*34 Decision will be entered for the petitioner.
A social club lost a number of its members and the remaining members decided to sell the clubhouse, pay off existing debts, and distribute the assets. The club had been exempt from income taxes until the date of the sale. Held, the sale of the club property and the distribution of the pro rata share of assets among the members did not destroy the club's exemption from income taxes for the final year of its operation.
*433 This case involves the liability of the petitioner for income taxes for the year 1928 in the amount of $ 3,139.97. The question to be decided is whether the petitioner, a social club, was exempt from income taxes*35 for the last year of its operation. The question occurs because *434 the petitioner, intending to dissolve, sold its clubhouse at a profit and included the proceeds of the sale among the assets distributed to its members when the club ceased to operate.
Most of the facts have been stipulated.
FINDINGS OF FACT.
Petitioner is a membership corporation organized January 14, 1888, under the laws of the State of New York. Petitioner was formed as a club. There was no authorized stock and petitioner never issued any stock. Petitioner was not organized for profit.
Petitioner was incorporated under the name "Reform Club" and its name was changed to "Mill Lane Club, Inc." on March 30, 1928. The club was originally incorporated to carry on activities for improvement of financial methods in civic administration and the removal of all unjust restrictions upon the freedom of trade and commerce.
Petitioner purchased the real property known as 9 South William Street in the Borough of Manhattan, city, county, and State of New York (hereinafter called "the premises") on or about May 5, 1910, for use as a club building. In 1911 the petitioner moved into the premises and used the same as its*36 clubhouse continuously until August 21, 1928.
For at least 5 years prior to August 1, 1928, petitioner had ceased to engage in any activities other than the activities of a luncheon club.
Except for the sale of the premises, the sources of petitioner's income were solely receipts from operating the restaurant plus extra charges for rent of private rooms, and the usual club dues from members. No income was received from the use of petitioner's facilities by the general public. No cash payments were made for luncheons. Members signed the usual luncheon checks, and bills were rendered to members every month.
For some time prior to the spring of 1928, the club had been losing members steadily and had been suffering in its financial operations. The club was maintained by dues, and occasionally assessments imposed against members, besides the charges actually made for meals and incidentals furnished to members.
At a stated meeting of the board of directors of petitioner, duly held and convened at the premises on June 19, 1928, at which a quorum was present, the following resolutions were duly adopted by the affirmative vote of more than two-thirds of the whole number of the board of*37 directors:
Whereas, at a special meeting of the Board of Directors of MILL LANE CLUB, INC., duly called for the 15th day of May, 1928, at which a quorum was *435 present, the Secretary was directed to call a special meeting of the members of MILL LANE CLUB, INC., to be held at the Club House, No. 9 South William Street, Borough of Manhattan, City and State of New York, on June 1st, 1928, at 1: P. M., (1) to vote upon the question whether the members of the Club approve the action of the Board of Trustees of the Corporation, in accepting, subject to the approval of the members of the corporation, an offer for the purchase of the land and building constituting the Club premises, for the sum of Two Hundred Thousand ($ 200,000.) Dollars, and (2) to vote upon the question whether in the event that said land and building shall be sold as aforesaid, the Club's indebtedness and obligations shall be liquidated and the remaining assets of the Corporation distributed among its members and the MILL LANE CLUB, INC. shall be dissolved;
Whereas, said special meeting of the members of MILL LANE CLUB, INC., was held on said June 1st;
Whereas, there were on said June 1st 191 members of MILL LANE*38 CLUB, INC., and 150 attended said meeting in person or by proxy, of whom 149 voted in favor of the adoption of each of said resolutions, and 1 voted against the adoption thereof;
Now, Therefore, Be It
Resolved that MILL LANE CLUB, INC. shall sell its real estate, known as No. 9 South William Street, and No. 61 Stone Street, Borough of Manhattan, City and State of New York, for the sum of Two Hundred Thousand ($ 200,000.) Dollars, to ELEVEN SOUTH WILLIAM STREET COMPANY, INC., upon such terms as may be approved by the President of MILL LANE CLUB, INC.; and be it further
Resolved that the proper officers of MILL LANE CLUB, INC. be and hereby are authorized and directed to petition the Supreme Court of the State of New York on behalf of the corporation for leave to sell such real estate; to execute a contract of sale, a deed and such other documents as may be necessary to effect the foregoing sale and to convey title to said property; provided that wherever required by law the consent of the Supreme Court of the State of New York be obtained.
