Court-ordered land auction to disqualified person avoids self-dealing

Plain-English summary

A private foundation owned a 49.9 percent interest in a partnership holding about 6,000 acres, while a substantial contributor owned 0.1 percent and the remaining interests were held by the contributor's sister and another foundation. After years of litigation, a court ordered several related partnerships' land sold together at a public auction run by the local county. The substantial contributor planned to bid on the property. The IRS concluded that the foundation did not control the partnership under the regulatory aggregation tests and that the court-supervised auction would occur at arm's length. A winning purchase by the substantial contributor therefore would not be direct or indirect self-dealing under section 4941. The IRS did not decide whether the foundation's resulting transfer would be a qualifying distribution under section 4942(g)(3).

Ruling snapshot

• Question: Would a disqualified person's winning bid at the court-ordered public auction create self-dealing for the foundation?
• Outcome: Approved, the sale would not constitute self-dealing
• Key authorities: IRC §§ 507(d)(2), 4941, and 4946(a)(1); Treas. Reg. §§ 53.4941(d)-1 and 53.4941(d)-2; Rev. Rul. 76-158

Full text (IRS public release)

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

Number: 201510050

Release Date: 3/6/2015

Contact Person:

Identification Number:

Telephone Number:

Employer Identification Number:

Date: December 10, 2014

Legend:

Partnership =
DP =
Sister =
Foundation =
Date =

UIL: 4941.00-00

Dear :

This is in response to your letter dated September 25, 2014 in which you requested certain rulings
with respect to I.R.C. § 4941.

Background:

You are exempt under § 501(c)(3), and you are characterized as a private foundation under § 509(a).
You own a 49.9 percent income interest in Partnership, which owns nearly 6,000 acres of farmland
and wetland, almost entirely consisting of wetlands. The other partners in Partnership with you
include a disqualified person (DP), owning .1 percent of the partnership, who is a substantial
contributor to you; Sister, owning 3.56 percent of the partnership, who is the sister of DP; and
Foundation, owning 46.44 percent of the partnership, to which Sister is a substantial contributor. Both
you and Foundation were founded by DP’s and Sister’s mother, who is a substantial contributor to
both foundations.

DP and Sister are also partners in several other partnerships all owning a total of approximately
16,000 acres of land, including the land discussed above. DP and Sister have been unable to
determine the appropriate use of the land held by these partnerships for a number of years. The
inability to agree led to years of contentious court battles over the appropriate use and disposition of
the land held by these partnerships. After years of litigation, the court issued an order that all the
partnerships are to be liquidated and all of the land held by them is to be sold as one unit. The
proceeds from such a sale will be divided among the partners in accordance with their income share
and total acreage owned by their particular partnership. The appointed Special Master has
determined that these lands will be sold in a public auction after Date. The auction will be conducted
by the local county where the land is located.

DP proposes to bid in the public auction in an attempt to buy the full amount of the land, including the
6,000 acres owned by Partnership. Should DP have the highest bid he will purchase the land from

Partnership with proceeds going to both you and Foundation in proportion to the foundations’ income
interests in the land.

Ruling Requested:

The sale of the underlying assets of the partnership to DP, should he get the winning bid, will not
result in “self-dealing” as defined in § 4941.

Law:

I.R.C. § 507(d)(2) provides that a substantial contributor means any person who contributed or
bequeathed an aggregate amount of more than $5,000 to the private foundation, if such amount is
more than two percent of the total contributions and bequests received by the foundation.

I.R.C. § 4941 imposes a tax on each act of self-dealing between a disqualified person and a private
foundation.

I.R.C. § 4941(d)(1) defines self-dealing as the direct or indirect sale or exchange of property between
a private foundation and a disqualified person, the direct or indirect furnishing of goods, services, or
facilities between a disqualified person and a private foundation, and the direct or indirect payment of
compensation by a private foundation to a disqualified person among other things.

I.R.C. § 4946(a)(1) provides that a “disqualified person,” with respect to a private foundation, includes
a substantial contributor, as defined under section 507(d)(2); a foundation director, trustee, or officer;

and any spouse, ancestor, child, grandchild, great grandchild, and any spouse of a child, grandchild,

or great grandchild of that contributor, director, or officer.

Treas. Reg. § 53.4941(d)-1(a) provides that it is immaterial whether a transaction results in a benefit
or a detriment to the private foundation in determining whether the transaction is an act of self-
dealing.

Treas. Reg. § 53.4941(d)-1(b)(5) provides that an organization is controlled by a private foundation if
the foundation or one or more of its foundation managers (acting only in such capacity) may, only by
aggregating their votes or positions of authority, require the organization to engage in a transaction
which if engaged in with the private foundation would constitute self-dealing. Similarly, for purposes of
this paragraph, an organization is controlled by a private foundation in the case of such a transaction
between the organization and a disqualified person, if such disqualified person, together with one or
more persons who are disqualified persons by reason of such a person's relationship to such
disqualified person, may, only by aggregating their votes or positions of authority with that of the
foundation, require the organization to engage in such a transaction. The “controlled” organization
need not be a private foundation.

