Foundation receives rules for inherited business interests, apartment rent, and mortgage debt

Plain-English summary

A private foundation is the remainder beneficiary of a trust that will distribute corporate and limited liability company interests after the death of the current beneficiary. The assets include an interest in a company that owns a mortgaged apartment complex. The IRS ruled that the estate-administration exception to indirect self-dealing will be available during a reasonable settlement period, although it did not approve any particular transaction. Stock in a real estate management corporation will be an excess business holding, but the foundation will have five years from distribution to dispose of it if the stated conditions are met. The apartment rent will qualify as rent from real property excluded from unrelated business taxable income, except to the extent the debt-financed income rules apply. The apartment mortgage will not count as acquisition indebtedness for 10 years after the foundation acquires the interest, provided the foundation neither assumes the debt nor pays for the equity.

Ruling snapshot

• Question: How will the self-dealing, excess-business-holdings, rental-income, and debt-financed-income rules apply when the foundation receives the trust's business interests?
• Outcome: Approved (all five requested rulings granted, subject to stated conditions)
• Key authorities: IRC §§ 512(b)(3), 514(c)(2)(B), 4941, 4943(c), 4947; Treas. Reg. §§ 1.512(b)-1(c)(5), 1.514(c)-1(b)(3), 53.4941(d)-1(b)(3), 53.4943-6(b)(1), 53.4947-1(b)(2)(v)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201849009                                              [Third Party Communication:
Release Date: 12/7/2018                                        Date of Communication: Month DD, YYYY]
Index Number: 512.01-02, 514.00-00,
              4941.04-00, 4943.03-00                           Person To Contact:
                                                               -----------------------, ID No. -------------------
------------------------------------------------------------   ---------------------------------------------------
--------                                                       Telephone Number:
-----------------------------------------                      ----------------------
 ------------------------------                                Refer Reply To:
                                                               CC:TEGE:EOEG:EO1
                                                               PLR-107056-18
                                                               Date:
                                                               August 24, 2018




Legend:

Foundation        = -------------------------------------------------------------------
Trust             = ---------------------------------
Trustor           = -------------------------
Spouse            = -------------------------
Corp1             = ---------------------------
Corp2             = -----------------------------
Corp3             = --------------------------------
LLC1              = ----------------------------------
LLC2              = ----------------------------------------
LLC3              = ---------------------------------
Date1             = -----------------------
Date2             = ------------------------
Date3             = -----------------------

Dear -------------:

This letter responds to Foundation’s March 1, 2018, request for rulings regarding
unrelated business income tax and excise tax issues under sections 512, 514,
4941, 4943, and 49471 in connection with the termination of Trust and receipt of
Trust property.

Facts


1
    All section references are to the Internal Revenue Code of 1986, as amended, unless otherwise stated.


According to the information provided by Foundation, Trust is an irrevocable trust
created under a revocable living trust agreement dated Date1 by Trustor, as amended
by a first amendment dated Date2 (together, the "Trust Agreement"). Trust was created
after the death of Trustor. Executors of Trustor’s estate elected to treat all the assets of
Trust as qualified terminable interest property (QTIP) pursuant to section
2056(b)(7)(B)(v). No deductions were claimed under sections 170, 545(b), 642(c),
2055, 2106(a)(2), or 2522 with respect to any assets transferred to Trust at Trustor's
death.

Under the Trust Agreement, Trustor’s spouse (Spouse) is entitled to receive during
Spouse’s lifetime all the net income of Trust and distributions from principal within the
discretion of the trustees for Spouse’s care, support, health, and maintenance. The
assets of Trust remaining at Spouse's death are distributable to Foundation. At
Spouse's death, all the assets of Trust will be includible in Spouse's gross estate
pursuant to section 2044 and, if the requirements are satisfied, will be deductible from
Spouse's gross estate pursuant to section 2055.

Under the Trust Agreement, the trustees of Trust have the authority to sell or exchange
trust property and to acquire by purchase or exchange such property as the trustees
may deem advisable.

Foundation is recognized as exempt from federal income tax under section 501(c)(3)
and as a private foundation. Foundation was created under a charitable trust
agreement dated Date3 by Trustor and Spouse as donors.

Corp1 is a domestic stock corporation wholly owned by Trust and an S corporation for
federal income tax purposes. Spouse, as the sole income beneficiary of Trust, made a
timely election to treat that portion of Trust holding the stock of Corp1 as a qualified
subchapter S trust under section 1361(d)(2)(A).

