Deductions - Net Investment Income of Private Foundations


The net investment income of a private foundation is the amount by which its gross investment income and net capital gain exceed allowable deductions. In determining net investment income, a private foundation may deduct from gross investment income all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment in­come or for the management, conservation, or maintenance of property held for the production of income, subject to the modifications given later. Expenses include the part of the foundation’s operating expenses that is paid or incurred for the production or collection of gross investment income. A private foundation’s oper­ating expenses include compensation of of­ficers, other salaries and wages of employees, outside professional fees, interest, rent, and taxes on property used in the foundation’s oper­ations. However, the tax on net investment in­come may not be deducted.

If any expenses, including salaries and com­pensation, are incurred for both investment pur­poses and exempt purposes, they must be allocated between the investment activities and the exempt activities. Expenses paid or incurred for exempt functions are not deductible in figur­ing net investment income. Also, any expenses that are taken into account in figuring the tax on unrelated business income may not be de­ducted in figuring net investment income.

No deduction is allowed for any expense that was not incurred for the purposes stated earlier. Thus, no deduction is allowed for charitable con­tributions, net operating losses, or any of the special deductions for corporations.

Deduction modifications. The following modifications must be made to otherwise allow­able deductions in arriving at net investment income:

  • Depreciation is allowed only on the basis of the straight line method,
  • Depletion is allowed only on the basis of the cost depletion method,
  • The basis used in figuring depreciation or depletion is the basis determined under normal basis rules, without regard to the fair market value on December 31,1969 (see Basis, under Capital Gains and Losses), and
  • The deduction for expenses paid or in­curred in any tax year for the production of gross investment income earned as an in­cident to a charitable function cannot be greater than the income earned from the function that is includible as gross invest­ment income for the year. For example, when rental income is incidentally realized in 2008 from historic buildings held open to the public, deductions paid or incurred in 2008 for the production of that income will be limited to the amount of rental income includible as gross investment income for 2008.

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