IRS revokes a social club whose income came entirely from rentals and investments

Plain-English summary

The IRS revoked an organization's tax-exempt status as a social club under Section 501(c)(7). The organization held an annual alumni reunion and several meetings, but it owned a lodge and parking lot that it leased under long-term contracts to unrelated fraternities and another tenant. It also maintained an actively managed investment portfolio. For both years under examination, the organization reported no membership dues and received all of its gross receipts from rental and investment activities. The IRS concluded that these recurring activities were substantial, did not further the club's social purposes, and caused non-member income to far exceed the 35 percent limit. The organization was required to begin filing Form 1120 instead of Form 990 after the revocation date.

Ruling snapshot

• Question: Does a club remain exempt under § 501(c)(7) when all of its receipts come from recurring rentals and investments rather than member support?
• Outcome: Revocation of exempt status
• Key authorities: IRC §§ 501(a), 501(c)(7), and 7428; Treas. Reg. § 1.501(c)(7)-1; Public Law 94-568; Rev. Rul. 58-589; Rev. Rul. 66-149

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
1100 Commerce Street, MC 4920DAL
Dallas, TX 75242

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Date: August 6, 2020

Number: 202052045

Release Date: 12/24/2020 Taxpayer ID Number:

Form:

UIL: 501.07-00 For Tax Period(s) Ending:

Person to Contact:
Identification Number:
Telephone Number:

Fax Number:

CERTIFIED MAIL — Return Receipt Requested
LAST DAY FOR FILING A PETITION WITH THE TAX COURT:

Dear

This is a final determination that you do not qualify for exemption from federal income tax under
Internal Revenue Code (IRC) Section 501(a) as an organization described in IRC Section
501(c)(7) for the tax period(s) above. Your determination letter dated August 9, 19XX is
revoked.

Our adverse determination as to your exempt status was made for the following reasons:

You have not established that you are operated substantially for pleasure and
recreation of its members or other non-profitable purposes and no part of the earnings
inures to the benefit of private shareholder within the meaning of IRC Section
501(c)(7). You have made your recreational and social facilities available to the
general public. You have exceeded the non-member income test for tax years ending
January 31, 20XX and January 31, 20XX.

Organizations that are not exempt under IRC Section 501 generally are required to file federal
income tax returns and pay tax, where applicable. For further instructions, forms, and
information please visit www.irs.gov.

If you decide to contest this determination, you may file an action for declaratory judgment under
the provisions of IRC Section 7428 in one of the following three venues: 1) United States Tax
Court, 2) the United States Court of Federal Claims, or 3) the United States District Court for the

1

District of Columbia. A petition or complaint in one of these three courts must be filed within
90 days from the date this determination was mailed to you. Please contact the clerk of the
appropriate court for rules and the appropriate forms for filing petitions for declaratory
judgment by referring to the enclosed Publication 892. You may write to the courts at the
following addresses:

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

U.S. Court of Federal Claims
717 Madison Place, NW
Washington, DC 20439

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

Processing of income tax returns and assessments of any taxes due will not be delayed if
you file a petition for declaratory judgment under IRC Section 7428.

You may be eligible for help from the Taxpayer Advocate Service (TAS). 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.

Taxpayer Advocate assistance can’t be used as substitute for established IRS procedures,
formal appeals processes, etc. The Taxpayer Advocate is not able to reverse legal or
technically correct tax determination, nor extend the time fixed by law that you have to file a
petition in 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 can get any of the forms or publications mentioned in this letter by calling 800-TAX-
FORM (800-829-3676) or visiting our website at www.irs.gov/forms-pubs.

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

Sincerely,

[illegible signature]
Sean E. O'Reilly
Director, Exempt Organizations Examinations

Enclosures:
Publication 892

2

Department of the Treasury Date:
Internal Revenue Service 03/18/2020
Tax Exempt and Government Entities Taxpayer ID number:

Form:

Tax periods ended:

Person to contact:
Name:
ID number:
Telephone:
Fax:
Address:

Manager's contact information:
Name:
ID number:
Telephone:

Response due date:

CERTIFIED MAIL — Return Receipt Requested

Dear

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
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. 8-2019)
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,

[illegible signature]
Maria Hooke
Director, Exempt Organizations Examinations

Enclosures:
Form 6018
Form 4621-A
Form 886-A
Pub 892

Pub 3498

Letter 3618 (Rev. 8-2019)
Catalog Number 34809F

Form 886A Department of the Treasury - Internal Revenue Service Schedule No. or
Explanation of Items Exhibit
Name of Taxpayer Year/Period Ended
20XX- 20XX

ISSUE:
Whether ( ) continues to qualify for
exemption as an organization described in the Internal Revenue Code (IRC) §501(c)(7).

