote the intellectual, moral and social welfare of its
members to accumulate funds with which to purchase and own real estate for the purpose of erecting and maintaining
thereon a fraternity chapter house; to rent, mortgage, or sell said real estate of any part thereof as allowed by law; and for all
other objects pertaining to the organization and maintenance of a college fraternity consistent with the statute under which
this corporation is formed.

The organization’s Form 990 states the primary exempt purpose is to provide fraternity housing for
students.

[Redacted] reported the following revenue on its Form 990-EZ for the year ended July 31, 20XX. Percentage
of each type of overall revenue by type is also indicated below:

REVENUE TYPE AMOUNT % of
TOTAL
Contributions / Gifts 0 0.0%
Investment Income 0 0.0%
TOTAL 0 0.00%
Investment income is derived from rental of the fraternity house owned by [redacted]. Based on

information on the Form 990-EZ this is the only activity carried on by the fraternity.

LAW

§501(c)(7) of the Internal Revenue Code exempts from income tax clubs organized for pleasure,
recreation, and other non-profitable purposes, substantially all the activities of which are for
such purposes and no part of the net earnings of which inures to the benefit of any private
shareholder.

§1.501(c)(7)-1(a) of the Federal Tax Regulations states that the exemption provided by section
501(a) for organizations described in section 501(c)(7) applies only to clubs which are organized
and operated exclusively for pleasure, recreation, and other non-profitable purposes, but does not

Form 886-A (1-1994) Catalog Number 20810W Page_1 publish.no.irs.gov Department of the Treasury-Internal Revenue Service

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS
Name of taxpayer Tax Identification Number Year/Period ended
July 31, 20XX

apply to any club if any part of its net earnings inures to the benefit of any private shareholder. In
general, this exemption extends to social and recreation clubs which are supported solely by
membership fees, dues, and assessments. However, a club otherwise entitled to exemption will not
be disqualified because it raises revenue from members through the use of club facilities or in
connection with club activities.

§1.501(c)(7)-1(b) of the Federal Tax Regulations states that a club which engages in business, such
as making its social and recreational facilities available to the general public or by selling real
estate, timber, or other products, is not organized and operated exclusively for pleasure, recreation,
and other non-profitable purposes, and is not exempt under section 501(a). Solicitation by
advertisement or otherwise for public patronage of its facilities is prima facie evidence that the
club is engaging in business and is not being operated exclusively for pleasure, recreation, or social
purposes.

Public Law 94-568 provides that social clubs are permitted to receive up to 35% of their gross
receipts from sources outside of their membership without losing their tax-exempt status and that
within that 35%, not more than 15% of gross receipts should be derived from the use of a social
club’s facilities or services by the general public.

Tax exempt organizations are subject to income tax on their net unrelated income. For most tax-
exempt organizations, Internal Revenue Code section 512(a)(1) is the controlling code section with
respect to unrelated business income (“UBI”).

Section 512(a)(1)of the Internal Revenue Code states that except as otherwise provided in this
subsection, the term “unrelated business taxable income” means the gross income derived by any
organization from any unrelated trade or business regularly carried on by it, less the deductions
allowed by this chapter which are directly connected with the carrying on of such trade or
business, both computed with the modifications provided in subsection (b).

Section 512(b) of the Code states that the modifications referred to in subsection (a) are the
following: Section 512(b)(1): There shall be excluded all dividends, interest, payments with
respect to securities loans (as defined in subsection (a)(5)), amounts received or accrued as
consideration for entering into agreements to make loans, and annuities, and all deductions directly
connected with such income

Form 886-A (1-1994) Catalog Number 20810W Page 2 publish.no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS
Name of taxpayer Tax Identification Number Year/Period ended
July 31, 20XX

Section 512(b)(2) of the Code states that there shall be excluded all royalties (including overriding
royalties) whether measured by production or by gross or taxable income from the property, and all
deductions directly connected with such income.

Section 512(b)(3)(A) (i) of the Code states that there shall be excluded all rents from real property. For

social clubs described in IRC 501(c)(7) (along with a few other code sections, not relevant
here), UBI is governed by Internal Revenue Code section 512(a)(3), “Special rules applicable to

organizations described in paragraph (7), (9), (17), or (20) of section 501(c)”.

Section 512(a)(3)(A) states that in the case of an organization described in paragraph (7) of section
501(c), the term “unrelated business taxable income” means the gross income (excluding any exempt
function income), less the deductions allowed by this chapter which are directly connected with the
production of the gross income (excluding exempt function income), both computed with the
modifications provided in paragraphs (6), (10), (11), and (12) of subsection (b). (Please note that the
modification which excludes rental income from UBI is found in paragraph (3) of subsection (b),
not in paragraphs (6), (10), (11) or (12) of subsection (b)).

In Spokane Motorcycle Club v. United States, 222 F.Supp. 151, the court ruled that refreshments,
goods, and services furnished to members of a charitable, nonprofit corporation from business
enterprise net profits constituted benefits inuring to individual members, and, therefore, corporation
was not exempt from federal income tax. Judge Powell further stated, “But it is clear that when a
club, otherwise exempt, engages in a business from which it derives profits from outside sources
wholly disproportionate to its nontaxable purposes, and such profits inure to the benefit of its
members in the nature of permanent improvements and facilities, it loses its exempt status under the
definitive provisions of the statute. It should be noted that to be exempt from taxation, the club must
not only be organized exclusively for pleasure, recreation and other non- profitable purposes, but it
must be operated exclusively for those purposes as well.”

