Tax on Net Investment Income: Capital Gains and Losses


In figuring the tax on net investment income, a private foundation must include any capital gains and losses from the sale or other disposition of property held for investment purposes or for the production of income.  This includes capital gain dividends received from a regulated investment company.  If the foundation sells or otherwise disposes of property used in the production of income that is subject to the unrelated business income tax, any gain or loss from the sale of that property must be included in net investment income, but only to the extent that it is not included in figuring the tax on unrelated business income.  Property is treated as held for investment purposes even though the property is disposed of by the foundation immediately upon its receipt, if it is the kind of property that generally produces interest, dividends, rents, royalties, or capital gains through appreciation.

The Pension Protection Act of 2006, P.L. 109-280 (PPA), signed by the President on August 17, 2006, makes clear that, for taxable years beginning after enactment, gross investment income, as defined in section 4940(c)(2) of the Internal Revenue Code, includes income from sources similar to other sources specified. It also changes the treatment of capital gains and losses so that all capital gains and losses, including capital gains and losses from the sale or other disposition of assets used to further an exempt purpose, are included in gross income.  In addition to the exception for gains or losses included in figuring the tax on unrelated business income (described above), there is a specific exception for like-kind exchanges of related-use property. 

Losses.  Capital losses from the sale or other disposition of investment property may be sub­tracted from capital gains incurred in the sale or disposition of other investment property during the same tax year, but only to the extent of the gains.  If the capital losses are greater than the capital gains, the excess may not be subtracted from gross investment income, nor may the losses be carried back or forward to other tax years regardless of whether the foundation is a corporation or a trust.

Basis.  The basis for determining gain from the sale or other disposition of property is the greater of:

  1. The fair market value of the property on December 31,1969, plus or minus all adjustments after 1969 and before the date of disposition if the property was held by the private foundation on that date and continuously thereafter until disposition, or
  2. The basis of the property on the date of disposition under normal basis rules (actual basis).

For purposes of determining gain on prop­erty acquired by gift after December 31, 1969, the basis of the property is its basis in the hands of the donor at the time of the gift.

Normal basis rules are used in determining a loss on disposition.  For purposes of determining a loss, the basis of property acquired by gift is the lesser of the donor’s basis at the time of the gift or the fair market value at the time of the gift.  The rules that generally apply to dispositions of property are used to calculate gain or loss.

Securities listed on recognized stock ex­change.  The fair market value for figuring ba­sis for determining gain on the sale or exchange of stocks and bonds traded on a stock ex­change, in an over-the-counter market, or other­wise, is the mean between the highest and lowest quoted selling prices on the valuation date.

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