4.76.28  Multiple Parent Title Holding Companies

4.76.28.1  (05-01-2010)
Introduction

  1. This manual section contains both detailed technical information and specific examination guidelines for an organization recognized as exempt from income tax under IRC §501(c)(25). It provides examination techniques effective in identifying and developing issues commonly encountered during the examination of an IRC §501(c)(25) organization.

  2. These guidelines provide specific assistance for the examination of an IRC §501(c)(25) organization and are not all-inclusive. The intent is not to restrict the examiner in identifying issues or using examination techniques not included herein.

4.76.28.2  (05-01-2010)
Exemption Requirements

  1. IRC §501(c)(25) was enacted into law in the Tax Reform Act of 1986 (Public Law 99-514), effective for taxable years beginning after December 31, 1986. The code section was specifically designed to provide for exemption for title holding organizations with up to 35 shareholders or beneficiaries. Holdings are limited to interests in real property.

  2. IRC §501(c)(25) requires that an organization must have the following attributes in order to qualify for exemption.

    1. Be organized for the exclusive purposes of acquiring real property and holding title to, and collecting income from, such property, and remitting the entire amount of income from such property (less expenses) to its shareholders or beneficiaries described in (3) below.

    2. Be a corporation with no more than 35 shareholders or a trust with no more than 35 beneficiaries.

    3. Each shareholder or beneficiary may have only one class of stock or beneficial interest.

    4. Notice 88-121 also provides that an IRC §501(c)(25) organization may be organized as a non-stock corporation if its articles of incorporation or bylaws provide members with the same rights as required by Notice 87-18.

    5. A corporation or trust must permit its shareholders or beneficiaries to dismiss the corporation’s or trust’s investment adviser, upon a majority vote of the shareholders or beneficiaries.

  3. Each shareholder or beneficiary must be:

    • A qualified pension, profit sharing, or stock bonus plan that meets the requirements of IRC §401(a);

    • A governmental plan (within the meaning of IRC 414(d);

    • The United States, any State or political subdivision thereof, or any agency or instrumentality of any of the foregoing; or

    • Any organization described in IRC §501(c)(3).

  4. A corporation or trust must permit its shareholders or beneficiaries to terminate their interest in the corporation or trust by either, or both, of the following alternatives, as determined by the corporation or trust:

    1. By selling or exchanging their stock in the corporation or interest in the trust (subject to any Federal or State securities law) to any organization described in (3) above so long as the sale or exchange does not increase the number of shareholders or beneficiaries in such corporation or trust above 35, or

    2. By having their stock or interest redeemed by the corporation or trust after the shareholder or beneficiary has provided 90 days notice to such corporation or trust.

  5. A corporation or trust must not derive more than 15 percent of the total rent for the taxable year from rent attributable to personal property which is leased under or in connection with a lease of real property.

  6. A corporation or trust must not derive more than 10 percent of its gross income from otherwise disqualifying income which is incidentally derived from the holding of real property. Examples of such income include revenues from vending machines and parking lots.

  7. IRC §501(c)(25)(A)(iii)(II) requires the organization to remit the entire amount of income from such property (less expenses) to 1 or more organizations which are shareholders of such corporation or beneficiaries of such trust. Such remission must occur at least annually, in the same manner as required for §501(c)(2) organizations.

  8. Notice 87-18, 1987-1 C.B. 455, requires that an IRC §501(c)(25) applicant’s articles of incorporation or trust instrument include provisions that clearly demonstrate that the organization meets the requirements set forth in 4.76.28 (2) through 4.76.28(4) above.

  9. Notice 88-121, 1988-2 C.B. 457, modifies Notice 87-18 by providing that if state law prevents a corporation from including in its articles of incorporation the provisions required by Notice 87-18, such provisions must instead be included in the bylaws of the corporation.

  10. An organization seeking exemption under IRC §501(c)(25) should submit a completed Form 1024,, Application for Recognition of Exemption Under Section 501(a), to Cincinnati.

  11. The application should include all information required by Schedule A, Form 1024. With respect to Question 4 of Schedule A, the organization should show the basis whereby each shareholder or beneficiary is described in section 501(c))(25)(C).

