Difficult Interpretative Questions

The majority's interpretation of the property use condition naturally suggests that there is some recognizable difference between remodeling a house and demolishing and rebuilding the house. I assume the majority does not mean to suggest that any remodeling of a home (1) terminates the use of that home as the taxpayer's principal residence and (2) resets the temporal clock to zero time elapsed. If not, then is there some level of remodeling that does (1) terminate the use of the home as the taxpayer's principal residence and (2) set the temporal clock to zero? What about a taxpayer who, wanting a bigger house, demolishes the old house (but not the foundation) and constructs a larger (taller) house using the old foundation? Is that remodeling or rebuilding? What about keeping part of the foundation, and expanding horizontally? If that is remodeling, then there may be an easy way for the Court to reach a similar result in the case before us. The parties have stipulated an exhibit, a blueprint, that shows footprints of both the old and the new house. I have examined the exhibit, and the footprints overlap. Might we not conclude that part of the foundation of the old house was incorporated into the new, thus making the case a remodeling case and not a rebuilding case?

The majority's report will undoubtedly raise the kind of remodeling versus rebuilding questions that I have raised. I think that the better course would be to avoid provoking those questions.

Disposition of House Followed by Sale of Land

Cases, see, e.g., Bogley v. Commissioner, 263 F.2d 746 (4th Cir. 1959), revg. 30 T.C. 452 (1958), suggest that, and the regulations, sec. 1.121-1(b)(3), Income Tax Regs., confirm that, if the principal residence consists of both land and improvements, both a prior sale of the improvements and part of the land and a subsequent sale of the remaining land can qualify under section 121(a). Although petitioners are perhaps at a disadvantage for not arguing it, it does not seem to me to be an impossible stretch to view the demolition of the original house as a sale for zero dollars followed by a later sale of the land. There would then be a ground to apply section 121(a) to the subsequent sale of the land. The demoli

tion/disposition of the original house would give rise to a nondeductible loss, with the basis in the house going to the land. See sec. 280(B). Any gain attributable to the original house and land would be realized on the sale of the land (and new house). That approach requires the allocation of the proceeds between the new house and the land, which apparently petitioners did not think to address.

Conclusion

I would treat the demolition and reconstruction of petitioners' house no differently from a renovation. As a second best solution (if I had adequate information), I would treat the original house as being sold for zero dollars upon its demolition and apply section 121 to a subsequent sale of the land (and new house).

WELLS, GOEKE, KROUPA, and HOLMES, JJ., agree with this dissent.

FREE FERTILITY FOUNDATION, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 17122-07X.

Filed July 7, 2010.

P, a nonprofit corporation founded by S, provides S's sperm free of charge to women seeking to become pregnant through artificial insemination or in vitro fertilization. S and his father, F, are P's board members and officers. S and F ultimately determine to whom P will distribute sperm. P, seeking tax exemption as a private operating foundation pursuant to sec. 501(c)(3), I.R.C., contends that it operates exclusively for the charitable purpose of promoting health.

1. Held: P's activities do not promote health for the benefit of the community.

2. Held, further, pursuant to sec. 501(c)(3), I.R.C., P is not operated exclusively for exempt purposes and therefore does not qualify for tax exemption.

Marcus S. Owens and Nancy Ortmeyer Kuhn, for petitioner.

Philip T. Hackney and Michael B. Blumenfeld, for respondent.

OPINION

FOLEY, Judge: Pursuant to section 7428(a), 1 petitioner seeks a declaratory judgment that it meets the requirements of section 501(c)(3) and is exempt from Federal income taxation. This case was submitted for decision based on the stipulated administrative record as defined in Rule 210(b)(12). Petitioner has exhausted its administrative remedies as required by section 7428(b)(2) and Rule 210(c)(4), received a final adverse determination letter dated June 15, 2007, and invoked the jurisdiction of this Court by a petition filed July 31, 2007.

Background

William C. Naylor, Jr. (Naylor), is a software engineer who holds more than 10 patents on various inventions. On March 1, 2001, Naylor entered into a contract (2001 contract) with a Spokane, Washington, sperm bank to store and distribute his sperm to recipients of his choice. Pursuant to the 2001 contract, Naylor was required to pay annual storage fees and designate recipients.

On October 15, 2003, Naylor founded and incorporated petitioner in California as a nonprofit public benefit corporation. The purpose of the corporation is to provide sperm free of charge to women seeking to become pregnant through artificial insemination or in vitro fertilization. Petitioner advertises online through a search engine and a Web site.

