Club Developers Need Tax Foresight
By Mitchell L. Stump, CPA
Where a real estate development is being constructed with a golf, tennis and/or dining club as part of the overall concept, there are a number of significant tax issues that need to be addressed by the developer. The decisions made by the development company from the onset have a significant tax effect on any future member owned club entity. This article touches upon some of the consequences of developer tax planning.
Property Ownership Association vs Club Entity
Will Timing Of Turnover Eliminate 501(c)(7) Tax Exempt Status?
Final IRS Regulations under Section 337 of the Internal Revenue Code will prevent many clubs from electing to be 501(c)(7) tax exempt when members take over control and ownership of their club. In its wisdom, the IRS believes Congress meant for similar club entities that have been in existence for more than 7 years should not benefit from 501(c)(7) tax exempt status without paying a tax on the difference between the tax basis of the organizations assets and the fair market value. Thus, many clubs will not attempt to apply for exempt status because of a variety of developer actions. Consider the tax ramification of how slow real estate sales will take the conversion to members past the arbitrary 7 year period. Formation of the club entity early in the development process also has an effect on starting the 7 year period to run.
Will Cost Allocations Of Developer Require 501(c)(7) Tax Exempt Status?
If it were not enough to worry about the timing of an election to be 501(c)(7) tax exemption, the method of allocation of the cost to build the club has a distinct effect on the decision making process. An IRS Field Service Advisement followed by a court decision gives developers the IRS's opinion on cost allocations. The IRS position appears to be to capitalize as much of the costs as possible to the club and not allocate to the surrounding real estate. The IRS position may in fact be beneficial to club members because they may have a higher tax basis for their assets received in the conversion of the club to member owned. More aggressive developers, tax wise, have been attempting to allocate more of the club costs back to their real estate in order to recognize less of a profit from the sales early on in the project.
This question was posed to the IRS in a Field Service Advice issued September 3rd, 1999: "Can a developer of real estate allocate the costs of a golf course and related facilities to the basis of homesite lots sold for purposes of determining gain or loss resulting from the sale?" The brief answer provided by the IRS was: "Where the developer has properly filed an election pursuant to Rev. Proc. 92-29, the cost of a golf course and related facilities which benefit two or more homesites in the subdivision may be included in basis of the homesite lots for purposed of computing gain or loss."
A recent US District Court case followed a line of cases addressing the basic problem of what constitutes a proper adjustment to the basis of property in the context of a common improvement that benefits lots in a residential subdivision. A developer's retention of ownership rights in a golf course and country club will preclude it from including the development costs of those properties in the basis of residential lots sold in the sale project.
Will Membership In Club Hinder 501(c)(7) Tax Exempt Status?
Congress did not anticipate corporations as being allowed as members of a 501(c)(7) tax exempt club. Developers allowing this form of membership may present a stumbling block in the path of a club feeling it is necessary to operate with the tax exempt structure of the Internal Revenue Code.
Founder Memberships have been the topic of discussion for several clubs in recent years. If this type of membership has preferential treatment within the club when compared to the fees paid for the product or service, there could be an unanticipated tax ramification to the Founder Member or the club.
Developers cannot operate in a vacuum, taking care of only their own tax considerations. The tax structure a real estate developer uses during the development stage of a club has significant tax ramifications to the membership organization they transfer to the members. As part of the due diligence of a conversion committee of a developer controlled club, each of the tax decisions made by the developer must be reviewed with an eye on how the decision effects the club going forward. Developers that have the foresight to give consideration to the tax issues of future owners of a club will avoid lengthy discussions during the conversion process.