Corp2 is a domestic stock corporation wholly owned by LLC1, which is a domestic
single-member limited liability company wholly owned by Corp1 and a disregarded
entity for federal tax purposes.

Corp3 is a domestic stock corporation wholly owned by Corp2 and manages residential
real estate properties. Corp2 and Corp3 are qualified Subchapter S subsidiaries of
Corp1 under section 1361(b)(3) and thus are not treated as separate corporations from
Corp1 for federal tax purposes.

LLC2 is a domestic limited liability company treated as a partnership for federal tax
purposes in which Trust and Corp2 own a large minority interest; Corp2 also manages
LLC2.

LLC3 is a domestic limited liability company treated as a partnership for federal tax
purposes and majority-owned by Trust. LLC3 owns an apartment complex with parking
spaces available for no additional charge for tenants and guests only, an on-site leasing


office, clubhouse, fitness room, swimming pool, picnic area, and spa. There is
mortgage indebtedness against the LLC3 real property. The personnel involved in the
operation of the property, provided by Corp3, consist of a property manager who
oversees the leasing and maintenance functions, a leasing agent responsible for
leasing the apartments, and a maintenance manager and maintenance technician who
provide maintenance as needed to tenants with plumbing, electrical, appliance, or other
problems with the property. The services provided to tenants of the apartment units by
LLC3 are limited to necessary and customary maintenance and utility services. The
maintenance staff provides janitorial and related services for common areas only, such
as the clubhouse, fitness room, swimming pool, picnic area, and spa, which are made
available to all tenants as an amenity with no additional charge. Tenants are
responsible for paying for their own gas and electric services, and for their share of
water, sewer, and garbage services. A contract landscaping company maintains the
common-area grounds. LLC3 also contracts with an independent security company for
property security. No pool lifeguard or other services in connection with property
common areas are provided. No housekeeping, cleaning, or other services are
provided for occupied apartment units other than the general maintenance services
described above and necessary preventative maintenance, including checking fire
extinguishers and examining smoke alarms. LLC3 provides "turnkey" cleaning when an
apartment is vacated, and tenants are responsible for any damage to apartment units
beyond ordinary wear and tear. Repainting and other unit upgrades are done only when
apartments are vacated or when required to retain the property in rentable condition. All
of the services described above are rendered only in connection with the rental of
apartment units for personal occupancy.

Tenants pay rent only for their respective private apartment dwelling units. Apartment
units are unfurnished and contain only the usual kitchen and laundry appliances, for
which there is no separate rent charged. The portion of rents attributable to these
appliances, if any, is minimal, and in any case well below 5% of overall rents. No rents
are based in whole or in part on the income or profits derived by any person from the
property leased.

During the lifetime of Spouse (i.e., before termination of Trust), LLC2 or Corp2 may
have an opportunity to exercise its option to purchase from a member, or a member of
LLC2 may elect to require LLC2 or Corp2 to purchase, the member's interest in LLC3
for fair market value, as determined by appraisal, either for cash at closing or in
installments pursuant to a promissory note.

During the lifetime of Spouse, LLC3 or Corp2 may have an opportunity to exercise its
option to purchase from a member, or a member of LLC3 may elect to require LLC3 or
Corp2 to purchase, the member's interest in LLC3 for fair market value, as determined
by appraisal, either for cash at closing or in installments pursuant to a promissory note.

After the death of Spouse, the assets of Trust will become distributable to Foundation.
Currently those assets would include Trust's interest in Corp3, LLC2, and LLC3. During
the administration of Trust pending distribution to Foundation, LLC2 or Corp2 may have


an opportunity to exercise its option to purchase from a member, or a member of LLC2
may elect to require LLC2 or Corp2 to purchase, the member's interest in LLC2 for fair
market value, either for cash at closing or in installments pursuant to a promissory note.
During administration of Trust pending distribution to Foundation, LLC3 or Corp2 may
have an opportunity to exercise its option to purchase from a member, or a member of
LLC3 may elect to require LLC3 or Corp2 to purchase, the member's interest in LLC3
for fair market value, either for cash at closing or in installments pursuant to a
promissory note.