  12. Organizations formed before 1969 and churches are not subject to the application requirements of IRC §508 and may not have ever applied for and received a determination letter.

4.76.28.3  (05-01-2010)
Qualified Subsidiaries

  1. IRC §501(c)(25)(E) was enacted in Pub. Law 100-649 to permit IRC §501(c)(25) organizations to have fully-owned subsidiary corporations, called “qualified subsidiaries”, that could hold some or all of the assets of the IRC §501(c)(25) organization.

    1. A qualified subsidiary is not treated as a separate corporation for tax purposes and, accordingly, the Service will not issue a letter to the subsidiary recognizing it as exempt.

    2. All assets, liabilities, and items of income of qualified subsidiaries are considered assets, liabilities, and items of income of the IRC §501(c)(25) organization, and must be included in the organization’s annual returns.

  2. A qualified subsidiary does not file a separate Form 990 or other federal tax or information return.

  3. The Service does not issue a ruling to a qualified subsidiary recognizing it as such. However, to meet the requirements of some state tax authorities that a qualified subsidiary have its own exemption letter to qualify for exemption from state tax, the Service will issue a ruling to the IRC §501(c)(25) parent that its subsidiaries are qualified subsidiaries under IRC §501(c)(25)(E).

  4. IRC §501(c)(25)(E)(ii) provides that the term “qualified subsidiary” means any corporation if, at all times during the period of its existence, the IRC §501(c)(25) parent held 100 percent of its stock. Thus, an IRC §501(c)(25) parent cannot acquire a pre-existing corporation from the pre-existing corporation's shareholder, unless that shareholder is also an IRC §501(c)(25) organization. A qualified subsidiary must be a subsidiary of a §501(c)(25) organization, not a direct subsidiary of a pension plan or other permissible §501(c)(25) shareholder.

  5. An IRC §501(c)(25) parent may have more than one qualified subsidiary. The statute contains no express limit on the number of qualified subsidiaries a parent may own directly.

  6. A qualified subsidiary must comply with all rules of IRC §501(c)(25) for the parent to retain exemption. The activities of the qualified subsidiary are considered along with the other activities of the parent (and any other qualified subsidiaries).

    Example: If a qualified subsidiary received unrelated business taxable income from parking, and such income was incidentally derived from its holding of real property, but did not exceed 10% of the combined gross income of the parent and all qualified subsidiaries, then the parent would retain its exemption along with its qualified subsidiaries.

  7. If the parent transfers any qualified subsidiary stock to another person, the subsidiary is disqualified. If the parent transferred less than all the stock it held in the qualified subsidiary, the parent would then be holding an impermissible interest in personal property and would no longer meet the requirements for exemption under IRC §501(c)(25).

  8. If a qualified subsidiary issued stock to anyone other than its parent, the qualified subsidiary would be disqualified. This would also result in the parent's loss of exemption, as the parent would own stock, an impermissible holding for a §501(c)(25) title holding company.

  9. If a qualified subsidiary conducted an unrelated trade or business, that was not incidental to its holding of real property, the activity would not result in its disqualification, but would cause the parent's loss of exemption, as well as the loss of exemption of all the parent's other qualified subsidiaries (unless the requirements of IRC §501(c)(25)(G)(ii) were satisfied).

  10. IRC §501(c)(25)(E)(iii) provides that if a corporation which was a “qualified subsidiary” ceases to meet the requirements of IRC §501(c)(25)(E)(ii), it is treated as a new corporation acquiring all of its assets (and assuming all of its liabilities) from its IRC §501(c)(25) parent immediately before the date it ceased to be a “qualified subsidiary” in exchange for its stock. When a qualified subsidiary becomes disqualified, the rules set out in IRC §337(d) should be considered, along with the rules governing corporate reorganizations set out in IRC §351.

4.76.28.4  (05-01-2010)
Assets

  1. IRC §501(c)(25) title holding companies generally may not own stock, as stock is not real property. The sole exception to this rule is IRC §501(c)(25)(E), which permits a title holding company to own 100 percent of the stock in a qualified subsidiary.