In Aviation Club of Utah v. Commissioner of Internal Revenue, 162 F.2d 984, the court upheld the
position taken by the tax court in a previous ruling whereby the income received by the club from non-
exempt activities was so disproportionate to the income received from exempt purposes that the club
lost its exempt status. Judge Murrah invoked the same concept as that in Spokane Motorcycle Club v.
United States, whereby if a club engages in a business from which it derives profits from outside
sources wholly disproportionate to nontaxable purposes, and such profits inure to the benefit of its
members in the nature of permanent improvements and facilities, the club loses its exempt status.

In Revenue Ruling 68-119, 1968-1 C.B. 268 an equestrian social club that holds an annual one-day
steeplechase meet which is open to the general public is found to be tax-exempt under IRC

501(c)(7). In this case, the club is said to derive a small amount of income from nonmembers in
excess of expenses attributable to their participation and attendance. If any profit results, it is turned
over to charity. Other club activities are supported by member dues. Therefore, the ruling holds, the
income from non-members does not inure to the club’s members.

Form 886-A (1-1994) Catalog Number 20810W Page 3 publish.no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A

(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended

July 31, 20XX

In Revenue Ruling 58-589, 1958-2, CB 266 states the following: Section 1.501(c)(7)-1 of the
Income Tax Regulations relating to the exemption of social clubs under section 501(a) of the
Internal Revenue Code of 1954 reads as follows:

(a) The exemption provided by section 501(a) for organizations described in section 501(c)(7) applies
only to clubs which are organized and operated exclusively for pleasure, recreation, and other non-
profitable purposes, but does not apply to any club if any part of its net earnings inures to the benefit
of any private shareholder. In general, this exemption extends to social and recreational clubs which
are supported solely by membership fees, dues, and assessments. However, a club otherwise entitled to
exemption will not be disqualified because it raises revenue from members through the use of club
facilities or in connection with club activities.

(b) A club which engages in business, such as making its social and recreational facilities available to
the general public or by selling real estate, timber, or other products, is not organized and operated
exclusively for pleasure, recreation, and other non-profitable purposes, and is not exempt under section
501(a). Solicitation by advertisement or otherwise for public patronage of its

facilities is prima facie evidence that the club is engaging in business and is not being operated
exclusively for pleasure, recreation, or social purposes. However, an incidental sale of property will
not deprive a club of its exemption.

It is clear under the foregoing regulations that a club which engages in business, such as making its
social and recreational facilities available to the general public or by selling real estate, etc., may not
be considered as being organized and operated exclusively for pleasure, recreation or social
purposes. It is equally clear that activity by a social club such as the solicitation by advertisements
or otherwise of public patronage of its facilities may be averse to the establishment of an exempt
status.

Therefore, to qualify for income tax exemption, a social club should not advertise its facilities for
nonmember patronage since this would be prima facie evidence it was engaging in business. Likewise
a social club should not engage in any type of business activity for profit which is designed to increase
or which could result in an increase in net earnings inuring to the benefit of any shareholder or
individual. Net earnings may inure to members in such forms as an increase in services offered by the
club without a corresponding increase in dues or other fees paid for club support or as an increase in
the club's assets which would be distributable to members upon the dissolution of the club.

TAXPAYER'S POSITION

The organization has not responded to correspondence or phone calls and as such its position on the
proposed revocation is not known.

GOVERNMENT’S POSITION

Form 886-A (1-1994) Catalog Number 20810W Page_4 publish.no.irs.gov Department of the Treasury-Internal Revenue Service


Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS
Name of taxpayer Tax Identification Number Year/Period ended
July 31, 20XX

The Club is not supported solely by membership fees, dues, assessments, and revenue from member
use of club facilities, as contemplated by Treasury Regs. §1.501(c)(7)-1(b). In Revenue Ruling 68-
119, 1968-1 C.B. 268 an equestrian social club that holds an annual one-day steeplechase meet which
is open to the public is found to be tax-exempt under IRC

501(c)(7). In this case, the club is said to derive a small amount of income from nonmembers more
than expenses attributable to their participation and attendance. If any profit results, it is turned over
to charity. Other club activities are supported by member dues. Therefore, the ruling holds, the
income from non-members does not inure to the club’s members. In the case Alpha Upsilon most of
its income is from unrelated, non-member income and therefore this Revenue Ruling does not apply.

The Club does not meet the criteria in Revenue Ruling 58-589, 1958-2, CB 266. Although the club
does not make its social and recreational facilities available to the public, it derives all its income
from the rental of real property and none from social activities for its members. A club which

engages in business, such as renting its real property is not fulfilling the requirements for exemption
under IRC section 501(c)(7).

Form 886-A (1-1994) Catalog Number 20810W Page 5 publish.no.irs.gov Department of the Treasury-Internal Revenue Service