Rulings Requested

Foundation requests the following rulings:

1. After the death of Spouse, the estate administration exception to indirect self-dealing
under Treas. Reg. § 53.4941(d)-1(b)(3) will be available with respect to transactions
between Trust and disqualified persons during a reasonable period of settlement within
the meaning of Treas. Reg. § 53.4947-1(b)(2)(v).

2. Trust's stock in Corp3 will constitute an excess business holding under section
4943(c) upon distribution to Foundation.

3. Foundation will have a period of five years within which to dispose of Corp3 stock or
other excess business holdings (within the meaning of section 4943(c)) distributed from
Trust to Foundation after the death of Spouse, commencing on the date of distribution
to Foundation, provided that (a) the Corp3 stock or other excess business holding was
held by Trust at Spouse's death and (b) the Corp3 stock or other excess business
holding is distributed to Foundation within a reasonable period of settlement of Trust
under Treas. Reg. § 53.4947-1(b)(2)(v).

4. Foundation‘s share (or that of Trust at any time when Trust is subject to section
4947) of rental income received by LLC3 will constitute "rents from real property" under
section 512(b)(3)(A)(i), excludible from unrelated business taxable income under
section 512(a)(1), except to the extent attributable to debt-financed property under
sections 512(b)(4) and 514.

5. For purposes of determining unrelated business taxable income under section 512,
and pursuant to section 514(c)(2)(B), any indebtedness secured by mortgages against
real property owned by LLC3 will not be treated as acquisition indebtedness for
purposes of section 514(a) during a period of ten years following the date of acquisition
by Foundation of any interest in LLC3, provided that (a) Foundation does not assume
and agree to pay the indebtedness secured by the mortgages and (b) Foundation does
not make any payment for the equity in the property.


Law

Section 501(a) exempts from federal income taxation organizations described in
section 501(c).

Section 501(c)(3) describes organizations organized and operated exclusively for
charitable purposes.

Section 509(a) provides that, unless specifically excepted, any organization described
in section 501(c)(3) is a private foundation.

Section 511(a)(1) imposes a tax for each taxable year on the unrelated business
taxable income of every organization described in section 501(a).

Section 512(a)(1) provides that the term "unrelated business taxable income" means
the gross income derived by any organization from any unrelated trade or business
regularly carried on by it, less the deductions allowed by this chapter which are
directly connected with the carrying on of such trade or business.

Section 512(b)(3)(A)(i) excludes from unrelated business taxable income rents from
real property.

Section 512(b)(4) provides, in part, that notwithstanding section 512(b)(3), unrelated
business taxable income includes the amount ascertained under section 514(a)(1).

Section 513(a) provides that the term "unrelated trade or business" means, in the
case of an organization subject to the tax imposed by section 511, any trade or
business the conduct of which is not substantially related (aside from the need of
such organization for income or funds or the use it makes of the profits derived) to the
exercise or performance of such organization of its charitable, educational, or other
purpose or function constituting the basis for its exemption under section 501.

Section 514(a)(1) provides that in computing under section 512 the unrelated
business taxable income for any taxable year, there shall be included with respect to
each debt-financed property as an item of gross income derived from an unrelated
trade or business an amount which is the same percentage (but not in excess of 100
percent) of the total gross income derived during the taxable year from or on account
of such property as the average acquisition indebtedness (as defined in section
514(c)(7)) for the taxable year with respect to the property is of the average amount
(determined under regulations prescribed by the Secretary) of the adjusted basis of
such property during the period it is held by the organization during such taxable year.

Section 514(b)(1) defines "debt-financed property" as any property which is held to
produce income and with respect to which there is an acquisition indebtedness at any


time during the taxable year (or, if the property was disposed of during the taxable
year, with respect to which there was an acquisition indebtedness at any time during
the 12-month period ending with the date of such disposition).

Section 514(c)(1) defines "acquisition indebtedness," with respect to any debt-
financed property, as the outstanding amount of the indebtedness incurred in
acquiring or improving the property, the indebtedness incurred before the acquisition
or improvement of such property if such indebtedness would not have been incurred
but for such acquisition or improvement, and the indebtedness after the acquisition or
improvement of such property if such indebtedness would not have been incurred but
for such acquisition or improvement and the incurrence of such indebtedness was
reasonably foreseeable at the time of such acquisition or improvement.

