501 c(7) question

Working with a property owners association that operates various amenities including a pool and clubhouse for its members. Membership is limited to owners within a specific subdivision, and the organization is supported by its membership dues. Public access is very limited, generally to guests of owners with a small fee. Such fees total less than 2% of revenues each year.

The organization sponsors a swim team, with fees to the participants making up less than 3% of total revenues. To date, swim team members have been limited to children within the community. Swim team fees are exclusively used to support the swim team's activities.

Question is whether to allow children living outside the community to participate in the swim team, paying the same fee.

Given the "outside" revenue would be well less than 15%, I don't see a problem aside from the camel's nose under tent.

Anyone run across a similar question?

I've not come across that question, but I did review taxation of homeowner's associations and 501(c)(7). FWIW, it seems to me that allowing other children to participate is well within the exempt purpose of the organization (i.e., is not "outside" income for FIT purposes.)

501(c)(7) reads:
(7)Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

What about possible UBTI?

It's not UBIT unless it's unrelated to the exempt purpose of the organization.

Thanks-

I would also submit that its not UBTI as its not engaged in for profit. No more than the money losing snowball stand they have at the pool. Thing doesn't make a dime, but kids get a shot at their first job, and its an amenity to pool patrons.

Hard to argue that providing social and recreational opportunities for the members isn't part of the exempt purpose.

Sec 512(a)(3)

(B) Exempt function income
For purposes of subparagraph (A), the term "exempt function income" means the gross income from dues, fees, charges, or similar amounts paid by members of the organization as consideration for providing such members or their dependents or guests goods, facilities, or services in furtherance of the purposes constituting the basis for the exemption of the organization to which such income is paid.

Rev Rul 2003-64.

In addition to dues, fees, and payments from members, A receives an insubstantial amount of income from nonmembers, who use A ’s golf course and purchase food and beverages at A ’s dining facility. Such nonmember income is treated as gross income from an unrelated trade or business under § 512(a)(3).

Rev Rul 81-69.

The social club's sales of food and beverages to nonmembers are not profit motivated because its prices are insufficient to recover costs. As a result, the organization has consistently had, and will apparently continue to have, only losses from its sales to nonmem­bers.

HOLDING

Because the sales to nonmembers are not profit motivated, the social club may not, in determining its unrelated business taxable income under section 512 of the Code, deduct from its net investment income its losses from such sales to nonmembers.

Some IRS training material in 1996. https://www.irs.gov/pub/irs-tege/eotopicc96.pdf

Consequently, the exemption for social clubs operates properly only if the club's income is derived exclusively from members. For many years, however, income derived by clubs from outside of their membership (e.g., investment income), operated to subsidize the recreational facilities or activities for the members with revenue that was taxed neither to the members nor to the club. To prevent club members from receiving benefits not contemplated by IRC 501(c)(7), Congress extended the unrelated business income tax to social clubs in the 1969 Tax Reform Act. In doing so, however, Congress decided that, unlike most other types of exempt organizations, which were exempted because they provide some sort of community service or public benefit, clubs should be taxed on all income derived from outside their membership, including investment income. Special rules were provided for nonrecognition of gain from certain sales of club property when the proceeds are reinvested by the club for exempt purposes.

I'm not saying they lose their exemption. There's a safe harbor for that. But the safe harbor is not for UBTI.
https://www.irs.gov/pub/irs-tege/rp71_17.pdf

This audit standard relates only to determinations of exempt status. There is no minimum audit tolerance with respect to unrelated business taxable income.

And back to the IRS training document.

It is intended that these organizations be permitted to receive up to 35 percent of their gross receipts, including investment income, from sources outside of their membership without losing their tax-exempt status. It is also intended that within this 35-percent amount not more than 15 percent of the gross receipts should be derived from the use of a social club's facilities or services by the general public...

They're within the safe harbors, but those are for determining exemption, not UBTI.

Once again, I stand corrected.

Education is a wonderful thing, and I just got some.

Now the question is, how in the world do I convince this bunch of volunteers to track sales to guests and the associated costs? Or, since any and all operations that received $$ from guests lose money, are they OK? The investment income (savings interest) is only a few hundred a year.