Since 1916, Congress has exempted from income taxation clubs formed to facilitate social interaction between its members. 

As a result, country clubs, hunting and fishing clubs, college sororities and fraternities, and tennis, swimming, and other sport clubs, among others, are generally exempt from taxation on income derived from their members. Section 501(c)(7) of the Internal Revenue Code of 1986, as amended ("Code").   The exemption applies to clubs "organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder."  

Prohibited inurement under Code Section 501(c)(7) in this context pertains to use of club assets or facilities to generate income from the public rather than club members.  For example, use of a tennis club to generate income from the general public attending a national tennis tournament was deemed prohibited private inurement by the social club. West Side Tennis Club v. Commissioner, 39 BTA 149 (BTA 1939). 

In 1976, Congress loosened the rules regarding social clubs to allow them to generate up to 35% of their annual revenue from non-member income, such as from rents charged to the public or from investments.  S. Rep. No. 94-1318, 94th Cong., 2nd Sess. 4 (1976), 1976-2 C.B. 597, 599.  See also H.R. Rep. No. 94-1353, 94th Cong., 2d Sess. 4 (1976). Thus, such clubs may rent out their facilities to non-members or generate investment income to a limited degree each year. 

Eventually, social clubs desire to end their operations.  When that happens, the question arises of what impact the sale and eventual distribution of net profits will have on the club and its members.  As a result of several Internal Revenue Service rulings, the tax picture is clear.  A liquidating sale of assets, such as a clubhouse or sporting facilities, will not cause the social club to lose its tax exemption.  While a social club generally can earn no more than 35% of its annual income from non-membership income, an exception permits exclusion of "unusual income" from this calculation.  Gins from the sale of assets upon dissolution of a social club qualifies as unusual income excluded from the calculation of income for purposes of the Code Section 501(c)(7) requirements.  Thus, social clubs that sell off their assets remain tax-exempt up through the date of sale and the distribution of the liquidated assets to its active members.  Rev. Rul. 58-501.  See, e.g., IRS Private Letter Ruling 201003022 (Jan. 22, 2010) (revenue from the sale of social club property is excluded from the calculation of whether the club derives its primary support from members). 

Although a liquidating social club will remain tax-exempt, that does not mean that the Club will escape taxation on income from its sale of assets.  The net gain from such an asset sale is treated as taxable "unrelated business taxable income" and will be taxed at the highest federal corporate income tax rate of 21%.  Code Section 512.  The income must be reported on a Form 990-T filed by the club for the year of the sale. 

Distribution of the net liquidation proceeds to club members itself does not amount to private inurement that will cause the social club to lose its tax exemption on that basis.  See IRS Gen. Counsel Memo. (citing Rev. Rul. 58-501) ("The fact that a portion of the profit resulting from the sale was distributed to the members does not cause the club to lose its exemption. Every social and recreational group has a prospect of eventually being disbanded and dissolved. Therefore, the fact that the assets of a club will, upon dissolution, be paid to members or shareholders is not alone sufficient to make the organization liable to render income tax returns.") (citations omitted). 

A social club could avoid taxation of the gain from the sale of its assets if, within a period beginning 1 year before the sale and 3 years after the sale, it purchases other property to use in operating a social club.  Code Section 512(a)(3)(D).  This provision offers the possibility that existing members transfer control over the club to another group of members who may want to continue the club's activities in another location. 

 After the club has sold all of its property and liquidated its assets, it may distribute the resulting net income to its members.  Each member will realize capital gain on the distribution, which is treated as a sale of their club membership.  The tax basis of a member's membership is equal to the amount that they paid initially for the interest; annual dues are deemed to be for annual club membership benefits and are not included in the tax basis of the membership.  Rev. Rul. 55-737 (cited in IRS Gen. Counsel Memo. 39658).