Foundation lost exemption for commercial management activities

Plain-English summary

A private foundation had been formed to assist underprivileged children but also managed commercial and residential rentals and an automobile repair shop. The examination report said the foundation performed property-management, bookkeeping, accounting, rent-collection, and repair-related functions of a kind ordinarily conducted by commercial businesses. Those activities consumed a substantial amount of operating time and had not been disclosed as activities in the organization's exemption application or articles. The IRS concluded that the foundation had a substantial nonexempt commercial purpose and operated materially differently from its original representations. It revoked section 501(c)(3) status retroactively, while stating that the rental income would be unrelated business income if revocation were not sustained.

Ruling snapshot

• Question: Did a private foundation remain exempt when a substantial part of its activity consisted of managing real estate and an automobile repair shop?
• Outcome: Revoked retroactively because the organization operated for a substantial nonexempt commercial purpose.
• Key authorities: IRC § 501(c)(3); Treas. Reg. § 1.501(c)(3)-1(c), (d), and (e); Rev. Proc. 2018-5 § 12.03; B.S.W. Group, Inc. v. Commissioner; Interneighborhood Housing Corp. v. Commissioner

Full text (IRS public release)

Transcriber's note: this document is a seven-page scan containing a two-page final adverse determination, a two-page proposed adverse determination, and a three-page examination report. All seven page images were checked. Obvious OCR errors in headers, words, citations, ordinal symbols, and form layout were corrected by comparison with the images. Redacted blank spaces are preserved, and no missing names or amounts were reconstructed. 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 M/C 4920 DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: February 22, 2019

Release Number: 201926016
Release Date: 6/28/2019
UIL Code: 501.03-00

EIN:
Person to Contact:
Identification Number:
Telephone Number:
In Reply Refer to: TE/GE Review Staff

LAST DATE FOR FILING A PETITION
WITH THE TAX COURT: May 23, 2019

CERTIFIED MAIL – Return Receipt Requested

Dear

This is a Final Adverse Determination Letter that your exempt status under section 501(c)(3)
of the Internal Revenue Code (IRC) is revoked. Recognition of your exemption under IRC
section 501(c)(3) is revoked effective January 1, 20XX.

Our adverse determination was made for the following reason(s):

You have not established that you are operated exclusively for an exempt
purpose or that you have been engaged primarily in activities that accomplish
one or more exempt purposes within the meaning of IRC section 501(c)(3).

Contributions to your organization are not deductible under section 170 of the Internal
Revenue Code.

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 December 31, 20XX and for all
years thereafter.

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.

As you were a private foundation as of the effective date of the revocation, you are a taxable
private foundation until you terminate your private foundation status under section 507 of
the Internal Revenue Code. In addition to your income tax return, you must also continue
to file Form 990-PF by the 15th Day of the fifth month after the end of your annual

accounting period.

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.

The Taxpayer Advocate Service (TAS) is an independent organization within the IRS that
can help protect your taxpayer rights. We 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 our assistance, which is always free, we will do everything possible to help you.
Visit taxpayeradvocate.irs.gov or call 1-877-777-4778.

We will notify the appropriate State Officials of this action, as required by section 6104(c) of
the Internal Revenue Code.

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

Sincerely yours,

For Maria Hooke
Director, Exempt Organizations Examinations

Enclosure:
Publication 892

Department of the Treasury
Internal Revenue Service

IRS

CERTIFIED MAIL — Return Receipt Requested

Dear

Why you’re receiving this letter

If you agree

Tax Exempt and Government Entities Division
Exempt Organizations Examination

Date:
03/12/2018

Taxpayer ID number:

Form:
990-PF
Tax periods ended:

December 31, 20XX

Person to contact:

Employee ID number:
Telephone number:
Fax:

Address:

Manager’s contact information:

Employee ID number:

Telephone number:
Response due date:

April 12, 2018

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)(3) 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
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.

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

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.

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,
Russell T. Renwicks

For

Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Forms 886-A, Form 6018,
Publications 892 and 3498

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
20XX
ISSUE # 1
Whether ( ) qualifies for exemption as a § 501(c)(3) organization when a

substantial portion of its overall activities is providing management services for an automobile repair shop
and real estate holdings?