  2. An IRC §501(c)(25) organization may acquire and hold options to purchase real property if the options are purchased in accordance with a plan to purchase the particular real estate involved and not for purposes of options trading.

  3. An organization may hold reasonable cash reserves sufficient to meet its operational requirements.

    1. The reserves must be held in cash, or in short term investments such as certificates of deposit, bankers' acceptances, interest-bearing savings accounts, commercial paper, government obligations, and shares in money market funds.

    2. Investments will not be considered short term if the period to maturity exceeds 91 days.

4.76.28.5  (05-01-2010)
Unrelated Business Income

  1. An IRC §501(c)(25) may not engage in unrelated business activities. In general, the receipt of unrelated business income by an IRC §501(c)(25) organization will subject the organization to loss of exempt status. The following are exceptions:

    1. IRC §501(c)(25)(F) treats as real property a limited amount of personal property leased with the real property. This applies only if the rental income attributable to the personal property does not exceed 15 percent of the total rental income.

    2. Acquisition indebtedness as described in IRC §514(b)(9), does not include indebtedness incurred in acquiring or improving certain real property.

    3. To the extent shareholders of an IRC §501(c)(25) organization are "qualified organizations as described in IRC §501(c)(25" ), the organization will not be considered to have acquisition indebtedness and income from the property will not be taxable. “Qualified organizations” are schools described in IRC §170(b)(1)(A)(ii), their affiliated IRC §509(a)(3) supporting organizations, and qualified trusts under IRC §401.

  2. As amended, IRC §514(c)(9) now provides that a “disqualified holder” of an interest in an IRC §501(c)(25) organization will take into account as gross income from an unrelated trade or business its pro rata share of income that would be treated as unrelated debt-financed income but for the application of IRC §514(c)(9)

    1. Disqualified holders are shareholders or beneficiaries of an IRC §501(c)(25) organization that are not schools described in IRC §170(b)(1)(A)(ii), their affiliated IRC §509(a)(3) supporting organizations, and qualified trusts under IRC §401.

    2. For interests acquired after June 10, 1987, shareholders and beneficiaries are put in the same position with respect to holdings of an IRC §501(c)(25) organization that they would be in if they held the property directly.

  3. IRC §501(c)(25)(G) allows IRC §501(c)(25) organizations to receive unrelated business income of up to 10 percent of their gross income, provided that the unrelated business income is incidentally derived from the holding of real property.

    1. Examples of such income include revenue from vending machines and parking lots.

    2. Exempt status will not be affected by the receipt of debt-financed income which is treated as unrelated business taxable income solely because of IRC §514.

  4. Income derived from a business operation or the business of acquiring, improving, and selling real property or trading options, is income from unrelated trade or business and will result in the loss of exempt status.

4.76.28.6  (05-01-2010)
Pre-Audit Examination Procedures

  1. Prior to initial contact with the organization, request the determination file from Cincinnati using Form 8057. Electronic copies can be requested and will be provided on CD.

  2. Determine whether the organization has filed a determination application on Form 1024. If formed before 1969, or a title holding company for a church, there may be no application on file aside from the organizing documents.

    1. For organizations that have no determination application, ask in the initial document request (IDR) for the organizing documents. Any documents secured should later be sent to Cincinnati for inclusion in the determination file. See IRM 4.75.16 for EO microfiche procedures.

    2. Upon receipt of the determination file, determine if the organization has included all the required language in its organizing documents as specified in Notice 87-18, 1987-1 C.B. 455 and Notice 88-121, 1988-2 C.B. 457.

    3. Review the organizing documents to determine whether the organization is organized for the exclusive purpose of holding title to property.

      Note:

      If state law prevents a corporation from including the required language in its articles of incorporation, the organization must include such language in its bylaws.

    4. Review articles of incorporation and other corporate documents to ensure the organization has no more than 35 shareholders or beneficiaries and only one class of stock or beneficial interest.

  3. Research IDRS to verify that the organization's shareholders or beneficiaries are described in IRC §501(c)(25)(C). If unable to determine which entities are the shareholder(s), include in the initial IDR a request for documentation, such as determination letters.

  4. If the determination application describes the real property to be held, perform web searches to :

    • Determine whether the property still exists,

    • View aerial images of the property, for estimating whether the description of any property in the application is still accurate,

    • See if there is a property management company operating the facility.

