IRS Rules Nonprofit’s Income Excludable Under § 115(1) and Contributions Deductible Under § 170(c)(1)

Nonprofit’s Property Reclamation Efforts Deemed Essential Governmental Function

The IRS ruled that a county-created nonprofit’s income from blighted property reclamation qualifies for exclusion under § 115(1) of the Internal Revenue Code, which exempts income derived from essential governmental functions accruing to a political subdivision. Contributions to the nonprofit were deemed deductible under § 170(c)(1), which permits charitable deductions for gifts made for exclusively public purposes to a state or political subdivision. The decision underscores that property reclamation—when structured as a core governmental function—can secure tax-exempt status for related income and deductibility for supporting contributions, offering a critical precedent for counties and nonprofits engaged in similar revitalization efforts.

County’s Blighted Property Crisis Sparks Creation of Nonprofit Agent

State law authorized County to create a nonprofit corporation for reclaiming and reusing vacant, abandoned, foreclosed, or nonproductive properties. In response to a growing blight crisis, County passed a resolution empowering its treasurer to incorporate Taxpayer as a nonprofit, nonstock corporation under State law. County designated Taxpayer as its agent to reclaim, rehabilitate, and repurpose vacant, abandoned, tax-foreclosed, and other real property within County.

Taxpayer’s purposes were to reclaim, hold, manage, and repurpose such properties; assist governmental and other entities in assembling and clearing title for productive use; and encourage housing and economic development within County. Its organizational documents explicitly limited its activities to those consistent with the status of an organization whose income is excludable from gross income under § 115(1)—which excludes income derived from the exercise of any essential governmental function and accruing to a state or any political subdivision thereof.

Taxpayer’s board of directors included County’s treasurer, chief executive officer, and president of County’s legislative body, along with two members appointed by the largest municipality in County and up to four additional directors selected unanimously by the statutory members. All directors served without compensation and were subject to Taxpayer’s conflicts of interest policy, which supplemented State ethics rules to prevent private benefit to County officials or employees. The policy required annual acknowledgment of compliance and mandated disclosure of political contributions from directors who were elected officials when bidding on contracts.

Under State law, Taxpayer was subject to open meetings and public records requirements, filed annual financial reports with State’s auditor, posted reports on its website, and was subject to audit. Funding derived primarily from County appropriations, including a fixed percentage of delinquent real property tax collections and general fund allocations, as well as fees and proceeds from property disposition. Taxpayer’s organizational documents required periodic reviews to ensure it performed essential governmental functions, maintained reasonable compensation arrangements, and avoided impermissible private inurement or benefit. County retained the power to dissolve Taxpayer at any time, with remaining assets reverting to County’s general fund upon dissolution.

Taxpayer’s Dual Request: Income Exclusion and Charitable Deduction Eligibility

The taxpayer sought two rulings: (1) that its income was excludable from gross income under Section 115(1), which excludes income derived from essential governmental functions accruing to a state or political subdivision; and (2) that contributions to it were deductible under Section 170(c)(1), which permits deductions for gifts to states or political subdivisions for exclusively public purposes. The taxpayer argued its activities—including blight remediation and property disposition—constituted core governmental functions, with proceeds flowing to County and other political subdivisions.

The IRS applied its established legal framework—Revenue Ruling 57-128—to evaluate these claims. This ruling employs a six-factor test to determine whether an entity operates as a governmental instrumentality, focusing on legal creation, government control, public purpose, funding sources, accountability, and sovereign immunity.

IRS Applies Six-Factor Test to Determine Instrumentality Status

The IRS analyzed the taxpayer’s status as a wholly-owned instrumentality of County using the six-factor test from Revenue Ruling 57-128, which evaluates whether an entity qualifies as a governmental instrumentality under federal tax law. The six factors assess legal creation, government control, public purpose, funding sources, accountability, and sovereign immunity.

The IRS concluded that the taxpayer’s activities align with traditional governmental functions such as land management and economic development, distinguishing it from commercial enterprises. The taxpayer’s operations are explicitly tied to County’s governmental objectives, with revenue accruing to County and its activities subject to open meetings, public records requirements, and annual financial reporting. County exercises effective control over the taxpayer, including board composition and dissolution power, while state law restricts revenue use to statutorily defined purposes. Financial dependence on County does not disqualify instrumentality status, provided other factors are met.

IRS Rules: Taxpayer’s Income Excludable, Contributions Deductible

The IRS ruled that the Taxpayer’s income is excludable from gross income under Section 115(1), which excludes income derived from the exercise of an essential governmental function and accruing to a state or political subdivision. The IRS determined that the Taxpayer’s activities—reclaiming, rehabilitating, and repurposing vacant, abandoned, and tax-foreclosed properties—constitute an essential governmental function. The Taxpayer’s income accrues to County, a political subdivision, as required by the statute.

The IRS also ruled that contributions to the Taxpayer are deductible under Section 170(c)(1), which allows deductions for contributions to states or political subdivisions for exclusively public purposes. The Taxpayer qualifies as a wholly-owned instrumentality of County, as confirmed by the IRS’s application of the six-factor test in Revenue Ruling 57-128. The IRS relied on Revenue Ruling 75-359, which holds that contributions to a wholly-owned instrumentality of a political subdivision are deductible under Section 170(c)(1).

The IRS cautioned that this ruling is non-precedential and applies only to the specific facts presented. Any material change in the Taxpayer’s structure, operations, or funding sources could alter the IRS’s determination.

What This Ruling Means for Counties and Nonprofit Instrumentalities

This ruling provides clarity for counties and nonprofit instrumentalities engaged in property reclamation and economic development. The IRS confirmed that income derived from blight remediation and land reclamation efforts may qualify for tax exemption under § 115(1) if performed by a governmental instrumentality, and that contributions to such entities are deductible under § 170(c)(1).

For practitioners, the ruling underscores the importance of maintaining strict government control, public purpose alignment, and financial dependence on political subdivisions. The IRS’s six-factor test from Revenue Ruling 57-128 remains the benchmark for determining instrumentality status. Taxpayers must ensure deep integration into government operations, with clear public benefit documentation and avoidance of excessive private benefit.

The ruling’s non-precedential nature limits its broader application. Taxpayers cannot rely on it as binding authority, and structural or operational changes could jeopardize favorable treatment. Practitioners should advise clients to attach this ruling to relevant tax returns as required by § 6110(k)(3) and prepare for potential IRS scrutiny.