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Country Club Can't Deduct Nonmember Event Losses from Investment Income

(Parker Tax Publishing October 2018)

The Sixth Circuit affirmed a Tax Court decision disallowing a tax-exempt country club from using losses from unprofitable nonmember events to avoid paying tax on its investment income. Although the Sixth Circuit disagreed with the Tax Court's reasoning that, under Portland Golf Club v. Comm'r, 497 U.S. 154 (1990), the country club was required to show evidence of profitability to prove its intent to profit and could not consider the hobby loss factors in Code Sec. 183, the Sixth Circuit concluded that, even applying the hobby loss factors, the country club's long history of consistent and unexplained losses overwhelmed all other evidence of its intent to profit from the events. Losantiville Country Club v. Comm'r, 2018 PTC 353 (6th Cir. 2018).


Losantiville Country Club (Losantiville) is a private country club in Ohio operating as a Code Sec. 501(c)(7) tax exempt organization. Like other social clubs, Losantiville derives income from several sources: membership dues and member expenditures on food and drink, facility rentals to nonmembers, and interest and dividends on club investments. These last two sources of income are taxable as unrelated business income.

Between 2002 and 2015, Losantiville hosted nonmember events to generate additional sales revenue and attract new members. Gross receipts from these events always exceeded the cost of services provided but, every year, the club reported a net loss after deducting general operating costs attributable to the nonmember sales.

Between 2010 and 2012, Losantiville offset its investment income with its purported Code Sec. 162 losses on the nonmember events and avoided paying any income tax. Eventually, the club's streak of losing money on its nonmember sales and its consistent Code Sec. 162 deductions drew IRS scrutiny. In 2013, the IRS determined that Losantiville did not intend to profit from its nonmember sales, could not deduct those losses, and therefore owed unrelated business income tax on its investment income. The IRS also assessed accuracy-related penalties.

Before the Tax Court, Losantiville argued that the IRS focused too closely on the club's lack of profitability and that the club's intent to profit should be determined by applying the hobby loss factors in Reg. Sec. 1.183-2(b). The club also defended itself against the penalties the IRS assessed, arguing that it relied on its accountant's preparation of the club's returns. The Tax Court rejected these arguments, finding that the hobby loss factors did not apply to Code Sec. 501(c)(7) organizations and that, under the Supreme Court's decision in Portland Golf Club v. Comm'r, 497 U.S. 154 (1990), Losantiville had to show profitability to evidence an intent to profit from the activity. The Tax Court also determined that Losantiville failed to prove it relied in good faith on its tax preparers. Losantiville appealed to the Sixth Circuit.


Under Code Sec. 162(a), a social club generally may deduct losses from nonmember activities against other taxable gains so long as the activities are trades or businesses. In Portland Golf Club, the Supreme Court held that, because a profit motive is the most important indicator of a trade or business, a social club must prove that it intended to profit from an activity before deducting Code Sec. 162 losses from that activity. The IRS applies the nine hobby loss factors in Reg. Sec. 1.183-2(b) to distinguish between losses of for-profit activities, which are deductible, and losses of not-for-profit hobbies, which are not deductible. These hobby loss factors analyze, among other considerations, whether the taxpayer has another major source of income, keeps complete books and records, seeks advice from an expert, and previously succeeded in similar ventures.

On appeal, Losantiville contended that the Tax Court incorrectly interpreted Portland Golf Club and should have considered evidence other than the club's lack of profitability. Losantiville claimed that a holistic view of its business practices revealed its intent to profit, and that if the Tax Court had applied the hobby loss factors, it would have decided that the club operated with a valid profit motive. Specifically, Losantiville pointed to two factors: the businesslike way the club planned and conducted nonmember events and the appreciation of the value of its land.

The Sixth Circuit affirmed the Tax Court's decision and held that Losantiville was not entitled to deduct the nonmember event losses because it did not intend to profit from the nonmember sales. While finding that the Tax Court incorrectly concluded that the hobby loss factors were inapplicable, the Sixth Circuit found that any error on the Tax Court's part in discounting those factors was harmless because Losantiville failed to show an intent to profit from the nonmember sales. The Sixth Circuit understood the Tax Court's reluctance to apply the hobby loss factors to determine the profit motive of a tax-exempt social club, noting that the hobby loss rules generally apply to high earning taxpayers attempting to reduce their taxes by reporting losses from extravagant side jobs, such as horse breeding or auto racing.

According to the Sixth Circuit, Portland Golf Club held that a taxpayer can meet the intent-to-profit requirement without showing consistent profitability, but the decision only hinted at other acceptable indicia. The Sixth Circuit noted that, in one footnote, the Supreme Court discussed how the club could have demonstrated an intent to profit by reference to the hobby loss factors, but another footnote stated that the factors did not apply to nonprofit social clubs. The Sixth Circuit found that, despite this tension, courts have allowed the principles from Code Sec. 183 to guide their profit motive analyses, and some courts have applied the factors even when they were inapplicable because they offered a functional metric for distinguishing deliberately unprofitable businesses from those merely ineptly run.

The Sixth Circuit noted that demonstrating a profit motive without profitability is difficult, and found that such taxpayers generally must show that their intent to profit was somehow thwarted. In the court's view, establishing an intent to profit when an organization is consistently unprofitable is even more difficult. A long history of consistent and unexplained losses, the court found, can overwhelm all other factors.

The Sixth Circuit found that Losantiville never presented any evidence that it attempted to stem its flood of losses or that it expected to eventually profit. The court rejected the club's argument that it operated in a businesslike manner, finding that the club cited no concrete evidence that it adopted any new techniques or abandoned unprofitable methods in a manner consistent with an intent to improve profitability. Losantiville also failed, in the court's view, to demonstrate that it owned real estate primarily with the intent to profit from the increase in its value or that its nonmember events reduced the net cost of carrying the land for its appreciation in value. The court explained that deductions and income from separate activities may be aggregated only when the undertakings are sufficiently connected. Taxpayers cannot, the court concluded, deduct large losses simply by conducting an unprofitable activity on a piece of land that is appreciating independently or in spite of the activity.

Turning to issue of penalties, the Sixth Circuit found that Losantiville produced no evidence that its reliance on its tax preparers was objectively reasonable or in good faith. The court noted that Losantiville submitted no opinion letters and no correspondence detailing advice or suggestions that its accountants provided. To the contrary, the court found that Losantiville conveyed its own opinions about the club's tax obligations to its accountants. The Sixth Circuit also found that Losantiville lacked substantial authority for its decision to take an unauthorized deduction. In the court's view, Losantiville marshalled virtually no evidence supporting its arguments for the underpayment, even under its argument for a novel application of Portland Golf Club.

For a discussion of Code Sec. 501(c)(7) social clubs, see Parker Tax ¶60,510. For a discussion of the hobby loss rules under Code Sec. 183, see Parker Tax ¶97,501.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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