All the recitals in the foregoing resolution as to matters occurring prior to the adoption of the resolution actually occurred as therein set forth.
*39 On June 19, 1928, petitioner entered into a written contract with 11 South William Street Company, Inc., for the sale of the premises for the sum of $ 200,000. The contract of sale contained a further provision that petitioner upon the passing of title, should recieve from the purchaser a lease granting petitioner the right to remain in possession of the premises and to continue to use the same as a clubhouse, as theretofore, for 30 days after the passing of title.
On August 1, 1928, the sale of the premises was completed and the consideration therefor received. The sale of the premises resulted in a net profit to petitioner in the amount of $ 31,190.48. On completion of the sale and in accordance with the contract of sale, the purchaser executed a lease whereby petitioner was permitted, for the rental of $ 1, to continue to occupy the premises from August 1, 1928, to September 8, 1928, for use only as a clubhouse. Petitioner actually *436 used the premises as a clubhouse until August 21, 1928, when it discontinued said use and removed from the premises. After August 21, 1928, petitioner never engaged in any activities as a club.
The petitioner's net earnings or net income*40 for 1928 in the amount of $ 26,166.41 consisted of $ 31,190.48 profit on sale of petitioner's property, less $ 5,024.07 operating loss.
On or about September 17, 1928, petitioner sent $ 200 to each of its members under cover of a circular letter as follows:
Mill Lane Club, Inc.
Temporary OfficeRoom 1209, 61 BroadwayNew York CityTo the Members of
Mill Lane Club, Inc.:
The sale of the Club's personal and real property has been completed; and the Club's trustees and officers will proceed to wind up the Club's affairs and to dissolve the Club as soon as possible.
The Trustees have authorized a partial distribution of moneys made available by the sale of the Club's property, and accordingly checks are sent to members herewith. Necessarily considerable time must elapse before a final distribution can be made but final distribution will be made as soon as possible.
Dated, New York,
September 17, 1928.
Bert Hanson,
President.
E. J. Zimmer,Treasurer.
Thereafter, after payment of all debts and obligations and the setting up of a reserve for contingent obligations, the proceeds of the sale of the premises were fully distributed among the members of petitioner. No *41 formal steps were taken to dissolve petitioner as provided by law.
Respondent has ruled that petitioner was exempt from income taxes to and including July 31, 1928. The ruling was contained in a letter dated October 16, 1940, and is as follows:
It is the opinion of this office, based upon the evidence presented, that you are exempt from Federal income tax under the provisions of section 231 (9) of the Revenue Act of 1926 and the corresponding provisions of prior revenue acts for 1927 and prior years.
Accordingly, you will not be required to file returns of income for 1927 and prior years.
As a result of the fact that you ceased to function as a club in 1928 and have not been legally dissolved, it is held that you are not entitled to exemption under the provisions of section 101 (9) of the Internal Revenue Code and the corresponding provisions of prior revenue acts for 1928 and subsequent years. Furthermore there is no provision of law under which you can be held to be exempt from Federal income taxation for 1928 and subsequent years. You will, therefore, be required to file returns of income for 1928 and all subsequent years.
*437 The respondent further ruled, on November*42 5, 1940, as follows:
You should report in your income tax return for the year 1928, all income and deductions arising subsequent to July 31, 1928, including the gain, if any, from the sale of your club property, determined as provided in Form 1120.
The respondent further ruled, on July 31, 1941, as follows:
The decision that the club should report in its income tax return for 1928 all income and deductions arising subsequent to July 31, 1928, was based on the fact that on August 1, 1928, the title to the property sold by the club passed to the purchaser. The general rule followed by this Bureau is that when a tax exempt club engages in a transaction by which it derives profit which is to be distributed among its members, its tax exempt status is thereby destroyed and such profit is subject to tax in the hands of the club.
The petitioner has never acquiesced in the rulings that petitioner is subject to income tax for 1928 and subsequent years.
Some time after respondent made his ruling, the petitioner filed a return for the calendar year 1928 with the collector of internal revenue for the second district of New York.
The petitioner was organized and operated exclusively for recreational*43 purposes and no part of its net earnings inured to the benefit of any private shareholder.
OPINION.
Petitioner is a membership corporation which operated primarily as a luncheon club during the period here material. It was formed in 1888 and was exempt from income taxes prior to 1928.