Section 514(c)(2)(A) provides that where property is acquired subject to a mortgage
or other similar lien, the amount of indebtedness secured by such lien or mortgage
shall be considered as an indebtedness of the property acquired even if the
organization did not assume or agree to pay the indebtedness.

Section 514(c)(2)(B) provides that where an organization acquires property by
bequest or devise, the indebtedness secured by the mortgage shall not be treated as
acquisition indebtedness during a period of 10 years following the date of acquisition.
If the organization acquires property by gift subject to a mortgage which was placed
on the property more than 5 years before the gift, which property was held by the
donor more than 5 years before the gift, the indebtedness secured by such mortgage
shall not be treated as acquisition indebtedness during a period of 10 years following
the date of such gift. This exception does not apply if the organization, in order to
acquire the equity in the property by bequest, devise, or gift, assumes and agrees to
pay the indebtedness secured by the mortgage, or if the organization makes any
payment for the equity in the property owned by the decedent or the donor.

Section 4941(a) imposes an excise tax on disqualified persons (as defined in section
4946) for each act of self-dealing between a disqualified person and a private
foundation.

Section 4941(d)(1) defines "self-dealing" as any direct or indirect (1) sale or
exchange, or leasing, of property between a private foundation and a disqualified
person, (2) lending of money or other extension of credit between a private foundation
and a disqualified person, (3) furnishing of goods, services, or facilities between a
private foundation and a disqualified person, (4) payment of compensation (or
payment or reimbursement of expenses) by a private foundation to a disqualified
person, or (5) transfer to, or use by or for the benefit of, a disqualified person of the
income or assets of a private foundation.


Section 4941(d)(2)(A) provides, in pertinent part, that the transfer of real or personal
property by a disqualified person to a private foundation shall be treated as a sale or
exchange if the property is subject to a mortgage or similar lien which a disqualified
person placed on the property within a 10-year period.

Section 4943(a)(1) imposes an excise tax on a private foundation's excess business
holdings in a business enterprise during any tax year.

Section 4943(c)(1) defines "excess business holdings" as the amount of stock or
other interest in any business enterprise which a private foundation would have to
dispose of to a person other than a disqualified person in order for the remaining
holdings of the foundation in such enterprise to be permitted holdings.

Section 4943(c)(2)(A) provides, in part, that the permitted holdings of any private
foundation in an incorporated business enterprise are 20 percent of the voting stock,
reduced by the percentage of the voting stock owned by all disqualified persons.

Section 4943(c)(6) provides, in pertinent part, that if there is a change in the holdings
in a business enterprise (other than by purchase by the private foundation or by a
disqualified person) which causes the private foundation to have excess business
holdings in such enterprise, the interest of the foundation in such enterprise
(immediately after such change) shall (while held in the foundation) be treated as held
by a disqualified person (rather than by the foundation) during the 5-year period
beginning on the date of such change in holdings.

Section 4943(d)(1) provides that in computing the holdings of a private foundation, or
a disqualified person (as defined in section 4946) with respect thereto, in any
business enterprise, any stock or other interest owned, directly or
indirectly, by or for a corporation, partnership, estate, or trust shall be considered as
being owned proportionately by or for its shareholders, partners, or beneficiaries.

Section 4946(a)(1) provides that a "disqualified person," with respect to a private
foundation, includes:

      (A) a substantial contributor to the foundation,
      (B) a foundation manager (within the meaning of subsection (b)( l )),
      (C) an owner of more than 20 percent of -
             (i) the total combined voting power of a corporation,
             (ii) the profits interest of a partnership, or
             (iii) the beneficial interest of a trust or unincorporated enterprise,
          which is a substantial contributor to the foundation,
      (D) a member of the family (as defined in section 4946(d)) of any individual
      described in subparagraph (A), (B), or (C),


      (E) a corporation of which persons described in subparagraph (A), (B), (C), or
      (D) own more than 35 percent of the total combined voting power,
      (F) a partnership in which persons described in subparagraph (A), (B), (C), or
      (D) own more than 35 percent of the profits interest,
      (G) a trust or estate in which persons described in subparagraph (A), (B), (C),
      or (D) hold more than 35 percent of the beneficial interest.

Section 4946(a)(2) provides that the term "substantial contributor" means a person
who is described in section 507(d)(2) (i.e., a person who contributed or bequeathed
an aggregate amount of more than $5,000 to the private foundation if such amount is
more than 2 percent of the total contributions and bequests received by the
foundation before the close of the taxable year of the foundation in which the
contribution of bequest is received by the foundation from such person).

