Private Foundations –Self-Dealing IRC 4941(d)(1)(A)

IRC Section and Treas. Regulation

  • IRC 4941 Taxes on Self-Dealing
  • IRC 4941(d)(1) Self-Dealing, In General
  • Treas. Reg. 53.4941(d)-2 Specific acts of self-dealing
  • Treas. Reg. 53.4941(d)-2(a)(1) Sale of exchange of property, in general
  • Treas. Reg. 53.4941(d)-2(a)(2) Mortgaged property
  • Treas. Reg. 53.4941(d)-2(b)(1) Leases, in general
  • Treas. Reg. 53.4941(d)-2(b)(2) Certain leases without charge
  • Treas. Reg. 53.4941(d)-2(b)(3) Certain leases of office space
  • Treas. Reg. 53.4941(d)-3 Exceptions to self-dealing
  • Treas. Reg. 53.4941(d)-3(b)(1) Furnishing of goods, services of facilities to a disqualified person, in general
  • Treas. Reg. 53.4941(d)-3(b)(2) General public
  • Treas. Reg. 53.4941(d)-3(d) Certain transactions between a foundation and a corporation

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources)

Analysis

Generally, IRC 4941 imposes an excise tax on any direct or indirect act of self-dealing between a private foundation and a disqualified person. Self-dealing transactions described under IRC 4941(d)(1) are:

(A) the sale, exchange, or leasing of property;
(B) the lending of money or other extension of credit;
(C) the furnishing of goods, services, or facilities;
(D) the payment of compensation or expenses by the foundation to a disqualified person;
(E) the transfer or use of the foundation’s income or assets by or for the benefit of a disqualified person; and
(F) certain payments to government officials.

This Issue Snapshot focuses on IRC 4941(d)(1)(A), the other subsections noted above will be the subject of future Issue Snapshots.

Section 53.4941(d)-2(a)(1) provides that in general the sale or exchange of property between a private foundation and a disqualified person shall constitute an act of self-dealing.

Examples:

The sale of incidental supplies by a disqualified person to a foundation shall be an act of self-dealing regardless of the amount paid to the disqualified person for the incidental supplies.

The sale of stock by a disqualified person to a foundation in a “bargain sale” shall be an act of self-dealing regardless of the amount paid for such stock.

Note: That an installment sale may be subject to the provisions of both IRC 4941(d)(1)(A) and 4941(d)(1)(B).

Sale or exchange of mortgaged property

A special rule in IRC 4941(d)(2)(A) provides that the transfer of real or personal property by a disqualified person to a foundation is treated as a sale or exchange if the foundation:

(a) assumes a mortgage or similar lien which was placed on the property prior to the transfer, or

(b) takes the property subject to a mortgage or similar lien placed on it by the DP within the 10-year period ending on the date of transfer.

The term "similar lien" includes, but is not limited to, deeds of trust and vendors' liens. It does not include any other lien which is insignificant in relation to the fair market value of the property transferred.  Rev. Rul. 78-395 and Rev. Rul. 80-132 provide guidance in determining what is a "mortgage or similar lien" within the meaning of Treas. Reg. 53.4941(d)-2(a)(2).

Rev. Rul. 78-395, 1978-2 C.B. 270, concerns a disqualified person who contributed his entire interest in certain land and improvements to a foundation.  The foundation did not assume the existing liens on the property and improvements but accepted the gift subject to them.  One of the liens, a deed of trust, was placed on property by the disqualified person within the 10-year period described in IRC 4941(d)(2)(A).  Accordingly, the transfer is treated as an act of self-dealing.

In Rev. Rul. 80-132, 1980-1 C.B. 255, a disqualified person donated a life insurance policy to a private foundation that was subject to an outstanding loan made to the donor within the 10-year period. The amount of the loan was not insignificant in relation to the value of the policy. Under the terms of the policy, failure to repay the principal or interest on the policy loan reduces the proceeds that are payable to the beneficiary upon voluntary surrender of the policy or upon the death of the insured. The fact that the insurer will not demand repayment of the loan or payment of interest as it accrues does not mean that the loan is not a "mortgage or other lien" within the meaning of Treas. Reg. 53.4941(d)-2(a)(2). The transfer of the policy relieved the donor of the obligation to repay the loan, pay interest on the loan as it accrues, or suffer continued diminution in the value of the policy.  Accordingly, the donation of the life insurance policy subject to an outstanding policy loan is an act of self-dealing within the meaning of IRC 4941(d)(1)(A).

