The opinion
OCEAN PINES ASSOCIATION, INC., PETITIONER v.
COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
Docket No. 5127–08. Filed August 30, 2010.
P, a homeowners association exempt from tax under sec.
501(c)(4), I.R.C., operated two parking lots and a beach club
eight miles from the area in which its members lived. The
parking lots and the primary beach club facilities were acces-
sible only to the association’s members and their guests. The
association did not report its net income from the parking lot
and beach club activities as unrelated business taxable
income on its tax returns for 2003 and 2004. R issued a notice
of deficiency determining that the net income was subject to
the unrelated business income tax because the operation of
the parking lots and the beach club is not substantially
related to the promotion of community welfare (the purpose
constituting the basis of the association’s exemption under
sec. 501, I.R.C., see secs. 1.501(c)(4)–1(a)(2), 1.513–1(a), (d)(1),
Income Tax Regs.) and because the revenue received from
operating the parking lots is not rent from real property
under sec. 512(b), I.R.C. Held: The operation of the parking
lots and the beach club is not substantially related to the pro-
motion of community welfare because the facilities are not
open to the general public. Held, further, the revenue received
from operating the parking lots is not rent from real property.
Steven M. Gevarter, for petitioner.
Jared W. Murphy, for respondent.
OPINION
MORRISON, Judge: On November 29, 2007, respondent
Commissioner of Internal Revenue mailed a notice of defi-
ciency for the taxable years 2003 and 2004 to petitioner
Ocean Pines Association, Inc. We refer to respondent as the
IRS. We refer to petitioner as the Association. In the notice,
the IRS determined the following deficiencies in income tax
and additions to tax under section 6651(a)(1): 1
1 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect
276
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 277
Addition to tax
Year Deficiency sec. 6651(a)(1)
2003 $65,929 $16,482
2004 94,195 23,549
After concessions, the issues remaining for decision are: (1)
whether the Association’s operation of a beach club and two
nearby parking lots is substantially related to the promotion
of community welfare (we hold that the operation is not
substantially related, and that therefore the operation is sub-
ject to the tax on unrelated-business income), and (2)
whether the revenue received by the Association from its
members for parking on its two parking lots is exempt from
the tax on unrelated-business income as rent from real prop-
erty within the meaning of section 512(b)(3) (we hold that
the revenue is not rent from real property).
Background
The parties agreed to submit this case to the Court with-
out trial under Rule 122. We adopt as findings of fact all
statements contained in the stipulation of facts. The stipula-
tion of facts and the attached exhibits are incorporated here
by this reference. The Association is a homeowners associa-
tion and nonstock corporation organized and incorporated
under the laws of Maryland with its principal office in Mary-
land. The IRS ruled that it was exempt from federal income
tax as an organization described in section 501(c)(4) (civic
league or organizations not organized for profit but operated
exclusively for the promotion of social welfare).
The Association’s articles of incorporation state that one of
its purposes is ‘‘to further and promote the community wel-
fare of property owners in the residential community located
in Worcester County, Maryland known as ‘Ocean Pines’ ’’. Its
membership consists of all of the owners of residential prop-
erty within the 3,500-acre area known as Ocean Pines.
According to the 2000 census, the population of Ocean Pines
was 10,496. The Association collects property assessments
and other fees from its members and enforces zoning restric-
tions against its members. It maintains bulkheads, road-
for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Proce-
dure.
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278 135 UNITED STATES TAX COURT REPORTS (276)
ways, and parking lots within Ocean Pines. The Association
also operates recreational facilities in Ocean Pines that are
open to both members and nonmembers, including five swim-
ming pools, a golf course, two marinas, a yacht club, tennis
complexes, a soccer field, 10 parks, and five walking trails.
The Association provides, through its Recreation and Parks
Department, various seminars, sports camps, a children’s
softball league, swimming lessons, and adult aquatic pro-
grams to both members and nonmembers. Some of the rec-
reational facilities and services described above are free.
Others are available only for a fee, which is typically higher
for nonmembers than members. The Association maintains
two volunteer fire stations and a police force. Parking within
the Ocean Pines area is free and open to both members and
nonmembers.