Section 4946(a)(4) provides generally that the constructive ownership rules of section
267(c) apply in determining ownership of profits or beneficial interests.

Section 4947(a)(1) provides that, for purposes of chapter 42, a trust which is not
exempt from tax under section 501(a), all of the unexpired interests in which are
devoted to one or more of the purposes described in section 170(c)(2)(B), and for
which a deduction was allowed under section 170, 545(b)(2), 652(c), 2055,
2106(a)(2), or 2522, shall be treated as an organization described in section
501(c)(3).

Section 4947(a)(2) provides in part that, in the case of a trust which is not exempt
from tax under section 501(a), not all of the unexpired interests in which are devoted
to one or more of the purposes described in section 170(c)(2)(8), and which has
amounts in trust for which a deduction was allowed under section 170, 545(b)(2),
652(c), 2055, 2106(a)(2), or 2522, certain Code provisions, including section 4941,
shall apply as if such trust were a private foundation. This paragraph does not apply
with respect to (1) any amounts payable under the terms of such trust to income
beneficiaries, unless a deduction was allowed under section 170(f)(2)(8),
2055(e)(2)(8), or 2522(c)(2)(8), (2) any amounts in trust other than amounts for which
a deduction was allowed under section 170, 545(b)(2), 652(c), 2055, 2106(a)(2), or
2522, if such amounts are segregated from amounts for which no deduction was
allowable, or (3) any amounts transferred in trust before May 27, 1969.

Treas. Reg. § 1.512(b)-1(c)(5) provides that payments for the use or occupancy of
rooms and other space where services are also rendered to the occupant, such as for
the use or occupancy of rooms or other quarters in hotels, boarding houses, or
apartment houses furnishing hotel services, or in tourist camps or tourist homes,
motor courts, or motels, or for the use of occupancy of space in parking lots,
warehouses, or storage garages, do not constitute rents from real property.
Generally, services are considered rendered to the occupant if they are primarily for


his convenience and are other than those usually or customarily rendered in
connection with the rental of rooms or other space for occupancy only. The supplying
of maid service, for example, constitutes such service; whereas the furnishing of heat
and light, the cleaning of public entrances, exists, stairways, and lobbies, the
collection of trash, etc., are not considered as services rendered to the occupant.
Payments for the use or occupancy of entire private residences or living quarters in
duplex or multiple housing units, of offices in any office building, etc., are generally
treated as rents from real property.

Treas. Reg. § 1.514(c)-1(b)(3)(i) provides that where property subject to a mortgage
is acquired by an organization by bequest or devise, the outstanding principal
indebtedness secured by such mortgage is not to be treated as "acquisition
indebtedness" during the 10-year period following the date of acquisition. For
purposes of this exception, the date of the bequest or devise is the date the
organization receives the property.

Treas. Reg. § 1.514(c)-1(b)(3)(ii) provides that if an organization acquires property by
gift subject to a mortgage, the outstanding principal indebtedness secured by such
mortgage shall not be treated as "acquisition indebtedness" during the 10-year period
following the date of such gift, provided that (1) the mortgage was placed on the
property more than 5 years before the date of the gift, and (2) the property was held
by the donor for more than 5 years before the date of the gift. For purposes of the
preceding sentence, the date of the gift is the date the organization receives the
property.

Treas. Reg. § 1.514(c)-1(b)(3)(iii) provides that Treas. Reg. § 1.514(c)-1(b)(3)(i) and
(ii) shall not apply if (1) the organization assumes and agrees to pay all or any part of
the indebtedness secured by the mortgage, or (2) the organization makes any
payment for the equity owned by the donor in the property. Whether an organization
has assumed and agreed to pay all or any part of an indebtedness in order to acquire
the property shall be determined by the facts and circumstances of each action.

Treas. Reg. § 1.641(b)-3(a) provides that the period of administration or settlement of
an estate is the period actually required by the administrator or executor to perform
the ordinary duties of administration, such as the collection of assets and the payment
of debts, taxes, legacies, and bequests, whether the period requires is longer or
shorter than the period specific under the applicable local law for the settlement of
estates. An estate will be considered as terminated when all the assets have been
distributed except for a reasonable amount which is set aside in good faith for the
payment of unascertained or contingent liabilities and expenses (not including a claim
by a beneficiary in the capacity of a beneficiary).

