Assets test. A private foundation will meet the assets test if 65% or more of its assets:
Are devoted directly to the active conduct of its exempt activity, a functionally related business, or a combination of the two,
Consist of stock of a corporation that is controlled by the foundation (by ownership of at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total shares of all other classes of stock) and at least 85% of the assets of which are so devoted, or
Are any combination of (1) and (2).
Qualifying assets. An asset is devoted directly to the foundation’s exempt purpose only if it is used by the foundation in actually carrying on the charitable, educational, or other similar function that gives rise to the exempt status of the foundation. Assets such as real property, physical facilities or objects (such as museum assets, classroom fixtures, and research equipment) and intangible assets (such as patents, copyrights, and trademarks) are directly devoted to the extent they are used by the foundation in directly carrying on its exempt activities or program. However, assets (for example, stock, bonds, or rental property) including endowment funds, when held primarily for the production of income, for investment, or for some similar use, are not devoted directly to the active conduct of the foundation’s exempt function, even though income from the assets is used to carry on the foundation’s exempt function.
Whether an asset is held for the production of income, for investment, or for some similar use, rather than being used for the active conduct of the foundation’s exempt activities, is a question of fact.
For example, an office building used to provide offices for employees engaged in the management of endowment funds of the foundation is not devoted to the active conduct of the foundation’s exempt activities.
However, for property used both for exempt and other purposes, if the exempt use of the property represents at least 95% of the total use, the property will be considered to be used exclusively for an exempt purpose. Property acquired by a foundation to be used in carrying out its exempt purpose may be considered devoted directly to the active conduct of that purpose even though the property, in whole or in part, is leased for a limited and reasonable period of time during which arrangements are made for its conversion to the use for which it was acquired. Generally, one year is considered a reasonable period of time. Similarly, when property is leased by a foundation in carrying out its exempt purpose and when the rental income received from the property by the foundation is less than the amount that would be required to be charged to recover the cost of purchase and maintenance of the property, the property will be considered devoted directly to the active conduct of the foundation’s exempt activities.
Fair market value must be used in determining whether 65% or more of the assets are devoted directly to exempt purposes. However, in the case of assets that are unique and for which no ready market or standard valuation method exists, such as historical objects, buildings, certain works of art, and botanical gardens, the historical cost (unadjusted for depreciation) will be considered fair market value, unless the foundation can show that fair market value is other than cost. If the foundation can show that fair market value is other than cost, this substituted valuation may be used for the tax year for which the new valuation is shown and for each of the following 4 tax years.
See Valuation of assets for a discussion of valuations.
Assets maintained for extending credit or making funds available to members of a charitable class are not considered assets devoted directly to the active conduct of exempt activities. For example, assets set aside in special reserve accounts to guarantee student loans made by lending institutions will not be considered qualifying assets. Even though amounts set aside for specific projects may qualify (as explained earlier) as distributions expended directly for the active conduct of exempt activities for the income test, they do not qualify under the assets test as assets devoted directly to the active conduct of the foundation’s exempt activities.
Assets held for less than a full tax year. In applying the assets test, assets held for only part of the tax year are taken into account for the year by multiplying the fair market value of each asset by a fraction. The numerator of the fraction is the number of days during the year that the foundation held the asset, and the denominator is the total number of days in the year.