Non-profits do not pay Federal income taxes. Many states also exempt these entities from state income taxes. The local tax assessor may also exempt the entity from property taxes.
The IRS regulates non-profits by denying non-profit status to entities. It also has a whole regime of penalties and excise taxes to deter for-profit entities from trying to take advantage of these rules.
The non-profit rules are not all that clear. For example, a condo association may or may not qualify as a non-profit. There are a number of factors that have to be considered.
The IRS’s PLR 202145030 provides an opportunity to consider these rules. The letter ruling involves a business condo association that applied to be a non-profit.
Facts & Procedural History
The applicant is a condominium association. It was formed as a corporation to manage real estate owned by its members. The members owned an undivided fee interest as tenants in common in the common areas of the development. The development was for business condominiums.
The real estate included commercial buildings which share a common entrance, driveway, and parking area. The common space includes parking areas; driveways; walkways; curbs; gutters; sidewalks; yards and open spaces; planted and landscaped areas; enclosed trash receptacles or trash collection areas; electrical, water, gas and telephone utility facilities; fire hydrants; sumps or drainage areas; walls, fences and gates; and all other improvements.
The applicant filed an application to be exempt from federal income tax as a social welfare organization under IRC Section 501(c)(4). The IRS denied the application, as stated in the determination letter. The consequence is that the entity failed to file returns or pay tax and may even be liable for late filing penalties and interest.
Exemption for Civil Leagues & Organizations
Section 501(c)(4) provides for the exemption from income tax for certain civic leagues and organizations. There are several requirements that have to be met for the organization to qualify for this exemption.
The organization can not be organized for profit. It has to be a non-profit. It has to be operated exclusively for the promotion of social welfare. And the net earnings have to be devoted exclusively to charitable, educational, or recreational purposes.
The regulations say that it has to be engaged in promoting the common good and general welfare of the people of the community.
Benefit to the Community, Not the Owners
The IRS concluded that the applicant did not qualify as it did not probate the common good and welfare of the community. Rather, it benefitted the property owners. The IRS cited Rev. Rul. 73-306, 1973-2 C.B. 179:
provides that an organization formed for the purpose of promoting the common interest of tenants who reside m a particular apartment complex does not qualify for exemption under IRC Section 501(c)(4). Any person regularly living in the complex was eligible for membership. The organization represented its member-tenants in negotiations with the management of the complex in order to secure better maintenance and services, as well as reasonable rents. The ruling holds that the organization was not described in Section 501(c)(4) because it operated essentially to benefit its members and, thus, was not primarily engaged in activities that promote the common good and general welfare of the community.
The IRS’s analysis is as follows:
[t]he common areas of the condominium property are owned by the unit owners as tenants in common. The maintenance and care of the common areas constitutes the provision of private benefits for the unit owners. Since the organization’s activities were for the private benefit of its members, it could not be said to be operated exclusively for the promotion of social welfare.
As this determination letter shows, the corporation cannot exclusively benefit the owners. The outcome may have been different if the common areas were held for use by the public.
The IRS’s determination letter cites Rev. Rul. 81-116, 1981-1 C.B. 333 as an example of real estate held for public benefit. The ruling addresses land held to provide free parking. The IRS determined that this qualifies as non-profit as it benefitted the community. The IRS noted that the business condo association in the present case did not have a similar community benefit, but it highlights how advanced tax planning can help in structuring non-profits.
Commercial vs. Residential Condo Associations
This application was for a business condo development. It was not a residential condo association. There are special rules that allow residential condo associations to qualify for tax exemption.
These rules are set out in Section 528. There are several other requirements that have to be met, in addition to the real estate being held for residential use. If the requirements are met, the residential condo association can qualify as a non-profit.
Local Property Taxes
While not addressed in the IRS determination letter, there is a question as to why a business condo association would want to be a tax-exempt entity. The association only collects fees and then spends those fees for upkeep, maintenance, etc. It shouldn’t incur an income tax. And the payments to the association by its members are already tax-deductible.
One reason might be to avoid property taxes. Local tax assessors in states like Texas exempt non-profits from property taxes. Those that do not provide an exemption will often provide reduced tax rates for non-profits. This can provide a significant tax benefit for the members.