FACTS

Since 20XX, has been a private foundation under § 501(c)(3) of the Internal Revenue Code.

is the founder and only director of . Per its Articles of Incorporation, the purpose of is to
engage in charitable and educational activities for the primary purpose of providing assistance to
underprivileged children identified to by other charitable or governmental organizations.

Since 20XX, has managed a portfolio of real estate under an arrangement in which is entitled to
retain all rental income for its management services. manages [redacted] properties consisting of commercial
and residential rentals. does not own any real or personal property; however, the leased property at
issue is owned by as an individual.

In 20XX, spent approximately sixteen hours per month on foundation activities, approximately six
hours per month facilitating the collection of rent revenue, and an insignificant amount of time managing an
automobile repair shop. With respect to facilitating the collection of rent revenue by ; performs
bookkeeping and accounting services with assistance of others. With respect to managing the properties,
performs all functions of a property manager. These functions include overseeing the tenant
population, arranging for repairs and maintenance, assuring collection of rents and similar duties.

On their Form 990-PF for the year ending December 31, 20XX, reported income of $0 in interest, $0
in dividends and $0 in gross rents. There were no other sources of income reported. The auto repair shop
income of $0 and $0 net operating loss from the auto repair shop is reported on their 20XX Form 990-T.
also distributed $0 in contributions to charities in calendar year 20XX.

LAW

Section 501(a) exempts from Federal income tax any organization which meets the requirements set forth in
section 501(c), and section 501(c)(3) provides that an organization must satisfy three requirements if it seeks to
qualify as an exempt organization under such section. Specifically, the organization must be (1) organized and
operated exclusively for exempt purposes; (2) no part of its net earnings may inure to the benefit of any private
shareholder or individual; and (3) no substantial part of its activities may be devoted to political or lobbying
activities. The first requirement, specifically the operational test, is the only one at issue in this case, and the
taxpayer bears the burden of proving that it meets such requirement. Dumaine Farms v. Commissioner, 73 T.C.
650, 663 (1980); Hancock Academy of Savannah, Inc. v. Commissioner, 69 T.C. 488, 492 (1977).

Section 1.501(c)(3)-1(d)(2), Income Tax Regulations, defines the term "charitable" and provides, in part:

The term "charitable" is used in section 501(c)(3) in its generally accepted legal sense and is, therefore,
not to be construed as limited by the separate enumeration in section 501(c)(3) of other tax-exempt
purposes which may fall within the broad outlines of "charity" as developed by judicial decisions. Such
term includes: organizations designed (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and

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

20XX

LAW (CONTINUED)

discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community
deterioration and juvenile delinquency.

A taxpayer satisfies the operational test only if it engages primarily in activities which accomplish one or more
exempt purposes. Treasury Regulations section 1.501(c)(3)-1(c). An organization will not be so regarded if
more than an insubstantial part of its activities is not in furtherance of an exempt purpose. Treasury Regulations
section 1.501(c)(3)-1(c); Better Business Bureau v. United States, 326 U.S. 279, 283 (1945); B.S.W. Group, Inc.
v. Commissioner, 70 T.C. 352, 356-357 (1978). The regulations and the cases contemplate that a single activity
may be carried on for more than one purpose. However, the Tax Court has held that a single substantial non-
exempt purpose will disqualify an organization under section 501(c)(3) regardless of the number of truly exempt
purposes served. Copyright Clearance Center, Inc. v. Commissioner, 79 T.C.(1982); Federation Pharmacy
Services v. Commissioner, 72 T.C. 687 (1979), affd. 625 F. 2d 804 (8th Cir. 1980); Est of Hawaii v.
Commissioner, 71 T.C. 1067 (1979), affd. without pub. opinion 647 F. 2d 170 (9th Cir. 1981). If there is no
substantial non-exempt purpose, the income from a trade or business may be exempt where the activity is
carried out in furtherance of an exempt purpose. See, e.g., Industrial Aid for the Blind v. Commissioner, 73 T.C.
96 (1979); Peoples Translation Service v. Commissioner, 72 T.C. 42 (1979). Section 1.501(c)(3)-1(e)(1),
Income Tax Regulations, provides, in part: An organization may meet the requirements of section 501(c)(3)
although it operates a trade or business as a substantial part of its activities, if the operation of such trade or
business is in furtherance of the organization's exempt purpose or purposes. See Plumstead Theatre Society v.
Commissioner, 74 T.C. 1324 (1980), affd. per curiam 675 F. 2d 244 (9th Cir. 1982); Aid to Artisans, Inc. v.
Commissioner, 71 T.C. 202, 211 (1978). In determining whether an organization is exempt, the focus is on the
purpose for engaging in the activity, not the nature of such activity. North American Sequential Sweepstakes v.
Commissioner, 77 T.C. 1087, 1093 (1981); Ohio Teamsters Trust Fund v. Commissioner, 77 T.C. 189 (1981).
The pertinent inquiry is whether an organization's exempt purpose transcends the profit motive rather than the
other way around. Elisian Guild, Inc. v. United States, 412 F. 2d 121, 124 (1st Cir. 1969).

