Renovation Dollars and Sense: Understanding The Tax Implications Of A Club Renovation

By Mitchell L. Stump, CPA

Renovation projects at a club offer many challenges and opportunities for club management.  Extensive planning and budgeting is required for a project to be successful, and most everyone within a club will have some type of input into the process.  Elected club board members must initially provide the wisdom and guidance to decide whether to tackle a renovation, understanding a pulse of its membership.  Club management and staff can provide valuable input regarding alternatives and possibilities to consider.  Club employees will be responsible for the implementation of operational changes while the club's general membership must approve of, and be supportive of a renovation project.  The most successful club renovations are those where all of the parties involved come together to implement the club member's common goals.

From an accounting and tax perspective, key members of the renovation team must learn about the ramifications of their renovation decisions.  Most of the decision makers for a club do not have an extensive background in club accounting and tax issues caused by major renovation projects, as these are not undertaken regularly.  To make matters somewhat more difficult, much of the tax law applicable to clubs differ from those of most businesses enterprises, and tax law even differs between Section 277 taxable and 501(c)(7) tax-exempt clubs.  This article will touch upon some of the tax considerations that must be addressed as a renovation project progresses.

How Will A Proposed Renovation Be Financed?

There are a number of financing options available to clubs to pay for club renovations.  No one option is preferable to all clubs and each has its inherent benefits and detriments.  Club boards must weigh their options available, giving consideration to such things as the club membership's financial status, cost of the proposed project and the tax status of a club. 

Club representatives must understand that 501(c)(7) tax-exempt clubs do not face as many financing tax issues as Section 277 taxable clubs.  History has shown that there are several times during the life of a club when it appears to be preferable that it qualifies as being 501(c)(7) tax-exempt.  Being tax-exempt during a period of membership capital assessments and club renovations is one of those times.  501(c)(7) clubs should be mindful of entering into any transaction that could hinder their being able to retain tax-exempt status, avoiding unanticipated termination by the IRS at unacceptable times.  Following IRS guidelines, such as Revenue Ruling 71-17 rules for nonmember parties of more than eight, being under a 15%/35% limitations on nonmember income, and keeping within the de minimis level of nontraditional income is extremely important around renovation time.

Listed below is a sampling of how some clubs finance renovations and a brief discussion of a potential tax issue to consider:

• Member Special Assessments - Special assessment of members for renovation projects are not automatically considered nontaxable contributions to capital to a club.  At first glance, a layperson would assume that contributions from members for capital improvements could not possibly be interpreted to be a taxable event for a Section 277 taxable club.  One IRS agent, reviewing a request for determination of taxability, was very interested in whether the club's major renovation project would increase the value of a members' investment in the club.  Presumably, if the requesting club members could not display an investment motive for assessing, collecting and spending several millions of dollars on a renovation project, a Section 277 taxable club would have been found to have the assessment deemed taxable income to the club.  Given the fact that acquiring a membership in most clubs is generally not with an investment motive, taxable clubs may now find it difficult to positively answer this question to obtain nontaxable renovation proceeds.  Because moneys are often collected from members in a year prior to any offsetting tax-deductible expenses, such as depreciation, Section 277 taxable clubs may now find it more difficult to avoid tax on capital assessments for renovations. 

Having the foresight to obtain and retaining 501(c)(7) tax-exempt status may become the most viable way of avoiding this tax problem for a club. This quick study of tax law applicable to Section 277 clubs brings this form of financing a renovation into question.  There is a line of court cases and private letter rulings that provide guidance to clubs on how the IRS may interpret a club's assessment for renovations.  There can never be certainty about an assessments' taxability until the transaction is examined by the taxing authorities, or a club requests a private letter ruling.  It is strongly recommended that Section 277 taxable clubs request a private letter ruling in advance of assessing members, to insure that an unexpected tax liability does not exist.