  5. While web searching, retrieve any current and/or revised corporate information from the appropriate state regulatory agency.

  6. Obtain any prior and subsequent years Forms 990 and 990-T via Online SEIN (http://sein.osc.irs.gov).

    1. Review the Forms 990-T to determine the sources of income reported.

    2. Using the Forms 990-T as a guide, add to the initial IDR any items on the Form 990-T that merit review, including items such as property records.

    3. Review the Forms 990 to identify the list of shareholders, if provided.

    4. Match the income and expenses reported on the Form 990 to the Form 990-T. Note any differences, and whether there may be allocation issues.

    5. Perform the standard risk analysis, identifying the large, unusual and questionable items for inclusion on the initial IDR.

  7. Using these records, revise your initial interview accordingly. Interview the officers and/or managers who run the title holding corporation. At a minimum, ask the following questions:

    1. Who are the shareholders of the organization?

    2. Are the shareholders all exempt under IRC §501(c)(3), or do they include governmental units or pension plans?

    3. What is the foundation status of each shareholder, if exempt under IRC §501(c)(3)?

    4. What kind of property is held by the organization?

    5. Does the organization use a property management company?

    6. Who among the shareholders has the right to terminate the management company, or is it a group decision?

    7. Does the organization collect any form of income other than rent?

    8. How many tenants does each property held by the organization have?

    9. If there are subsidiaries, who owns the stock of the subsidiaries?

    10. Do the subsidiaries (if any) generate any income of their own?

    11. Are there any mortgages against any of the properties owned by the organization (and any subsidiaries)?

4.76.28.7  (05-01-2010)
Field Examination Procedures

  1. Determine whether the shareholders or beneficiaries control the title holding corporation, as specified in IRC §501(c)(25)(D) by:

    • Reviewing the organizing documents,

    • Reviewing the minutes,

    • Reviewing contracts and agreements, and

    • Interviewing the officials.

  2. Obtain any revised organizing documents not already included in the determination file, even if previously attached to Forms 990.

    Identify any changes to the number of shareholders, classes of stock, or other structural elements in the articles of incorporation and/or bylaws.

    Send copies of any revised documents to Cincinnati using the procedures in IRM 4.75.16 for updating the EO microfiche.

  3. Inspect all sources of income, e.g. cash receipts journal, bank statements, to determine if the organization receives income from unrelated business activities and the amount of such income.

    If the organization receives unrelated business income, determine whether the income:

    1. a. Is incidental to the holding of real property,

    2. Does not exceed 10 percent of the organization's gross income, and

    3. Matches the amount reported on Form 990-T.

  4. Review lease agreements to identify rental of personal property. Determine whether the rental of real property includes personal property. If rental of real property includes personal property, determine whether the amount attributable to personal property exceeds the 15 percent of total rental income.

  5. Determine whether the organization is receiving income from the business of acquiring, improving, and selling real property or trading options. Such income is unrelated trade or business income and will result in the loss of exempt status.

  6. Analyze the organization's balance sheet to identify all assets.

  7. Analyze financial records and interview officials to determine if the organization owns options and if the purpose of owning the options is to purchase real estate.

  8. Review minutes, correspondence files and agreements to determine if the organization owns one or more qualified subsidiaries and has not transferred stock to any person.

  9. Determine if the organization is improperly accumulating income.

4.76.28.8  (05-01-2010)
Concluding The Examination

  1. Determine if the organization continues to qualify for exemption under IRC §501(c)(25). Prepare a report of examination revoking the organization if:

    • The organization has any shareholders who are neither a qualified pension, profit sharing, or stock bonus plan that meets the requirements of IRC §401(a); a governmental plan (within the meaning of IRC 414(d); the United States, any State or political subdivision thereof, or any agency or instrumentality of any of the foregoing; nor any organization described in IRC §501(c)(3).

    • It is no longer organized for the exclusive purposes of acquiring real property and holding title to, and collecting income from, such property, and remitting the entire amount of income from such property (less expenses) to its shareholders or beneficiaries described above.