The Association owns beachfront property approximately
eight miles from the Ocean Pines area in Ocean City, an area
within Worcester County, Maryland. The Ocean City prop-
erty consists of two parking lots, containing 300 parking
spaces in total, and an oceanfront beach club, known as the
Ocean Pines Beach Club. The Association’s members who use
the parking lots and the beach club commute approximately
15 minutes by car from Ocean Pines to Ocean City. The
beach club is open from the beginning of Memorial Day
weekend until Labor Day (we refer to this period as the
summer months). The beach club is closed during the eve-
nings unless reserved for special events. The beach club
allows both Association members and nonmembers to pur-
chase food and beverage services and to use its restrooms for
free. However, the swimming pool, gym lockers, and shower
facilities are accessible only to Association members. The
record does not reveal whether the Association charges a
separate fee to its members who use these facilities. In the
summer months, the Association limits use of the parking
lots to its members who have purchased parking lot permits,
and their guests. They may use the parking lots during the
day until 4 p.m. Only the Association’s members are eligible
to purchase permits for the parking lots. The Association’s
members must pay a weekly or monthly fee depending on the
period for which the permit is issued. The Association’s
employees in Ocean Pines issue the permits. The Association
leases the parking lots to third-party businesses during the
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 279
summer months from approximately 4 p.m. until approxi-
mately 3 a.m. The Association also leases the lots during all
nonsummer months. It provides no significant services to the
third-party businesses. The Association employs a guard
daily during the summer months from 8 a.m. until 4 p.m.
The guard removes a chain barring entrance to the parking
lots at the beginning of each day during the summer months
(and replaces it at the end of each summer day) and checks
the parking permit decals on the vehicles as they enter the
parking lots. If the vehicles do not have permit decals, they
are turned away. If any vehicle remains on the parking lot
from the periods of use by the third-party businesses, the
parking guard places a note on the vehicle demanding that
the owner remove the vehicle from the parking lot as soon
as possible. The parking guard does not collect fees or park
vehicles; the lots offer no valet services. Parking is available
upon a first-come, first-served basis; i.e., there are no
assigned parking spaces. The Association does not maintain
common areas in Ocean City, such as beach or bike paths,
nor does it levy assessments on the residents or homeowners
in Ocean City.
In 2003, the Association received $232,089 in revenue from
the two parking lots, $61,024 of which was paid by the third-
party businesses. It paid $39,092 in expenses attributable to
the operation of the parking lots by the Association (as
opposed to the leasing of the parking lots to third-party
businesses). It incurred a $20,486 net loss for operation of
the beach club in 2003. In 2004, the Association received
$266,487 in revenue from the two parking lots, $64,692 of
which was paid by third-party businesses. It paid $21,939 in
expenses attributable to the operation of the parking lots by
the Association. It incurred a $1,741 net loss for operation of
the beach club in 2004. The Association timely filed Form
990, Return of Organization Exempt From Income Tax, but
did not file the form on which the unrelated business income
tax is reported, Form 990–T, Exempt Organization Business
Income Tax Return. The Form 990 is not in the record.
The IRS issued a notice of deficiency to the Association on
November 29, 2007 (discussed above), determining that the
Association owed unrelated business income tax on the net
income attributable to the operation of its parking lots. The
net income figures used to calculate the deficiency in unre-
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280 135 UNITED STATES TAX COURT REPORTS (276)
lated business income tax for each tax year at issue included
the income from the leasing of the parking lots to third par-
ties and a deduction for the parking lot expenses, but
excluded the losses from the operation of the beach club. 2
The IRS determined the late-filing addition to tax in the
notice because the Association failed to file a Form 990–T.
The Association filed a petition in response to the notice of
deficiency. When this case was called from the calendar for
the trial session of this Court at Baltimore, Maryland, the
parties filed a joint motion for leave to submit the case under
Rule 122, which the Court granted, and a stipulation of set-
tled issues. In the stipulation of settled issues, the IRS con-
ceded that
the revenue received by the Association from the leasing of its Ocean City
parking lots to third parties in the evening hours and during the off-sea-
son [3] is excepted from § 511 unrelated business taxable income because
it satisfies the § 512(b) exception to unrelated business income for the rent
from real property.
