Recently in clubs which are located within gated communities, there has been a lot of talk about mergers between clubs and property owners’ associations (POA), also known as homeowners’ association or masters associations. The mere thought of a merger is often assumed to be the equivalent to a mountain climber climbing Mount Everest. Oftentimes, members might think the hardest part of a merger may be the legal or accounting work… but from discussions with several clubs, it turns out the most difficult part is just getting the two boards to agree on the terms and move forward. Although a merger can prove to be beneficial for many different business reasons, there could also be significant limitations and issues from a tax perspective.
From an economic standpoint, some of the major benefits of a merger may include: sales tax benefits, property tax benefits, common area utilities and economies of scale (managerial, economic, purchasing power).
In most cases, there is no income tax benefit from merging; however, depending on the ownership structure of the two organizations, there could be a significant limitation on the post-merger organization’s ability to utilize net operating losses. In most clubs within a gated community, the ownership is predominantly the same. As a result, there may not be a deemed change in ownership at the time of the merger, although the only way to be sure would be through a separate study. If the ownership is predominantly the same, it allows for some flexibility in deciding what type of merger to choose from as well as the tax consequences that follow.
IRS Internal Revenue Code (IRC) section 368 identifies seven different types of corporate reorganizations. Each should be considered when contemplating a corporate reorganization in order to ensure the most beneficial path, not only from an accounting perspective but a legal perspective.
Perhaps the most important tax issue to consider in a corporate reorganization is discussed in IRC section 269. This section states that if the motive of a reorganization is tax avoidance, the IRS will disallow the tax benefit and rule against the transaction. A bona fide business purpose must be established as the principal purpose for a reorganization. In the event that a club and POA decided to merge they should document all the business reasons for the merger, some examples of which were discussed above.
If the board members have been contemplating a merger between the club and the POA, it would be best to speak to your CPA. Significant tax regulations and limitations may apply.