Resale of memberships under sec. 277 - IRS position.

• Author: Stump, Mitchell L.

Facts

A private membership club not exempt under Sec. 501(c)(7) is subject to Sec. 277 as to member-related income and expenses. When a member wishes to resign from membership in the club, the club repurchases the resigning member's certificate based on a formula, generally provided in the subscription agreement, and then resells the certificate at the current fair market value, usually a higher price.

In the cases currently under review by the IRS, the club pays the resigning member the greater of the resigning member's actual cost of the membership, or 80% of the membership's current resale value. The club then resells the certificate to a new member, retaining the difference and historically reporting the amounts as a capital transaction. It was assumed that this was a treasury stock transaction not subject to taxation.

Issue

Is the difference between the redemption agreement price (buy/sell equivalent) and the subsequent resale price includible in the club's gross income or is the club dealing in its own treasury certificates, subject to the nonrecognition provisions of Sec. 1032(a)? Secondarily, is any portion of the resold certificate proceeds paid to the club for the privilege of using the facility?

IRS District Council position

The entire membership fee, or at least the gain, represents a privilege to use the club's facilities and should be taken into account as ordinary income to the club. If only the gain is reportable, the corporation should be treated as selling the certificate, not on its own behalf but for its members, and the amount the member forfeits to the club should be taxed as ordinary income.

In arriving at its conclusion, IRS District Council cited The University Country Club, Inc., 64 TC 460 (1975). The Service noted that the court focused on the following factors in making its determination that a membership fee was primarily for a privilege to use a club's facilities rather than obtaining a proprietary interest: (1) the lack of control; (2) the diminished economic value because of restrictions; (3) the relationship between stock ownership and use of the club facilities.

Observation

In most private membership clubs there are restrictions on transfers by current members. If this restriction is deemed to diminish economic value in all equity memberships (as the IRS would argue), one of the three tests of University Country Club, Inc. will almost always be failed. To remain a private membership club, there must be...