On February 6, 2004, petitioner submitted to respondent Form 1023, Application for Recognition of Exemption, in which petitioner seeks tax-exempt status as a private operating foundation. On April 11, 2005, respondent requested a copy of petitioner's agreement with the sperm bank that stored its donated sperm. In response to the request petitioner, on May 31, 2005, submitted Naylor's 2001 contract.

Petitioner's Web site states that Naylor is its "single sperm donor" and chronicles Naylor's life from infancy to adulthood. Naylor's donor profile includes photographs, a physical description, health information, family history, and achievements. In particular, the Web site provides great detail of Naylor's academic and athletic accomplishments during

1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended, and all Rule references are to the Tax Court Rules of Practice and Procedure.

elementary school (e.g., spelling bee competition), junior high school (e.g., science fair competition), high school (e.g., swimming competitions), and college (e.g., recognition as "top engineering student"). On the Web site Naylor states:

I derive meaning and happiness from believing that I am making the world a better place. Being a sperm donor is a way that I can help a few people to have children who otherwise could not. This makes more of a positive difference to the world than all of the inventions and scientific discoveries that I could ever create.

Petitioner's bylaws provide for a board consisting of 1 to 10 directors, all of whom shall be appointed by Naylor. None of the directors may be compensated. Naylor and his father, a retired university professor, are petitioner's board members and officers. Naylor's father is petitioner's president and chairman of the board. Naylor is petitioner's secretary, treasurer, and sole financial contributor. Petitioner's board of directors selects all sperm recipients.

Women seeking to receive sperm from petitioner are required to submit answers to a questionnaire created by Naylor and his father (collectively, the Naylors). The questions relate to the woman's family background, living environment, age, history of fertility treatment, educational attainment, personal achievements, and desire to have a child. Preference is given to women "with better education" and no record of divorce, domestic violence, or “difficult fertility histories" and are from families "whose members have a track record of contributing to their communities"; who are in “a traditional marriage situation"; who are under age 37; who are ethnic minorities; and who are "from locations where *** [petitioner has] not previously accepted recipients." Petitioner scores the questionnaires by hand, transfers the information to a computer-readable form, and enters the information into a computer program which assigns a score to each woman. The threshold score required for a woman to receive sperm is adjusted so that the number of recipients accepted matches the number of sperm vials available. The Naylors are authorized to override a score to accept or reject anyone if, in their judgment, the computer program fails to account for a critical factor. In 2004 petitioner received 433 questionnaires and distributed sperm to 20 women. In 2005

petitioner received 386 questionnaires and distributed sperm to 4 women.

On November 30, 2005, respondent sent petitioner a proposed exemption denial letter. Petitioner, on March 30, 2006, submitted a written protest. The parties held a conference on November 28, 2006, to discuss petitioner's application for exemption. On June 15, 2007, respondent issued a final determination letter denying petitioner's request for exemption. On July 31, 2007, petitioner, a California corporation, filed its petition with this Court seeking review of the final determination.

Discussion

Pursuant to section 501(a), organizations described in section 501(c)(3) are exempt from Federal income taxation. Section 501(c)(3) organizations include:

Corporations * * * organized and operated exclusively for religious, charitable, * * * *** or educational purposes, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation * *. and which does not participate in, or intervene in * * *, any political campaign ***.

*

The requirement that a corporation be operated exclusively for exempt purposes is referred to as the "operational" test. See sec. 1.501(c)(3)–1(c), Income Tax Regs. To meet the requirements of the operational test, an organization must engage primarily in activities that accomplish exempt purposes, and no more than an insubstantial part of the organization's activities may be in furtherance of a nonexempt purpose. Sec. 1.501(c)(3)−1(c)(1), Income Tax Regs. An organization is not operated exclusively for exempt purposes unless it serves a public rather than a private interest. 2 Sec. 1.501(c)(3)-1(d)(1)(ii), Income Tax Regs.

Respondent contends that petitioner does not, pursuant to section 501(c)(3), operate exclusively for exempt purposes and therefore is not entitled to tax exemption. More specifically, respondent contends that petitioner's operations do not promote health or otherwise serve a charitable purpose. Peti

2 We need not and do not decide whether sec. 7491(a)(1) applies to a declaratory judgment action. The applicability of sec. 7491(a)(1) does not impact the outcome of this case.