Treas. Reg. § 1.641(b)-3(b) provides that the determination of whether a trust has
terminated depends on whether the property held in trust has been distributed to the


persons entitled to succeed to the property upon termination of the trust rather than
upon the technicality of whether or not the trustee has rendered its final accounting.
A reasonable time is permitted after such event for the trustee to perform the duties
necessary to complete the administration of the trust. Thus, if pursuant to the terms
of the governing instrument, the trust is to terminate upon the death of the life
beneficiary and the corpus is to be distributed to the remainder beneficiary, the trust
continues after the death of the life beneficiary for a period reasonably necessary to a
proper winding up of the affairs of the trust.

Treas. Reg. § 53.4941(d)-1(b)(3) provides that the term "indirect self-dealing" shall
not include a transaction with respect to a private foundation's interest or expectancy
in property (whether or not encumbered) held by an estate (or revocable trust,
including a trust which has become irrevocable on a grantor's death), regardless of
when title to the property vests under local law, if:

      (i) The administrator or executor of an estate or trustee of a revocable trust
      either:
              (a) Possesses a power of sale with respect to the property,
              (b) Has the power to reallocate the property to another beneficiary, or
              (c) Is required to sell the property under the terms of any option subject
              to which the property was acquired by the estate (or revocable trust);
      (ii) Such transaction is approved by the probate court having jurisdiction over
      the estate (or by another court having jurisdiction over the estate (or trust) or
      over the private foundation);
      (iii) Such transaction occurs before the estate is considered terminated for
      Federal income tax purposes pursuant to Treas. Reg. § 1.641(b)-3(a) (or in the
      case of a revocable trust, before it is considered subject to section 4947);
      (iv) The estate (or trust) receives an amount which equals or exceeds the fair
      market value of the foundation's interest or expectancy in such property at the
      time of the transaction, taking into account the terms of any option subject to
      which the property was acquired by the estate (or trust); and
      (v) With respect to transactions occurring after April 16, 1973, the transaction
      either:
              (a) Results in the foundation receiving an interest or expectancy at least
              as liquid as the one it gave up,
              (b) Results in the foundation receiving an asset related to the active
              carrying out of its exempt purposes, or
              (c) Is required under the terms of any option which is binding on the
              estate (or trust).

Treas. Reg. § 53.4943-5(b)(1) provides that the date of distribution shall be deemed
to occur no later than the date on which the trust or estate is considered to be
terminated pursuant to Treas. Reg. § 1.641(b)-3.


Treas. Reg. § 53.4943-6(b)(1) provides that in the case of an acquisition of holdings
in a business enterprise by a private foundation pursuant to the terms of a will or
trust, the five-year period described in section 4943(c)(6) shall not commence until
the date on which the distribution of such holdings from the estate or trust to the
foundation occurs, and refers to rules under Treas. Reg. § 53.4943-5(b)(1) relating to
the determination of the date of distribution pursuant to the terms of a will or trust.

Treas. Reg. § 53.4943-6(b)(1) provides that holdings in a business enterprise will not
be treated as acquired by a private foundation pursuant to the terms of a will where
the holdings in the business enterprise were not held by the decedent. Thus, in the
case of after-acquired property, the five-year period described in section 4943(c)(6)
shall commence on the date of acquisition of such holdings by the estate, and such
five-year period may expire prior to the date of distribution of such holdings from the
estate. To the extent that an interest to which section 4943(c)(6) applies is
constructively held by a private foundation under section 4943(d)(1) prior to the date
of distribution, it shall be treated as held by a disqualified person prior to such date by
reason of section 4943(c)(6).

Treas. Reg. § 53.4943-8(a) provides that for purposes of section 4943, in computing
the holdings in a business enterprise of a private foundation, or a disqualified person,
any stock or other interest owned, directly or indirectly, by or for a corporation,
partnership, estate, or trust shall be considered as being owned proportionately by or
for its shareholders, partners, or beneficiaries except as otherwise provided in this
section. Any interest in a business enterprise actually or constructively owned by a
shareholder of a corporation, a partner of a partnership, or beneficiary of an estate or
trust shall not be considered as constructively held by the corporation, partnership,
trust, or estate. Further, if any corporation, partnership, estate, or trust has a warrant
or other option to acquire an interest in a business enterprise, such interest is not
deemed to be constructively owned by such entity until the option is exercised.

