IRS and Dissolution Clauses for Charitable Organizations

• Published date: 01 December 2017
• Date: 01 December 2017
• DOI: http://doi.org/10.1002/npc.30404

Bruce R. Hopkins’ NONPROFIT COUNSEL

5

December 2017

THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

guaranteed right to its proportionate share of any future

proceeds (Reg. § 1.170A-14(g)(6)(ii)).

Analysis

The court held that the mortgages on Palmolive’s

property were not subordinated to the easement,

despite the deed’s ostensible subordination language.

In fact, stated the court, each of the mortgagees has

a “prior claim.” The court observed that the “suppos-

edly subordinate mortgagee’s actual priority in this deed

includes a prior claim with respect to insurance proceeds,

a priority that is at odds with true subordination.”

The “insurance (on the entire property) became part of

the mortgagees’ assurance that their loans (on the entire

property) would be repaid.” Thus, the “façade continued

to benefit Palmolive by serving as collateral for Palmolive’s

loans, and continued to benefit Palmolive and its lenders by

supporting insurance coverage that might yield proceeds to

repay Palmolive’s loans from the mortgagees.” The Coun-

cil’s “supposedly perpetual interest in the façade would in

fact have served Palmolive and the mortgagees (by serving

as collateral and supporting insurance coverage) but would

result in no benefit to” the Council. The court stated that

receipt of proceeds in the event of a condemnation is a

“critical right and interest” of the mortgagee; if that right

and interest is not subordinated, the donee’s “property

right” to proceeds is “undermined.”

Palmolive advanced the argument that the chances

of the building’s being destroyed by a casualty and the

Council’s not receiving its proportionate share of insur-

ance proceeds are so remote as to be negligible; it was

unavailing. The court wrote that “regularly recurring

circumstances” that are provided for in the regulations

(mortgages and extinguishment proceeds) are “by their

nature not ‘remote.’” [9.7(a)] ◆

IRS AND DISSOLUTION

CLAUSES FOR CHARITABLE

ORGANIZATIONS

As reflected in a recent private letter ruling, the IRS

declined to recognize the tax-exempt status, as a chari-

table entity, of an applicant organization (Priv. Ltr. Rul.

201738012). One of these reasons was that the organi-

zation had a defective dissolution clause, thus violating

the organizational test.

The ostensible offense is that the dissolution provi-

sion states that, on dissolution, the entity’s assets will be

distributed to an identified (to the IRS) organization. The

ruling does not state whether this other organization is a

charitable entity. The ruling provides only that the assets

would be distributed to a “specific organization.”

The ruling states that this form of dissolution clause vio-

lates the organizational test, specifically, Reg. § 1.501(c)(3)-

1(b)(4). That regulation, however, requires that the assets

be dedicated to an exempt purpose, which includes “one

or more” exempt purposes. The organizational test is silent

on the matter of “organizations,” other than to state that

a court may distribute assets to “another organization.”

This ruling is incorrect in its interpretation of the

scope of a permissible dissolution clause. [4.3(b)] ◆

FOUNDATION’S INVOLVEMENT

IN REZONING AGREEMENT

HELD TO NOT GIVE RISE TO

INDEBTEDNESS; RENTAL

INCOME HELD NOT UBI

The IRS ruled that a private foundation’s participation

in a proposed rezoning services agreement will not give

rise to an indebtedness, so that the property involved will

not be debt-financed property, and that its rental income

from the property will not otherwise be unrelated busi-

ness income (Priv. Ltr. Rul. 201740002).

Facts

A private foundation owns rental real property. The

lessees are not related to the foundation or any disquali-

fied person with respect to it. There is no debt on the

property, no part of the lease is attributable to personal

property, and no part of the rent depends on income or

profits derived by any person.

The foundation wants the property rezoned. The prop-

erty is adjacent to real property that is also to be rezoned.

To save money and enhance the likelihood of the rezoning

of both parcels, the foundation has engaged the services

of a developer, unrelated to the foundation, pursuant to a

rezoning services agreement. The developer will initially pay

all costs of the rezoning process; the foundation will reim-

burse the developer for its portion of the rezoning costs.

The foundation is obligated by the agreement to pay

the developer a fee in the event of successful completion

of the rezoning. Under certain circumstances, this fee

may be an early success fee, determined by applying a

percentage to the enhanced value of the property. If that

fee is not elected, a success fee, computed by a larger

percentage applicable to the increased value, will be paid.

Law

In the context of the unrelated debt-financed income

rules (IRC § 514), the word indebtedness is not defined.

Courts and the Treasury Department in its regulations

pertaining to the bad-debt deduction (IRC § 166), how-

ever, have held that indebtedness is an unconditional

and legally enforceable obligation for the payment of

money. The regulations add that the money involved

must be a fixed or determinable sum.