The statute applicable to this case is section 103 of the Revenue Act of 1928 1 which is equivalent to section 101 (9) of the Internal Revenue Code of 1939. No question of the statute of limitations is involved, although the crucial transactions occurred in 1928 and the year involved is 1928. The petitioner did not file a return covering these transactions until some years later, and the deficiency notice was timely issued in relation to the date of the return.
*44 For approximately 5 years prior to 1928, the petitioner had been losing members and money and it had become apparent by this year that the club would soon have to dissolve because of the decline in membership.
*438 The major asset of the club was its clubhouse and the property on which it was constructed located in the financial district in New York City. The property had been acquired in 1910 for a clubhouse.
Some time prior to June 1928, the adjoining owner offered to buy the property. The offer was put before the membership and it was voted to accept the offer, sell the property, pay off the club's indebtedness with the proceeds, and distribute the balance among the members and terminate the club's existence.
The property was sold on August 1, 1928, for $ 200,000. The petitioner realized a net gain of $ 31,190 from the sale and, after the payment of obligations, the club operations resulted in net earnings of $ 26,166 in 1928. The premises were occupied by the petitioner on a short lease subsequent to the sale in order to permit the termination of its affairs. Club operations ceased on August 21, 1928, and in September each member received $ 200 in partial distribution*45 of the club's assets with the notification that further and final distribution would be made. Technically, the club is still in existence although it has conducted no activities since August 1928.
The essence of the respondent's position is that the sale of the club property at a profit and the distribution of the profit among the members destroyed the club's exemption from income taxation. The petitioner argues that the sale of its property and distribution of its assets pursuant to a plan of dissolution does not destroy the exemption, even if the members receive some profit in the distribution.
To qualify for the exemption from income taxes, a social club must be: (1) Organized exclusively for pleasure, recreation, or nonprofitable purposes, (2) operated exclusively for pleasure, recreation, or nonprofitable purposes, and (3) no part of the net earnings of the club may inure to the benefit of any private shareholder. Santee Club v. White, (C. A. 1) 87 F.2d 5">87 F. 2d 5.
It is conceded that the petitioner was organized exclusively for pleasure, recreation, and nonprofitable purposes. Also, as noted above, it is conceded that it was always operated*46 exclusively for these purposes prior to 1928, and prior to that year it had no net earnings and nothing inured to the benefit of any member.
The respondent contends, first, that the petitioner was not operated exclusively for pleasure, recreation, and nonprofitable purposes during 1928 because it sold its clubhouse property at a profit on August 1, 1928. For this position, the respondent relies principally on Juniper Hunting Club, Inc., 28 B. T. A. 525. In that case, this Court held that a sportsmen's club lost its exemption under section 231 (9) of the Revenue Act of 1926 by selling a large tract of its game preserve and distributing a portion of the proceeds to the members. The facts of that case indicate that the property had increased in value because *439 of a local land boom, and taxes on it were expected to rise sharply. The property had become too valuable to hold as a game preserve and the club sold it, taking advantage of the enhanced value. But, it was noted that there was no intention of discontinuing the club and it continued to function following the sale. Only a single sale was involved and, consequently, it could not be concluded*47 that the club was in the real estate business. However, we held that the "sale was a violent departure from the regular activities of the Club. It was not a mere incident to the regular functions of the Club * * *. Financial gain was the principal end to which the sale of the land was directed." (28 B. T. A. at p. 529.)
The petitioner relies principally on Santee Club v. White, supra, and the change it brought in the respondent's regulations. In that case, a hunting club with a preserve of 25,000 acres sold off a small tract which had become useless for hunting. The property was sold at a profit and the proceeds paid into the club's treasury for general purposes. None of the money was distributed to the members, nor were the usual dues diminished. The court stated that the facts clearly showed that:
the sale of the tract in question was incidental to the general purposes of the Club. It was not made in pursuance of any plan to change the general purposes or activities of the Club, nor did it change them; they continued as before; the proceeds of the sale went to further them. The Club was not obliged to hold *48 indefinitely a piece of property which for its purposes had become valueless. This is obviously true as to personal property, and we see no reason why the same principle does not apply to real estate. Moreover, it seems to us very doubtful whether the single transaction here in question entered into as an incident to the Club's general activities, and not as a part of a course of business for profit, constituted engaging in the sale of real estate for profit * * *. A single transaction of incidental character does not constitute engaging in business. [87 F. 2d 5, at p. 7]
Prior to the decision in Santee Club v. White, supra, the respondent's regulations read, in part:
If a club, otherwise exempt, sells any of its property at a profit, it is not exempt for the taxable year for which the profit is taxable. [Regs. 86, art. 101 (9)-1; Regs. 94, art. 101 (9)-1.]