The IRS also conceded that the Association was not liable for
the late-filing addition to tax under section 6651(a)(1)
because it relied on the advice of its accountants in deter-
mining that filing a Form 990–T for the years at issue was
not necessary. The parties stipulated that the amount of net
income from the Association’s operation of the parking lots
and the beach club potentially subject to the unrelated busi-
ness income tax is $111,487 in 2003 and $178,115 in 2004.
These net income amounts were calculated by excluding the
revenue received from the third-party businesses for rental of
the parking lots, by including the parking lot fees received
from members of the Association, by deducting the losses
from the operation of the beach club, and by deducting all of
the expenses from the operation of the parking lots.
Discussion
The Association has the burden of proving that the deter-
minations of the deficiencies in the notice are wrong. See
2 As explained below, the IRS now concedes that the losses from the operation of the beach
club are deductible against the net income figures used to calculate the deficiency.
3 The revenue referred to in the stipulation of settled issues is the $61,024 paid in 2003 and
the $64,692 paid in 2004 by the third-party businesses, unreduced by any expenses allocable
to the Association’s operation of the parking lots.
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 281
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
For reasons explained below, we hold that the operation of
the parking lots and the beach club is not substantially
related to the promotion of community welfare and that the
income from operation of the parking lots is not rent from
real property within the meaning of section 512(b)(3). There-
fore, the income from operation of the parking lots and the
beach club is subject to the unrelated business income tax.
I. Whether the Operation of the Parking Lots and the Beach
Club Is Substantially Related to the Promotion of Com-
munity Welfare
Section 501(c)(4) exempts from Federal tax ‘‘Civic leagues
or organizations not organized for profit but operated exclu-
sively for the promotion of social welfare’’. Regulations clarify
that ‘‘An organization is operated exclusively for the pro-
motion of social welfare if it is primarily engaged in pro-
moting in some way the common good and general welfare
of the people of the community.’’ Sec. 1.501(c)(4)–1(a)(2),
Income Tax Regs. By implication, the regulation defines
‘‘exclusively’’ to mean ‘‘primarily’’. Thus, ‘‘an organization will
not be denied exemption if it partakes in activities not in fur-
therance of an exempt purpose so long as such noncon-
forming activities are insubstantial in comparison to activi-
ties which further exempt purpose(s).’’ Ky. Bar Found., Inc.
v. Commissioner, 78 T.C. 921, 923 (1982). Section 501(c)(4)
organizations, like some other types of tax-exempt organiza-
tions, must pay income tax on their ‘‘unrelated business tax-
able income’’. See sec. 511(a)(1). Section 512(a)(1) defines
‘‘unrelated business taxable income’’. It provides:
Except as otherwise provided in this subsection, the term ‘‘unrelated busi-
ness taxable income’’ means the gross income derived by any organization
from any unrelated trade or business * * * regularly carried on by it, less
the deductions allowed by this chapter which are directly connected with
the carrying on of such trade or business, both computed with the modi-
fications provided in subsection (b).
Section 513(a) provides that the term ‘‘unrelated trade or
business’’ means any trade or business the conduct of which
is not ‘‘substantially related (aside from the need of such
organization for income or funds or the use it makes of the
profits derived) to the exercise or performance by such
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282 135 UNITED STATES TAX COURT REPORTS (276)
organization of its charitable, educational, or other purpose
or function constituting the basis for its exemption under sec-
tion 501’’. Accordingly, income is unrelated business taxable
income if it is derived from a regularly carried-on trade or
business that is not substantially related to the purpose con-
stituting the basis of the organization’s exemption under sec-
tion 501. See sec. 1.513–1(a), (d)(1), Income Tax Regs. For
the conduct of a trade or business to be substantially related
to the purpose or purposes for which the organization was
granted a tax exemption, ‘‘performance of the services from
which the gross income is derived must contribute impor-
tantly to the accomplishment of these purposes.’’ Sec. 1.513–
1(d)(2), Income Tax Regs. The parties agree that the parking
lot and beach club activity constitute a regularly carried-on
trade or business, but disagree as to whether the activity is
substantially related to the purpose of promoting community
welfare, the purpose constituting the basis of the Associa-
tion’s exemption under section 501(c)(4).