Treas. Reg. § 53.4943-10(a)(1) defines the term "business enterprise" to include the
active conduct of a trade or business, including any activity which is regularly carried
on for the production of income from the sale of goods or the performance of services
and which constitutes an unrelated trade or business under section 513.

Treas. Reg. § 53.4943-10(c) provides generally that for purposes of section
4943(d)(4), the term “business enterprise” does not include a trade or business at
least 95 percent of the gross income of which is derived from passive sources. Gross
income from passive sources includes the items excluded by sections 512(b)(1)
(relating to dividends, interest, and annuities), 512(b)(2) (relating to royalties),
512(b)(3) (relating to rent) and 512(b)(5) (relating to gains or losses from the
disposition of certain property). Any income classified as passive does not lose its
character merely because section 512(b)(4) or 514 (relating to unrelated debt-
financed income) applies to such income.



Treas. Reg. § 53.4947-1(a) provides that the basic purpose of section 4947 is to
prevent trusts which are not exempt from tax under section 501(a), all or part of the
unexpired interests in which are devoted to one or more of the purposes described in
section 170(c)(2)(B), and which have amounts in trust for which a deduction was
allowed under section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522,
from being used to avoid the requirements and restrictions applicable to private
foundations. For purposes of this section, a trust shall be presumed (in the absence
of proof to the contrary) to have amounts in trust for which a deduction was allowed
under section 170, 545(b)(2), 556(b)(2), 652(c), 2055, 2106(a)(2), or 2522 if a
deduction would have been allowable under one of these sections.

Treas. Reg. section 53.4947-1(b)(1)(i) provides that, for purposes of this section and
Treas. Reg. § 53.4947-2, a "charitable trust," within the meaning of section
4947(a)(1), is a trust which is not exempt from taxation under section 501(a), all of the
unexpired interests in which are devoted to one or more of the purposes described in
section 170(c)(2)(B), and for which a deduction was allowed under section 170,
545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. A charitable trust (as defined
in this paragraph) shall be treated as an organization described in section 501(c)(3),
and, if it is determined under section 509 that the trust is a private foundation, then
Chapter 42, including section 4941, shall apply to the trust.

Treas. Reg. § 53.4947-1(b)(2)(i) provides that an estate from which the executor or
administrator is required to distribute all of the net assets in trust to charitable
beneficiaries will not be considered a charitable trust under section 4947(a)(1) during
the period of estate administration or settlement, except as provided in paragraph
(b)(2)(ii) of this section. A charitable trust created by will shall be considered a
charitable trust under section 4947(a)(1) as of the date of death of the decedent-
grantor, except as provided in paragraph (b)(2)(v) of this section (relating to trusts
which wind up).

Treas. Reg. § 53.4947-1(b)(2)(ii)(A) provides that when an estate from which the
executor or administrator is required to distribute all of the net assets in trust for
charitable beneficiaries, or free of trust to such beneficiaries, is considered terminated
for federal income tax purposes under Treas. Reg. § 1.641(b)-3(a), then the estate
will be treated as a charitable trust under section 4947(a)(1) between the date on
which the estate is considered terminated under Treas. Reg. § 1.641(b)-3(a) and the
date final distribution of all the net assets is made to or for the benefit of the charitable
beneficiaries.

Treas. Reg. § 53.4947-1(b)(2)(iv) provides in part that, for purposes of this paragraph,
the term "reasonable period of settlement" means that period reasonably required (or,
if shorter, actually required) by the trustee to perform the ordinary duties of
administration necessary for the settlement of the trust. These duties include, for


example, the collection of assets, the payment of debts, taxes, and distributions, and
the determination of the rights of the subsequent beneficiaries.

Treas. Reg. § 53.4947-1(b)(2)(v) provides that a revocable trust that becomes
irrevocable upon the death of the decedent-grantor, or a trust created by will, from
which the trustee is required to distribute all of the net assets in trust for, or free of
trust to, charitable beneficiaries is not considered a charitable trust under section
4947(a)(1) for a reasonable period of settlement (within the meaning of paragraph
(b)(2)(iv)) after becoming irrevocable. After that period, the trust is considered a
charitable trust under section 4947(a)(1).