FACTS:
was incorporated under the laws of the State of as a non-profit
corporation on March 29, 19XX “(a) to promote and courage social and fraternal
relations among its members and to promote their educational, intellectual and
cultural welfare; (b) to purchase, acquire, own and hold real property, both improved
and unimproved, and thereon to maintain, operate and conduct a building
or buildings and to furnish and equip same for the use of and occupation by
of , incorporated under the
laws of the state of , as tenant or otherwise, and to sell, mortgage and/or
encumber the same; (c) to acquire such property, including securities of other
corporations and/or associations, as may be necessary. convenient or incidental
to the foregoing purposes; (d) to promote the aims and objects of ;
(e) this corporation shall have and exercise all rights and powers conferred on
corporations under the laws of the State of , provided, however, that this
corporation is not empowered to engage in any activity which in itself is not in
furtherance of its purposes as set forth in subparagraphs(a), (b), (c) and (d) of this
Article Four.”.

On August 9, 19XX, was recognized to be exempt from federal income tax as
an organization described in IRC §501(c)(7).

is located at , .
Address reported on the return , is the Treasurer's
personal residence, where books and records are kept.

Members of are initiated members, in good standing of
of and other alumni who paid a one-time $0.00 fee.

Directors of are President, Vice President, Secretary, Treasurer,
and Parliamentarian.

exempt activities consist of an annual alumni reunion, 3 quarterly meetings
which are conducted over the phone and a combined 4th quarter/annual meeting,
conducted at a member’s house. Outside of these meetings, it has no other
social/pleasure activities.

does not carry out any social/pleasure activities at .

owns the property (lodge and attached parking lot) at .

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -1-

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

Name of Taxpayer Year/Period Ended
20XX- 20XX

The building and the parking lot minus the spaces that are separately leased to the
of ( ), are leased to ,
( ) fraternity under two, 0-years contracts, beginning in 08/01/20XX and 08/01/20XX.
From 08/01/20XX, rental fee is $0 per month for the first year and increases
approximately 0% each subsequent year until 07/31/20XX. From 08/01/XX, rental fee is
$0 per month for the first year and increases approximately 0% each subsequent year
until 7/31/20XX. puts down $0 security deposit at the time of the signing of the
lease. Contracts permit to sublease living quarters to two of its members. Currently,
one of its members (a graduate student) is occupying a room in the building.

Fifteen parking spaces in the parking lot adjacent to the building are leased to .
Contract with begins 06/01/20XX and lasts for 0 years. pays $0 each year for the
parking spaces.

Members of and are not members of . and are just other unaffiliated
fraternities.

has an investment portfolio, actively managed by .

In additional to capital gains from the selling of various securities in the investment
portfolio, collects dividends from the portfolio and interest from a money market
account.

Gross receipts reported on Form 990EZ for 20XX and 20XX:

Books and records show $0 was recorded as member dues for 20XX and nothing for
20XX.

fiscal year ends in January 31.

Years under examination are 20XX and 20XX.

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -2-

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

Name of Taxpayer Year/Period Ended
20XX- 20XX

LAW:

IRC §501(c)(7) exempts from federal income tax clubs organized for pleasure,
recreation, and other non-profitable purposes, substantially all of the activities of which
are for such purposes and not part of the net earnings of which inures to the benefit of
any private shareholder.

Treasury Regulation §1.501(c)(7)-1(a) states that the exemption provided by §501(a) for
organizations described in §501(c)(7) applies only to clubs which are organized and
operated exclusively for pleasure, recreation, and other nonprofitable 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 recreation clubs
which are supported solely by membership fees, dues, and assessments.

Treas. Reg. §1.501(c)(7)-1(b) 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 nonprofitable purposes, and is not exempt under
§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, including investment income,
without losing their tax-exempt status. 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.

Rev. Rul. 58-589, 1958-2 C.B. 266, states that a business activity will defeat
exemption, unless it is incidental, trivial or nonrecurrent. The Service has interpreted
incidental, trivial or nonrecurrent to mean insubstantial for this purpose.