A second significant issue under IRC 4941(d)(2)(A) is whether the disqualified person referred to in the statute is the mortgagor or the mortgagee. The mortgagor is the debtor who placed the mortgage on the property while the mortgagee is the lender who holds the mortgage. A case involving this question is discussed in G.C.M. 39033, dated September 20, 1983.  The purpose of IRC 4941(d)(2)(A) is to prevent the disqualified person-debtor from shifting his liability as mortgagor by contributing the underlying property to the foundation. This is an indirect use of the foundation's assets for the benefit of the disqualified person.

Sales or exchanges of property that are without charge

Section 53.4941(d)-2(d)(3) provides that the furnishing of goods, services, or facilities by a disqualified person to a foundation is not an act of self-dealing if they are furnished without charge. A furnishing is without charge even though the private foundation pays for transportation, insurance, or maintenance costs it incurs in obtaining or using the property, so long as the payment is not made directly or indirectly to the disqualified person.

Rev. Rul. 76-10; 1976-1 C.B. 355, provides that generally, by furnishing a meeting room or other facility to a DP, a PF would be engaging in an act of self-dealing. However, in this situation, the room is made available to the government official on the same basis that it is made available to other community and civic groups. Further, the use of the foundation's meeting room for communications between the government official and members of the public is functionally related to the foundation’s exempt purpose of making the room available for civic and community purposes. Accordingly, since the exception provided by IRC 4941(d)(2)(D) the use of the meeting room by the government official does not constitute an act of self-dealing within the meaning of IRC 4941(d)(1)(C).

Sales or exchanges of property that are functionally related

Treas. Reg. 53.4941(d)-3(b) provides that the furnishing of goods, services, or facilities by a foundation to a disqualified person is not an act of self-dealing if the same goods, etc. are made available to the general public on at least as favorable a basis and the goods, services, or facilities are functionally related (as defined in §4942(j)(4)) to the exercise or performance by the foundation of its exempt purpose.  There must be a substantial number of persons, other than disqualified persons, who are actually utilizing such goods, services, or facilities.

Rev Rul. 76-459, 1976-2 C.B. 369 provides that generally, by permitting a disqualified person to use its private road, a foundation would be engaging in an act of self-dealing.  However, here, the road is made available to the disqualified person on a basis that is no more favorable than the basis on which it is made available to the general public. In addition, a substantial number of persons other than the disqualified persons use the road. The fact that the disqualified person has agreed to maintain the road does not entitle it to any special privileges with respect to the use of the road not otherwise available to the general public. Further, the use of the road as an entrance to the foundation's museum is functionally related within the meaning of IRC 4942(j) to the foundation’s exempt purpose of operating a museum for the benefit of the general public.

Similarly, in Rev. Rul. 79-374, 1979-2 C.B. 387, the renting of office space by a foundation to a disqualified person is generally an act of self-dealing. An exception to this rule is provided where rental of office space is functionally related to a foundation's exempt purpose. In this ruling, although the disqualified persons conduct business activities in the same general subject area of the foundation's research, the rental of office space to the disqualified person does not contribute importantly to the foundation's exempt purpose of conducting agricultural research and experimentation. Therefore, the rental of office space is not functionally related to the organization's exempt purpose. Since the rental of office space is not functionally related to the foundation's exempt purpose, within the meaning of IRC 4942(j), the exception to the self-dealing rules provided in IRC 4941(d)(2)(D) do not apply.

Sales or exchanges of property that take place during a liquidation or merger

Section 53.4941(d)-3(d) provides that under certain conditions, a transaction between a foundation and a corporation which is a disqualified party is not considered self-dealing if the transaction takes place pursuant to a liquidation, merger, redemption, recapitalization, or other corporate adjustment, organization, or reorganization.  The foundation must be afforded at least as favorable treatment as other holders of securities in the corporation for the transaction not to be considered self-dealing. Compensating the foundation with property, such as debentures, for its stock when other holders of identical stock receive cash is evidence of not treating the foundation on a uniform basis. See Treas. Reg. 53.4941(d)-3(d)(2) for examples of this provision.