    • It is a corporation with more than 35 shareholders or a trust with more than 35 beneficiaries.

    • Any shareholder or beneficiary has more than one class of stock or beneficial interest.

    • The corporation or trust can not permit its shareholders or beneficiaries to dismiss the corporation’s or trust’s investment adviser, via a majority vote of the shareholders or beneficiaries.

    • The shareholders or beneficiaries are unable to terminate their interest in the corporation or trust by selling or exchanging their stock in the corporation or interest in the trust to any organization described above so long as the sale or exchange does not increase the number of shareholders or beneficiaries in such corporation or trust above 35,

    • The shareholders or beneficiaries are unable to terminate their interest in the corporation or trust by having their stock or interest redeemed by the corporation or trust after the shareholder or beneficiary has provided 90 days notice to such corporation or trust.

    • Any shareholder or beneficiary has terminated their interest in the organization by selling or exchanging their stock with an organization not described above.

    • The organization derived more than 15 percent of the total rent for the taxable year from rent attributable to personal property which is leased under or in connection with a lease of real property.

    • The organization derived more than 10 percent of its gross income from otherwise disqualifying income which is incidentally derived from the holding of real property.

    • The organization fails to remit the entire amount of income from such property (less expenses) to 1 or more organizations which are shareholders of such corporation or beneficiaries of such trust at least annually.

    • Any qualified subsidiaries cause the organization to lose exemption through actions of their own. See IRM 4.76.28.3 above.

  2. For an agreed revocation:

    1. Discuss the issue with the taxpayer fully to verify that they will agree.

    2. Issue the final report using Letter 3610, Forms 886-A, 4621-A, and 6018-A. Provide the taxpayer with 30 days to respond.

    3. Prepare Forms 2363-A for revocation. The first Form 2363-A will eliminate the exempt status, while the second Form 2363-A will change the filing requirement to Form 1120.

    4. Prepare the Form 1120 Conversion Package as outlined in IRM

    5. Close the case to Mandatory Review.

  3. For an unagreed revocation:

    1. If not otherwise excluded from Fast Track Settlement, issue a report of preliminary findings (draft RAR), with a drafted cover letter, Forms 886-A, 6018-A, and 14017. Issue with Publication 4539. Allow 30 days for a response.

    2. For cases not entered into the Fast Track Settlement process, issue the final report using Letter 3610, Forms 886-A, 4621-A, and 6018-A. Provide the taxpayer with 30 days to respond.

    3. Prepare Forms 2363-A for revocation. The first Form 2363-A will eliminate the exempt status, while the second Form 2363-A will change the filing requirement to Form 1120.

    4. Prepare the Form 1120 Conversion Package as outlined in IRM

    5. Close the case to Mandatory Review.

  4. If not revoking, identify any adjustments to be made to Form 990-T.

    1. Discuss the adjustment fully with the taxpayer to determine whether they will agree to the adjustment.

    2. If agreed, prepare a report of examination, issued via Letter 3621, Forms 886-A, and 4549.

    3. For agreed cases, collect payment at the time of agreement. If taxpayer indicates an inability to pay the tax due at closing, alternative payment methods should be discussed. An installment agreement should be offered if the taxpayer meet the requirements. Form 9465, Installment Agreement Request, can be used to solicit a payment agreement. See IRM 4.10.7.5.6.

    4. When closing agreed cases, prepare Letter 3607, to be accompanied by a copy of the Form 886-A and Form 4549. The case will be closed to ESS.

    5. For unagreed cases, if not otherwise excluded from Fast Track Settlement, issue a report of preliminary findings (draft RAR), with a drafted cover letter, Forms 886-A, 4549, and 14017. Issue with Publication 4539. Allow 30 days for a response.

    6. For cases not entered into the Fast Track Settlement process, issue the final report using Letter 3621, Forms 886-A, and 4549-A. Provide the taxpayer with 30 days to respond.

    7. Close unagreed cases to Mandatory Review at the end of the 30 day period. For short statute cases, statutory notice procedures may need to be followed.

  5. If the case is to be closed as a no change, prepare Letter 3594 and close following the procedures outlined in IRM 4.76.16.


More Internal Revenue Manual