In B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978), the Tax Court found that the provision of consulting
services in the area of rural-related policy and program development to tax-exempt and not-for-profit clients
several of the taxpayer's planned service areas, such as alternative housing, financing, solid waste
management, and environmental impact programs, were of the sort ordinarily carried on for profit by commercial
businesses such as banks, personnel agencies and trash disposal firms. Furthermore, the taxpayer's financing
was not typical of a § 501(c)(3) organization, the taxpayer did not provide any free or below-cost services, and
the taxpayer's clientele was not limited to § 501(c)(3) exempt organizations. As such, the Tax Court agreed with
the commissioner that the taxpayer did not meet the "operational" test under § 501(c)(3) because it was
primarily engaged in an activity which was characteristic of a trade or business.

Similarly, in Interneighborhood Housing Corp. v. Commissioner, T.C. Memo 1982-661, the Tax Court found that
the taxpayer failed to prove that it is organized and operated exclusively for charitable purposes when a major
part of their activity was the management of eight multiple family dwellings for a fee.

Revenue Procedure 2018-5, Sec. 12.03, states that the revocation or modification of a determination letter may
be retroactive if:

(1) there has been a change in the applicable law; (2) the organization omitted or misstated material
information. A misstatement of material information includes an incorrect representation or attestation as to the
organization’s organizational documents, the organization’s exempt purpose, the organization’s conduct of
prohibited and restricted activities, or the organization’s eligibility to file Form 1023-EZ; or (3) the organization
operated in a manner materially different from that originally represented in an application for recognition of
exemption.

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

1 8

Schedule number or exhibit

Form 886-A
(Rev. January 1994) EXPLANATIONS OF ITEMS

Name of taxpayer Tax Identification Number Year/Period ended

20XX

TAXPAYER’S POSITION

Unknown

GOVERNMENT’S POSITION

While a larger portion of overall amount of operational time is dedicated to charitable purposes,
spends a substantial amount of time on its management activities. Based on the facts presented, these
activities are of a sort ordinarily carried on for profit by commercial businesses such management firms.
See, B.S.W. Group, Inc. v. Commissioner, 70 T.C. 352 (1978) & Interneighborhood Housing Corp. v.
Commissioner, T.C. Memo 1982-661. As such, is operated for a substantial non-exempt purpose
and therefore does not qualify for exemption under § 501(c)(3).

On their Form 1023 application, mentions fundraising via solicitations (Part VIII — Item 4a) and grant
distributions (Part VIII — Item 13) as their only activities. Their purpose, as stated in Article II — Part A of
their Articles of Incorporation, is to engage in charitable and educational activities for the primary purpose
of providing assistance to underprivileged children identified to the Foundation by charitable organizations
exempt under 26 USC section 501(c)(3) or governmental or similar organizations. There is no mention of
managing property or an auto repair shop on their Form 1023 application or in their Articles of
Incorporation.

In accordance with Rev. Proc. 2018-5, Sec. 12.03, the revocation of their determination letter would be

retroactive to January 1, 20XX, since operated in a manner materially different from that originally
represented in their Form 1023 application for recognition of exemption.

CONCLUSION

is operated for a substantial non-exempt purpose and therefore does not qualify for exemption under
§ 501(c)(3). tax exempt status under section 501(c)(3) has been revoked retroactively to
January 1, 20XX.

If the revocation of their tax-exempt status is not sustained, then the rental income for its management
services will be treated as unrelated business income. (See Issue # 2).

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