The Association contends that the parking lot and beach
club activity ‘‘[promote] the community welfare of the prop-
erty owners’’ of Ocean Pines, which is one of the purposes of
the Association that was set forth in its articles of incorpora-
tion. It argues that ‘‘the ability to walk on the beach or swim
either in the ocean or in the pool at the * * * [beach club]
* * * directly promotes the health and wellness (i.e.,
‘community welfare’) of the * * * [Association’s] members’’.
The IRS argues, first, that the facilities at the beach club are
solely recreational and thus would be nontaxable if operated
by a section 501(c)(7) organization (a ‘‘club’’ that is ‘‘orga-
nized for pleasure, recreation, and other nonprofitable pur-
poses’’) but are taxable because they are operated by a sec-
tion 501(c)(4) organization. It argues, second, that the beach
club and the parking lots do not promote community welfare
because they are not open to the general public. We need not
determine whether the IRS’s first argument is correct. We
agree with the IRS’s second argument. We conclude that the
operation of the beach club and the parking lots does not pro-
mote community welfare because they are not accessible to
nonmembers; that is, the general public.
In Flat Top Lake Association, Inc. v. United States, 868
F.2d 108, 111–113 (4th Cir. 1989), the Court of Appeals for
the Fourth Circuit held that a homeowners association that
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 283
restricts the use of its facilities to its members does not pro-
mote the welfare of the community. Although Flat Top con-
cerned the question of eligibility for section 501(c)(4) status,
as opposed to the question of whether a particular activity of
a section 501(c)(4) organization is substantially related to the
promotion of community welfare and is therefore exempt
from the unrelated business income tax, the two questions
are related. As the Tax Court held in Profl. Ins. Agents of
Mich. v. Commissioner, 78 T.C. 246, 267 (1982), affd. 726
F.2d 1097 (6th Cir. 1984):
Logically, if * * * activities do not contribute to * * * [an organization’s
tax-exempt purpose] in the context of determining whether an organization
qualifies for exemption, then surely these same activities cannot be said
to be related to the organization’s exempt purpose in the context of the
UBTI provisions.
Applying these principles, a homeowners association gen-
erally does not promote community welfare if all of the
association’s facilities are closed to the general public (i.e.,
closed to nonmembers of the association). See Flat Top Lake
Association, Inc. v. United States, supra at 111–113. It fol-
lows that if a homeowners association has one facility that
is closed to the general public, then that facility is not
substantially related to the promotion of community welfare.
The income from that facility is subject to the unrelated busi-
ness income tax unless an exception applies.
The IRS does not contend that the Association’s tax-exempt
status should be revoked. It concedes that most of the
Association’s facilities and services are open to the general
public. Its contention is that income from the portion of its
facilities not open to the general public (i.e., the beach club
and the parking lots) is subject to the unrelated business
income tax because the operation of these facilities is not
substantially related to the promotion of community welfare.
We agree. The parking lots and the beach club are not acces-
sible to the general public. 4 Only Association members and
4 The Association argues for these purposes that its membership is so broad that its member-
ship should be considered the general public and therefore its parking lots and beach club
(which are open only to its members and their guests) should be considered open to the general
public. But the court in Flat Top held that a homeowners association that operates for the exclu-
sive benefit of its members ‘‘does not serve a ‘community’ as that term relates to the broader
concept of social welfare.’’ Flat Top Lake Association, Inc. v. United States, 868 F.2d 108, 111
(4th Cir. 1989).
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284 135 UNITED STATES TAX COURT REPORTS (276)
their guests may park in the parking lots. Although the
beach club allows both Association members and nonmem-
bers to access its food and beverage services and its rest-
rooms, its primary facilities (the swimming pool, gym lockers,
and showers) are accessible only to the Association’s mem-
bers. Thus, the operation of the parking lots and the beach
club is not substantially related to the purpose of ‘‘[pro-
moting] social welfare’’ within the meaning of section
501(c)(4) because they are not open to the general public.
Thus, unless an exception applies, the income attributable to
the operation of the parking lots and the beach club is sub-
ject to the unrelated business income tax.