Examples:

Rev. Rul. 76-18, 1976-1 C.B. 355, held that the sale of a foundation’s art objects to a disqualified person at a public auction conducted by an auction gallery to which the items were consigned for sale constitutes an act of self-dealing. The auctioneer is the agent of the seller and, under such circumstances, the seller and highest bidder for the property (the disqualified person) are principals to the transaction.  The general rule applies that sales between a disqualified person and a private foundation are acts of self-dealing.

Rev. Rul. 77-259, 1977-2 C.B. 387, held that the purchase by a foundation of a mortgage from a bank, a disqualified person, that in the normal course of its business acquires and sells mortgages, was not within the exception for general banking services and was an act of self-dealing under IRC 4941(d)(1)(A).

Leased property

Under IRC 4941(d)(1)(A) the leasing of property between a foundation and a disqualified person generally constitutes self-dealing. However, the leasing of property by a disqualified person to a foundation without charge is not an act of self-dealing.  Section 53.4941(d)-2(b)(2) provides that a lease is without charge even though the foundation pays for janitorial services, utilities, or other maintenance costs, if the payment is not made directly or indirectly to a disqualified person.

Public Law 96-608, effective December 28, 1980, amended IRC 4941(d)(2) to provide a permanent exception to IRC 4941(d)(1)(A) in certain circumstances where a private foundation leases office space from a disqualified person. The exception, described in IRC 4941(d)(2)(H), provides that the leasing by a disqualified person to a foundation of office space for use by the foundation in a building with other tenants who are not disqualified person’s shall not be treated as an act of self-dealing if: (i) the leasing of office space is pursuant to a binding lease which was in effect on October 9, 1969, or pursuant to renewals of such a lease; (ii) the execution of the lease was not a prohibited transaction (within the meaning of IRC 503(b) or any corresponding provision of prior law) at the time of the execution; and (iii) the terms of the lease (or any renewal) reflect an arm's-length transaction.

Section 53.4941(d)-4(f) provides that the sale, exchange, or other disposition (other than by lease) to a disqualified person, of property being leased to the disqualified person by the foundation is not an act of self-dealing if:

(i) the foundation is leasing substantially all the property to the disqualified person under a lease to which Treas. Reg. 53.4941(d)-4(c) applies;

(ii) the disposition occurs after October 4, 1976, and before January 1, 1978; and

(iii) the disposition satisfies the requirements of Treas. Reg. 53.4941(d)-4(f)(2).

Rev. Rul. 73-363, 1973-2 C.B. 383 provided the rental of charter aircraft by a disqualified person to a private foundation is a furnishing of property for use by the foundation and does not constitute the performance of personal services within the meaning of Treas. Reg. 53.4941(d)-3(c). Such rental is analogous to the rental of automobiles and is therefore a furnishing of goods, services, or facilities as described in Treas. Reg. 53.4941(d)-2(d). The fact that the rate charged is comparable to rates charged by other aircraft companies is not a relevant factor.  Accordingly, the rental of charter aircraft by the disqualified person to the foundation under the circumstances described constitutes an act of self-dealing under IRC 4941(d)(1)(C).

Issue Indicators or Audit Tips

Issue Indicators

Review the Form 990-PF to determine if any lease payments were made to the foundation from a disqualified person.

Review the Form 990-PF and see if any property has been sold by the foundation and identify the purchaser to ensure it is not a disqualified person.

Audit Tips

Examine the income stream of the foundation to ensure the income is not being derived from any activity involving a disqualified person. If so, determine if the activity falls within one of the exceptions to self-dealing pursuant to IRC 4941.

Review if there is a mortgage or lien on a non-cash gift such as property. If there is, it may be considered a sale from a disqualified person.

Review balance sheet items on Part II of Form 990-PF which may indicate sale, exchange or leasing of property with disqualified persons.  Check if there are additions or reductions in asset balances on Line 14 for land, buildings and equipment.

Review and verify transactions reported in Line #6 for receivables due from officers, directors, trustees and other disqualified persons and Line #20 for loans from officers, directors, trustees and other disqualified persons.