(Originally published in the June 2012 issue of Bruce R. Hopkins Nonprofit Counsel, available electronically to subscribers on publication.)
The fact that social clubs and certain other tax-exempt organizations are treated differently under the unrelated business rules, in relation to exempt organizations generally, has over the years bedeviled the IRS and the courts. One of these provisions is the rule that, if property used directly in the performance of an exempt function of an exempt social club is sold by the organization and, within a period beginning one year before the date of the sale and ending three years after it, other property is purchased and used by the organization directly in the performance of its exempt function, any gain from the sale is to be recognized only to the extent that the organization’s sales price of the old property exceeds the organization’s cost of purchasing the other property (IRC § 512(a)(3)(D)).
In 2003–2004, the IRS considered a situation where an exempt club was finding it difficult to continue in existence due to an aging membership, a dwindling of new members, and an increase in the cost of operation. The club’s members approved sale of the organization, dissolution of it, and liquidation of its assets to its members. The IRS, in 2004, ruled that any gain that this club realized on the sale of its assets is not to be treated as unrelated business taxable income, based on the above provision (Priv. Ltr. Rul. 200451031). A similar ruling had been issued in 2003 (Priv. Ltr. Rul. 200314030).
The IRS has decided that these rulings were issued in error. It noted a 1985 US Tax Court case where the court ruled that a club owed tax on the portion of the proceeds from sale of its property that exceeded the amount used to purchase new exempt property because those proceeds were not reinvested but were withdrawn for gain by its members (Tamarisk Country Club v. Commissioner). In these two cases, the IRS’s changed position is that since the property was intended to be sold by these clubs and the resulting income not used to purchase other property to be utilized by them directly in the performance of exempt functions, the gain from the sales must be recognized as unrelated business taxable income (IRC § 512(a)(3)(A)). Thus, the 2003 ruling was revoked (Priv. Ltr. Rul. 201213035), as was the 2004 ruling (Priv. Ltr. Rul. 201213034). [15.6]
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