Private golf and country clubs are often member-owned and operated as “501-C7” tax exempt entities. When developed, many were for-profit ventures that may have been not-for-profit, tax exempt status (501-C7). Lately, we’ve been retained for several appraisal assignments involving conversion of these clubs for the purpose of establishing value for federal income tax purposes.
As with any appraisal assignment, how the appraisal will be used is important to ensure that the scope of the appraisal assignment is relevant and communicated (report) in a way that addresses the issues important to the intended use. In appraisal assignments done for federal income tax purposes, key to the assignment is ensuring that the value estimated is stated and defined and developed in a manner consistent with Internal Revenue Service (IRS) and widely accepted appraisal standards (USPAP).
The first question I always ask is: Why are we doing this appraisal? The short answer is that (according to club CPA Mitch Stump) “it’s always a tax issue.” Typically, the property has a “book value” representing the tax basis of the property to be transferred from the for-profit entity to the 501-C7. Fundamentally, if the market value (value in exchange) of the property transferred exceeds the current tax basis (depreciated book value), there are taxes owed on the amount of the gain. Since the client (typically the club) could be stuck with a significant tax bill, and the appraisal is likely to be scrutinized by the IRS, it’s critical that the appraisal be detailed, thorough and objective.
A big part of this equation is the relationship between book value and market value. Technically, there isn’t one. However, since book value is based on cost less accrued depreciation, and clubs typically cost more to develop than their initial market value, there’s usually a significant difference between the two. If considerable depreciation has accrued, there could be a gain realized, which would be taxed.
First, it’s important for any club considering a conversion to understand that to qualify for tax exempt status, no more than 15% of gross revenues can come from non-member activities and no more than 35% of gross revenues can come from the total of non-member activities and investment income. Stump emphasizes that clubs need to focus on only conducting profitable outside functions because the qualification is based on gross receipts, not profits. Tax partner at RSM, Chris Cecil says it’s rare that clubs push the 35% rule relating to investment income, and that it’s critical to accurately track non-member revenue outlined in IRS revenue ruling 71-17 which contains the various record-keeping requirements for tax exempt status. Among the interesting provisions are the “Rule of 8”. Clubs must be able to substantiate that groups of 8 are truly member activities as opposed to outside income and that members cannot be reimbursed for expenses.
Cecil also mentioned that attention is required for “non-traditional” income. Included in this is (surprisingly) to-go (takeout) food, which is counted toward the 15% non-member activities and a 5% “non-traditional” income limit.
In many instances, we’ve been contacted by clubs that have either recently done capital improvements or are planning same. Among relevant questions is whether those improvements have (or will) enhanced the value of the club. It’s important to stress that market value presumes an arm’s length sale of the property, which however unlikely that sale may be is what’s measured for this exercise. Just because they look better and generate appeal, often these capital improvements carry increased operating costs (with limited or no additional revenues) that can mitigate any positive impact on the property’s market value in a potential sale. Clubs should always plan any capital improvements with the consideration of whether those improvements can be self sustaining, and if considering a conversion to tax exempt status whether they should be done prior to or after the conversion.
Deferred maintenance exists at many clubs, including some of the most upscale and prestigious. In some cases, depending on the level of tax basis and the club’s market value, the impact of deferred maintenance on market value can be significant in determining a club’s ultimate tax liability. As I wrote recently,deferred maintenance can be your club’s best friend in conversion situations as well. It is important to stress, however that there is a difference between deferred maintenance and capital improvements. I like to refer to them as “required versus desired”. Capital improvements will add to the basis while correcting deferred maintenance will not.
Deferred maintenance is defined in The Dictionary of Real Estate Appraisal – 7th Edition as: “Items of wear and tear on a property that should be fixed now to protect the value or income-producing
ability of the property, such as a broken window, a dead tree, a leak in the roof, or a faulty roof that must be completely replaced.” In golf & club property cases, these can also include components like irrigation systems, cart paths and bunkers that may have reached the end of their useful life. These items are almost always curable. The key phrase here is should be fixed now. What this means is they need to be addressed now (as of the date of appraisal) which would likely result in a deduction from value of the cost to cure the item. These are “required”.
If they need to be addressed “now” the cost to cure can be deducted from the valuation analysis which can impact the taxable basis for the newly established 501-C7 in a potentially favorable way for the taxpayer.
The market value of a member-owned club is typically only relevant in those instances where the club is being sold often to a for-profit buyer), when the club is seeking bank financing, when the club is evaluating its ad-valorem real estate tax assessment or when the club is doing a conversion from for-profit status (277) to tax exempt status (501-C7). In the conversion cases, understanding market value, what impacts it and how it differs from the tax basis (book value) is critical to ensuring that any tax paid will be fair and appropriate.