Treas. Reg. § 53.4941(d)-2(a) provides two examples of acts of self-dealing through a sale or
exchange. The examples include the sale of incidental supplies by a disqualified person to a private
foundation regardless of the amount paid to the disqualified person and the sale of stock or other
securities by a disqualified person to a private foundation in a “bargain sale” regardless of the amount
paid for such stock or other securities.

Revenue Ruling 76-158, 1976-1 C.B. 354, A private foundation, owning thirty-five percent of the

voting stock of a corporation and having a foundation manager personally owning the remaining sixty-
five percent but not holding a position of authority in the corporation by virtue of being foundation
manager, does not control the corporation for purposes of the self-dealing provisions of § 4941.

Analysis:

Section 4941 defines self-dealing as, among other things, the direct or indirect sale or exchange of
property between a private foundation and a disqualified person. Such a transaction between a
private foundation and a disqualified person will constitute an act of direct self-dealing, while a similar
transaction between a disqualified person and an organization controlled by the private foundation will
constitute an act of indirect self-dealing.

For purposes of determining whether an organization is controlled by a private foundation,

§ 53.4941(d)-1(b)(5) provides that an organization is considered to be controlled by a private
foundation if any one of four circumstances exist: (1) if the private foundation alone can control the
organization; (2) if the private foundation, by aggregating its votes or positions of authority with those
of one or more foundation managers (acting only in such capacity) can control the organization; (3) if
a foundation manager (acting only in such capacity) alone can control the organization; or (4) if the
foundation managers (acting only in such capacity), by aggregating their votes or positions of
authority with one another, can control the foundation. Here, you have demonstrated that you do not
control the partnership owning the land in the ways defined under § 53.4941(d)-1(b)(5). First, you do
not control the partnership on your own as you do not own over fifty percent of the voting stock of the
partnership. Second, there is no foundation manager that owns a voting interest in the partnership in
their capacity as a foundation manager so you cannot aggregate your shares with any such
disqualified person. See Rev. Rul. 76-158, supra. This fact means that you do not meet any of the
others of these four tests.

Section 53.4941(d)-1(b)(5) also provides that an organization is controlled by a private foundation in

the case of such a transaction between the organization and a disqualified person, if such disqualified
person, together with one or more persons who are disqualified persons by reason of such a person's
relationship (within the meaning of section 4946(a)(1)(C) through (G)) to such disqualified person,
may, only by aggregating their votes or positions of authority with that of the foundation, require the
organization to engage in such a transaction. Here, you do not meet this test either since such test
only includes the shares of DP and not those of Sister since sister is not a covered relationship status
under §§ 4946(a)(1)(C) thought (G). By combining your voting interest with that of DP you and DP
control exactly half of the voting interest of the partnership. Given that the other fifty percent is held
by Sister and Foundation, it can be shown through repeated disputes between Sister and DP over the
direction of the partnership and the land it owns that neither Foundation and Sister on the one hand or
you and DP on the other hand exercises control over the organization.

Additionally, you have many factors on your side to indicate that the sale of property is not controlled
by you, and that such sale is done in an arm’s length manner. The sale of the property is a result of a
court order by an impartial court after years of contested litigation. These proceedings make clear
that Sister, who controls the other half of the partnership and receives the other half of the income
created from the sale, is seeking the highest price and greatest return from the sale. The sale will be
conducted by a third party government official through an auction format, which will result in the
highest market price given that only the highest bid will win. These factors all indicate that the
transaction will occur at arm’s length and in the absence of control by one of the parties.

Given that you do not control the partnership within the meaning of § 53.4941(d)-1(b)(5), there can be
no indirect self-dealing. And since you are not disposing of the property yourself there is no direct
self-dealing.

Ruling:

The sale of the underlying assets of the partnership to DP, should he get the winning bid, will not
result in “self-dealing” as defined in § 4941.

This ruling will be made available for public inspection under section 6110 of the Code after certain
deletions of identifying information are made. For details, see enclosed Notice 437, Notice of
Intention to Disclose. A copy of this ruling with deletions that we intend to make available for public
inspection is attached to Notice 437. If you disagree with our proposed deletions, you should follow
the instructions in Notice 437.

This ruling is directed only to the organization that requested it. Section 6110(k)(3) of the Code
provides that it may not be used or cited by others as precedent.

This ruling is based on the facts as they were presented and on the understanding that there will be
no material changes in these facts. This ruling does not address the applicability of any section of the
Code or regulations to the facts submitted other than with respect to the sections described.
Specifically, this ruling does not reach any conclusion as to the qualifying distribution status of your
proposed transfer under § 4942(g)(3). Because it could help resolve questions concerning your
federal income tax status, this ruling should be kept in your permanent records.

If you have any questions about this ruling, please contact the person whose name and telephone
number are shown in the heading of this letter.

In accordance with the Power of Attorney currently on file with the Internal Revenue Service, we are
sending a copy of this letter to your authorized representative.

Sincerely,

Mary Jo Salins
Acting Manager, Exempt Organizations

Enclosure
Notice 437