• Outside Borrowings - Club renovations can be financed by way of outside borrowings and then be repaid at a later date from increased member dues.  The tax issue with this type of financing to a Section 277 taxable club is that repayment of the outside financing is generally with dues that are deemed taxable income.  This method may, however, become preferable to a club that wants to avoid having 100% of a special assessment taxable in one year without having any offsetting deductions.  Spreading the income out over a period of time, corresponding with the claiming of deductions, can possibly avoid a tax liability.
• Interest Free Loans From Members To Be Repaid Over Time - The IRS continues to allow membership organizations to engage in interest free loans with their members.  Because clubs have this loophole in the law that generally requires imputed interest on interest free loans, it may continue to be a way to provide a club long-term use of funds for renovations.  There does not appear to be a movement afoot to close this tax benefit to clubs.
• Interest Bearing Loans From Members - Due to the fact that members do not receive an income tax deduction for their payment of dues to clubs to pay interest, but will be required to pay tax on any interest income received from a club, will keep this method of financing from being popular.

There are obviously additional means of financing club renovations, as well as alternative ways to handle funds when received by a club.  Each transaction format has a different tax ramification that must be considered.  Some additional considerations include, but are not limited to, state and local sales taxes, documentary stamps on recorded notes, how funds are actually used by a club, whether funds are commingled with other funds of a club, temporally or permanently, how funds are booked in a club's accounting records, and even how the outside accounting firm discloses the transaction for GAAP purposes.

Taking this analytical step in the renovation process lightly may become costly to a club.

Tax Considerations From A Club Accounting Departments' Perspective:

Club accounting personnel play an important part in the renovation process.  Given the responsibility to properly account for and record club transactions, the accounting department must have a complete understanding of the particulars of a renovation project.  Overlooking any of the details, or not being privileged to all of the information, may be expensive for the club.  Listed below are a few of the items an accounting department must address.

• Abandoned Property - Any assets disposed of during the renovation process must be specifically accounted for.  This requires an accounting department to have detailed listings of every asset owned by the club.  Depreciation deductions are allowable for abandoned assets of a Section 277 taxable club.  A consideration by all clubs will be the tangible personal property tax returns.  To reduce personal property taxes, additions and deletions at a club must be as accurate as possible.  Failure to properly account for property no longer held by a club, or assets no longer serving their original purpose, can cost a club thousands of dollars over a period of time.
• Tees and Greens - Renovations of non-depreciable assets, such as putting greens and teeing areas on a golf course, allows for a deduction of the initial cost of building the asset being removed.  There is a requirement to capitalize the new costs of a renovation to such assets, which are non-depreciable.  (Note that currently, the IRS is of the opinion that greens and tees are not depreciable assets for tax purposes.  There is a movement underfoot within the industry to attempt to have this law changed.  Most in the club industry are aware that greens and tees are generally renovated on a regular bases.) 
• Repair or Replacement - During most renovation projects, there is invariably work done to other parts of a club that may not in fact be a part of the renovation at all.  Controllers must specifically identify mere repairs that are current year expenses to assets as opposed to renovation costs that must be capitalized and charged to a renovation budget and depreciated over time.
• Real Property Taxes - For real property tax purposes, renovations fall into categories that either increase the value of the real estate, or that are cosmetic in nature that may increase the value of a membership but may not increase property values.  Property tax appraisers may not want to, or be able to differentiate between the two.  >From a property tax perspective, there are dollars to be saved if it can be proved that expenses should be allocated to the value of a membership as opposed to the intrinsic value of club real estate.  (Changes for the sake of change may not increase the value of the real estate but may be necessary to keep the membership happy.)

As a club begins the renovation process, one member of the team must be assigned to the details of tax ramifications of actions to be taken.  The process will be methodical, requiring the asking of appropriate questions at every juncture and documenting conclusions.  Failure to address all of the issues can be detrimental to a club.  Take advantage of the accounting and tax ramifications of club renovations.

Mitchell L. Stump, CPA is the author and publisher of Club Tax Book, "An Accumulation of Tax Issues Specific To Clubs."  Detailed information on the issues discussed above, including copies of relative court cases and private letter rulings, can be found in this regularly updated manual.  He can be contacted at mitch@clubtax.com.