Refundable equity and what it means for your club
ECLUB NEWS |
Refundable equity could create a large liability on a club’s balance sheet and might make it difficult to sell new memberships… but did you know it could also create issues with the IRS?
We have all heard that refundable equity is more of a ”developer concept.” It was used to help ease the pain of buying a club membership at tens of thousands of dollars with the promise of getting some, or possibly all the money back after resignation. For most clubs, the largest headache related to refundable equity is making the payment to the outgoing member; however, something that crosses almost every club’s mind at some point is…does this payment require reporting to the IRS?
In several court cases and rulings, the IRS has stated that they view equity certificates in the same way that they view stock in a corporation. Additionally, the instructions for the 1099-B state that when an organization, in its ordinary course of business, regularly redeems its own stock, a 1099-B is required. This issue has also appeared in recent IRS audit defense, where the agents have requested to see 1099-Bs issued and matched them against all resigning members. All of which give a strong indication that the IRS requires a 1099-B to be issued for the sale of a member’s equity certificate when cash is received.
So in the same way that an individual receives a 1099-B at the end of the year for selling Amazon or Apple stock, they will also receive a 1099-B from selling an equity certificate. As with any stock, there is basis in an equity certificate. This basis could be used to offset most, if not all the gain. Therefore, the fact that an individual receives a 1099-B doesn’t necessarily mean a tax payment is required, however, it does mean that the transaction needs to be reported to the IRS.
There are a few common instances where a member can sell an equity certificate and make a profit. The most common one usually occurs when the individual has been a member of the club for a very long time. Another less common instance is when the equity certificate was purchased during developer control and was subsequently sold after the club had turned over to the members. The gain in this instance is due to the fair market value of the equity certificate significantly increasing after being turned over to the members. In the event a member makes a profit from the sale of his or her equity certificate in any way, they would be subject to capital gains tax.
Someone might ask, what if my club has refundable equity and does not issue 1099-Bs.
Failure for the club to properly report the sale of equity certificates on a 1099-B could cause penalties on a per instance missed basis. This penalty can range anywhere from $50 to $260 per instance missed, excluding situations where the club intentionally disregarded where penalties are substantially higher. If the club has refundable equity and is not currently issuing 1099-Bs, they should consult with their tax advisor to determine if a filing requirement exists.