II. Whether Parking Lot Income Is Rent From Real Property
Within the Meaning of Section 512(b)(3)
Section 512(a) provides that unrelated business taxable
income is income earned by a tax-exempt organization from
an unrelated trade or business it regularly carries on, subject
to the modifications in section 512(b). One of these modifica-
tions, in section 512(b)(3)(A)(i), is that ‘‘rents from real prop-
erty’’ are excluded from unrelated business taxable income.
The IRS claims that the income from operating the two
parking lots is not rent from real property because of state-
ments in legislative reports and because, it says, a regulation
explicitly bars income from operation of a parking lot from
qualification for the exception. The Association contends that
under the regulation, the income from operating the two
parking lots is rent from real property. We agree with the
IRS.
When Congress enacted the unrelated business income tax
provisions as part of the Revenue Act of 1950, ch. 994, 64
Stat. 906, the House Ways and Means Committee report
stated that the provision of the law excluding rents from real
property from unrelated business taxable income was
intended to exclude income from passive ownership of assets:
The tax applied to unrelated business taxable income does not apply to
dividends, interest, royalties (including of course, overriding royalties),
rents (other than certain rents on property acquired with borrowed funds),
and gains from sales of leased property. Your committee believes that such
‘‘passive’’ income should not be taxed where it is used for exempt purposes
because investments producing incomes of these types have long been rec-
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 285
ognized as proper for educational and charitable organizations. [H. Rept.
2319, 81st Cong., 2d Sess. 38 (1950), 1950–2 C.B. 380, 409.]
It later stated:
The term ‘‘rents from real property’’ does not include income from the oper-
ation of a hotel but does include rents derived from a lease of the hotel
itself. Similarly, income derived from the operation of a parking lot is not
considered ‘‘rents from real property.’’ [Id. at 110, 1950–2 C.B. at 459;
emphasis added.]
The Senate Finance Committee report also included the lan-
guage above regarding operation of a hotel and a parking lot.
S. Rept. 2375, 81st Cong., 2d Sess. 108 (1950), 1950–2 C.B.
483, 560.
The tax on unrelated business income, as enacted in 1950,
did not apply to churches and some other tax-exempt
organizations. Revenue Act of 1950, sec. 421(b)(1), 64 Stat.
948. In 1969, the Treasury Department recommended
extending the unrelated business income tax to all tax-
exempt organizations. U.S. Treasury Dept. Tax Reform
Studies and Proposals (Part 1) 26–27 (1969). The Joint Com-
mittee staff supported the Treasury Department’s rec-
ommendation, citing its own research on the scope of
churches’ unrelated business activities. One of the examples
of an unrelated business given by the staff was a church’s
operation of a parking lot. Staff of Joint Comm. on Taxation,
Tax-Exempt Organizations 20–21 (J. Comm. Print 1969). The
House Ways and Means Committee report on the Tax
Reform Act of 1969, Pub. L. 91–172, 83 Stat. 487, incor-
porated the Joint Committee’s examples of proliferating
church-operated businesses in describing why it was recom-
mending an expansion of the unrelated business income tax:
There is inequity in taxing certain exempt organizations on their ‘‘unre-
lated business income’’ and not taxing others. It has become apparent that
organizations now subject to the provision and those not subject to it are
equally apt to engage in unrelated business. For example, numerous busi-
ness activities of churches have come to the attention of the committee.
Some churches are involved in operating chains of religious bookstores,
hotels, factories, companies leasing business property, radio and TV sta-
tions, newspapers, parking lots, record companies, groceries, bakeries,
cleaners, candy sale businesses, restaurants, etc. * * * [Emphasis added.]
* * * * * * *
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286 135 UNITED STATES TAX COURT REPORTS (276)
The bill in extending the unrelated business income tax to churches pro-
vides a period of time * * * for churches to dispose of unrelated business
or to spin them off in separate taxable corporations.
[H. Rept. 91–413 (Part 1), at 47–48 (1969), 1969–3 C.B. 200, 230–231.]