Rev. Rul. 66-149, 1966-1 CB 146, held that a social club was not exempt from federal
income tax as an organization described in §501(c)(7) of the Code because it regularly
derived a substantial part of its income from nonmember sources such as, for example,
dividends and interest on investments.

Rev. Rul. 68-535, 1968-2 C.B. 219, held that a social club with regular sales of liquor to
members for consumption off-site isn’t exempt under IRC §501(c)(7).

In Santa Barbara Club v. Commissioner, 68 T.C. 200 (1974), the club sold liquor to its
members for consumption away from the club's premises. The activity was conducted
for over 40 years. The Court held the club was not exempt because the nontraditional

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -3-

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

Name of Taxpayer Year/Period Ended
20XX- 20XX

activity did not further the club’s social purposes, was recurrent, and the gross receipts
were in excess of 25% of total gross receipts.

In Polish American Club, Inc. v. Commissioner, T.C. Memo 1974-207 (1974), the
court decided that the club is not qualified for exemption under §501(c)(7) of the
Code because its non-member income was substantial, recurring and that it was not
operated exclusively for pleasure, recreation and other nonprofit purposes.

In Aviation Club of Utah v. Commissioner of Internal Revenue Service, 162 F.2d 984,
the court held that the income received by the club from non-exempt activities is
disproportionate compared to the income received from exempt purposes therefore, the
club lost its exempt status.

TAXPAYER’S POSITION:
Unknown at this time.

GOVERNMENT'S POSITION:
does not operate exclusively for pleasure, recreation, and other nonprofitable
purposes described in Treasury Regulation §1.501(c)(7)-1(a).

receives 100% of its gross receipts from sources outside of its membership.
reports no membership fees, dues, and assessments in 20XX and 20XX. Except for
an immaterial amount of interest income, practically all its annual receipts come from
a combination of rental payments from nonmembers and dividends plus realized
gains from the investment portfolio.

The investment and rental activities represent substantial sources for nonexempt,
unrelated business income because these activities are not incidental to
exempt purposes, and the income derived from them are nontrivial and recurring.
And as shown in Rev. Rul. 58-589, substantial business activities will defeat
exemption.

Total gross income from the investment portfolio alone accounts for 0% in 20XX and
0% in 20XX of overall gross income. operates similarly to the club
described in Rev. Rul. 66-149 where regular and substantial income from dividends
and investment gains effectively preclude exemption.

Besides the investment income, gross rental receipts account for 0% in 20XX
and 0% in 20XX of its overall gross income. These are substantial amounts derived
from nontraditional activities. The long-term leasing of the parking spaces to along
with the long-term leasing of the lodge and parking lot to , which includes a
provision for sub-leasing of rooms as residential housing to members represent
substantial nontraditional activities. These activities do not further exempt

Form 886-A(Rev.4-68) Department of the Treasury - Internal Revenue Service
Page: -4-

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

Name of Taxpayer Year/Period Ended
20XX- 20XX

purposes even if they were conducted on membership basis and will jeopardize its
exemption as demonstrated in Santa Barbara Club v. Commissioner.

As a result, total nonmember income well exceeds the 35% threshold set
under P.L. 94-568 in both 20XX and 20XX.
Since derives 100% of its income from nonmember sources and nothing from
membership dues, fees and assessments, this further illustrates a disproportionate
amount of nonexempt income relative to its exempt income. A significant percentage
of nonexempt income like the amount shown in this case has been proven as a basis
for revoking exemption, for example, in Aviation Club of Utah v. Commissioner of
Internal Revenue Service.
Additionally, because annual nonmember income is substantial and
recurring, thus proving that it is not operated exclusively for pleasure, recreation and
other nonprofit purposes as established in Polish American Club, Inc. v.
Commissioner.

CONCLUSION:

is not operated exclusively for pleasure, recreation and other nonprofit purposes
required under Treasury Regulation §1.501(c)(7)-1(a) because 100% of its income is
derived from nonexempt activities in each year under examination. These nonexempt
activities are nontrivial, recurring and do not further exempt purposes.
annual nonexempt income is disproportionately larger than its exempt income and far
surpasses the maximum level of 35% of total gross receipts allowed under P.L. 94-568.
Consequently, exemption under IRC 501(c)(7) should be revoked as of
February 1, 20XX. must file Form 1120, U.S. Corporation Income Tax Return
instead of Form 990, Return of Organization Exempt From Income Tax beginning with
tax year 20XX going forward.

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