Literally, under the foregoing regulation, a sale of club property at a profit under any circumstances destroyed the organization's exemption. However, after the decision of the First Circuit in Santee Club v. White, the regulations were modified by*49 substituting for the foregoing a more lenient provision stating:
Generally, an incidental sale of property will not deprive the club of the exemption. [T. D. 4760, 1937-2 C. B. 128.]
Subsequent decisions of this Court, and others, have followed the reasoning of Santee Club v. White, and the respondent's modified *440 regulations, and it appears now to be established that sales of property at a profit will not cause a social club to lose its exemption provided the sale is incidental to the club's purpose and any gains or net earnings from the transactions do not inure to the private stockholders of the club. Anderson Country Club, 2 T. C. 1238, 1243; Koon Kreek Club v. Thomas, (C. A. 5) 108 F.2d 616">108 F. 2d 616.
Therefore, the sale of the petitioner's clubhouse, at a profit, does not automatically destroy the exemption. We must inquire whether the sale was purely for profit-taking or whether it was prompted by circumstances, incidental to the club's purpose, which required a sale. We think in the circumstances of this case that the sale was not to realize the profit resulting from the*50 appreciation in value of the club property. The record leaves no doubt that the only reason for the sale of the petitioner's principal asset was to facilitate the dissolution of the club. A sale in such circumstances does not amount to a business or commercial activity to the extent that we could say, realistically, that during the last days of its operation the club was not operated exclusively for recreational or other exempt purpose. This transaction was obviously a singular event in the club's history; it would be a unique event in any organization's history. Presumably, it is impossible to dissolve the group more than once and the single, final, and most important transaction to facilitate the dissolution does not convert a social club into a real estate business.
We have remaining the question raised by the fact that a portion of the profits resulting from the sale was distributed to the members. The respondent contends that this distribution allowed net earnings to inure to the benefit of the members and the exempt status of the group was lost. We do not agree with the respondent's conclusions.
Every social or recreational group has a reasonable prospect of being disbanded*51 and dissolved. It was recognized in early interpretations that provisions in the charters of clubs which permitted division of club assets among members upon dissolution did not destroy the exempt status of such groups. It is stated in one interpretation that:
It is well settled that the fact that the assets of a club will, upon dissolution, be paid to members or shareholders is not alone sufficient to make the organization liable to render income tax returns. [S. M. 2710, III-2 C. B. 230.] 2
The respondent cites us to no authority or interpretation which is contrary to the above, or which indicates that the dissolution of a social club and the distribution among the members of the assets containing a small increment of gain destroys the exemption. And we think it would be somewhat a strange result to hold on the facts here that an organization which was exempt from income taxes for the entire period of its existence lost that status by the last act*52 of its life.
*441 Moreover, we do not think that the distribution which petitioner's members received can be properly characterized as net earnings. What each received was his pro rata share in the assets of the organization and the only reason that the club property was sold was to convert the assets into easily divisible form. We suppose, for example, that the club could have distributed the club property by giving each member a co-tenant's share in the ownership of the property, and then dissolved after assessing the members for the outstanding debts of the club. The members could then have joined together as individuals and sold the property without any gain to the club, although the net share ultimately received by each member would have been the same as that received through the steps that were actually followed in this case. However, the distribution of the property in kind to the individual members would have been a clumsy method of distributing the club's assets. It was a more efficient technique to convert the property into cash, pay off the club's debts, and divide the remainder. Such action was not a distribution of net earnings but a final division of assets*53 and this final transaction does not cost the club its exemption from income taxes for the final year of its operation.
In the words of the Santee Club decision, when the members determined to dissolve, they were "not obliged to hold indefinitely a piece of property which for its purposes had become valueless." Neither the sale of the property nor the distribution of part of the proceeds in final division of the assets caused the club to lose its exemption from income taxes.
Decision will be entered for the petitioner.
Footnotes
1. Revenue Act of 1928:
SEC. 103. EXEMPTIONS FROM TAX ON CORPORATIONS.
The following organizations shall be exempt from taxation under this title --
* * * *
(9) Clubs organized and operated exclusively for pleasure, recreation, and other nonprofitable purposes, no part of the net earnings of which inures to the benefit of any private shareholder;↩
2. See also S. M. 958, 1 C. B. 203↩.