Similarly, the report of the Senate Finance Committee
stated:
In recent years, many of the exempt organizations not now subject to the
unrelated business income tax—such as churches, social clubs, fraternal
beneficiary societies, etc.—have begun to engage in substantial commercial
activity. For example, numerous business activities of churches have come
to the attention of the committee. Some churches are engaged in operating
publishing houses, hotels, factories, radio and TV stations, parking lots,
newspapers, bakeries, restaurants, etc. Furthermore, it is difficult to jus-
tify taxing a university or hospital which runs a public restaurant or hotel
or other business and not tax a country club or lodge engaged in similar
activity. [S. Rept. 91–552, at 67 (1969), 1969–3 C.B. 423, 467; emphasis
added.]
The reports suggest that income from operating a parking lot
was not exempt from the unrelated business income tax
under any provision. The legislative history stated or implied
four times that the operation of parking lots yields unrelated
business taxable income and not rent from real property.
Section 1.512(b)–1(c)(5), Income Tax Regs., provides that
income from the operation of a parking lot is not rent from
real property. The regulation provides:
Rendering of services. For purposes of this paragraph, payments for the
use or occupancy of rooms and other space where services are also ren-
dered to the occupant, such as for the use or occupancy of rooms or other
quarters in hotels, boarding houses, or apartment houses furnishing hotel
services, or in tourist camps or tourist homes, motor courts, or motels, or
for the use or occupancy of space in parking lots, warehouses, or storage
garages, does not constitute rent from real property. Generally, services
are considered rendered to the occupant if they are primarily for his con-
venience and are other than those usually or customarily rendered in
connection with the rental of rooms or other space for occupancy only. The
supplying of maid service, for example, constitutes such service; whereas
the furnishing of heat and light, the cleaning of public entrances, exits,
stairways, and lobbies, the collection of trash, etc., are not considered as
services rendered to the occupant. Payments for the use or occupancy of
entire private residences or living quarters in duplex or multiple housing
units, of offices in any office building, etc., are generally treated as rent
from real property. [Emphasis added.]
The Association, in interpreting the above regulation, argues
that income from operating a parking lot is rent from real
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(276) OCEAN PINES ASSOCIATION, INC. v. COMMISSIONER 287
property unless the services provided by the tax-exempt
organization in operating it are ‘‘substantial.’’ It states that
the services it provides at the lots, i.e., the provision of
parking guards to open the lots and to check parking decals,
are insubstantial. It compares its level of service to its
parking lot customers to the level of service involved in the
trash collection mentioned in the regulation. But the test in
the regulation for determining whether the services are ren-
dered to the occupant (and therefore disqualify the organiza-
tion from using the rental exception) is not whether the serv-
ices provided are substantial, but whether the services are
(1) ‘‘primarily’’ for the ‘‘convenience’’ of the occupant and (2)
are ‘‘other than those usually or customarily rendered in
connection with the rental of rooms or other space for occu-
pancy only.’’ And as to the question of whether the services
provided by an operator of a parking lot satisfy this test, the
regulation also provides guidance. The first sentence of the
regulation lists ‘‘the use or occupancy of space in parking
lots’’ as an example of ‘‘use or occupancy of rooms and other
space where services are also rendered to the occupant’’. The
regulation, as we interpret it, determines that the services
provided by an operator of a parking lot (at least a typical
parking lot) are primarily for the convenience of the cus-
tomer and are other than those usually or customarily ren-
dered in connection with the rental of rooms or space for
occupancy only. 5 Although this conclusion might not apply to
a parking lot that is so unusual that it would not be consid-
ered a ‘‘parking lot’’ within the ordinary meaning of the term,
there is nothing to suggest that the services the Association
provides to its parking lot customers are unusual in this con-
text. Thus, the net income the Association earned from oper-
ating the parking lots during the summer months does not
constitute rent from real property as defined in section
512(b)(3). The net income is subject to the unrelated business
income tax.
In reaching our holdings here, we have considered all argu-
ments made, and, to the extent not mentioned above, we con-
clude they are moot, irrelevant, or without merit.
5 The lease payments from third-party businesses are rent from real property under the regu-
lation, and thus were properly conceded by the IRS as excludable from unrelated business tax-
able income, because Ocean Pines did not directly operate the parking lot on the behalf of the
third-party businesses.
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288 135 UNITED STATES TAX COURT REPORTS (276)
To reflect the foregoing,
Decision will be entered under Rule 155.
f
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