Treas. Reg. § 53.4947-1(b)(2)(vi) provides that a revocable trust that becomes
irrevocable upon the death of the decedent-grantor in which all of the unexpired
interests are charitable and under the terms of the governing instrument of which the
trustee is required to hold some or all of the net assets in trust after becoming
irrevocable solely for charitable beneficiaries is not considered a trust under section
4947(a)(1) for a reasonable period of settlement (within the meaning of paragraph
(b)(2)(iv) of this section) after becoming irrevocable except that section 4941 may
apply if the requirements of Treas. Reg. § 53.4941(d)-1(b)(3) are not met. After that
period, the trust is considered a charitable trust under section 4947(a)(1).

Treas. Reg. § 53.4947-1(c)(1)(i) provides that for purposes of this section and Treas.
Reg. § 53.4947-2, a "split interest trust," within the meaning of section 4947(a)(2), is a
trust which is not exempt from taxation under section 501(a), not all of the unexpired
interests in which are devoted to one or more of the purposes described in section
170(c)(2)(B), and which has amounts in trust for which a deduction was allowed under
section 170, 545(b)(2), 556(b)(2), 642(c), 2055, 2106(a)(2), or 2522. A trust is one
which has amounts in trust for which a deduction was allowed under section 642(c)
within the meaning of section 4947(a)(2) once a deduction is allowed under section
642(c) to the trust for any amount permanently set aside.

Treas. Reg. § 53.4947-1(c)(6)(ii)(A) provides that when an estate from which the
executor or administrator is required to distribute all of the net assets in trust or free of
trust to both charitable and non-charitable beneficiaries is considered terminated for
federal income tax purposes under Treas. Reg. § 1.641(b)-3(a), then the estate will
be treated as a split-interest trust under section 4947(a)(2) (or a charitable trust under
section 4947(a)(1), if applicable) between the date on which the estate is considered
terminated under Treas. Reg. § 1.641(b)-3(a) and the date on which the final
distribution of the net assets to the last remaining charitable beneficiary is made.

Treas. Reg. § 53.4947-1(c)(6)(iii) provides that a revocable trust that becomes
irrevocable upon the death of the decedent-grantor under the terms of the governing
instrument of which the trustee is required to hold some or all of the net assets in trust
after becoming irrevocable for both charitable and non-charitable beneficiaries is not


considered a split-interest trust under section 4947(a)(2) for a reasonable period of
settlement after becoming irrevocable, except that section 4941 may apply if the
requirements of Treas. Reg. § 53.4941(d)-1(b)(3) are not met. After that period, the
trust is considered a split-interest trust under section 4947(a)(2). The term
"reasonable period of settlement" means that period reasonably required (or, if
shorter, actually required) by the trustee to perform the ordinary duties of
administration necessary for the settlement of the trust. These duties include, for
example, the collection of assets, the payment of debts, taxes, and distributions, and
the determination of rights of the subsequent beneficiaries.

Analysis

Ruling 1.
After the death of Spouse, the assets of Trust will become distributable to Foundation.
Those assets currently include Trust’s interests in Corp2, LLC2, and LLC3, each
member of which will be treated as a disqualified person with respect to Foundation.

While Trust, whose sole remainder interest is charitable, generally has a reasonable
period to settle or wind up before it is subject to section 4941, its dealings with respect
to Foundation’s interest or expectancy could result in indirect self-dealing if the “estate
administration” exception to indirect self-dealing under Treas. Reg. § 53.4941(d)-1(b)(3)
is not met. The exception by its terms applies to an estate or revocable trust that has
become irrevocable on a grantor’s death. Although Trust is already irrevocable, upon
Spouse’s death Trust will be similarly situated to an estate or revocable trust that has
become irrevocable on a grantor’s death. It is reasonable to construe the reference in
the exception to an estate or revocable trust to include other trusts the assets of which
are includable in the beneficiary's gross estate for estate tax purposes (as Foundation
represents is the situation here). Thus, the estate administration exception will apply to
Trust upon Spouse’s death. We are not ruling, however, whether any particular
transaction contemplated by Trust will meet the requirements of this exception.

Rulings 2 and 3.
Treas. Reg. § 53.4943-8(b(1) provides generally that an interest actually or
constructively owned by a trust is deemed constructively owned by its remainder
beneficiaries (which, in the case of Trust, is Foundation). Under Treas. Reg. § 53.4943-
6(b)(1), however, in the case of an acquisition of holdings in a business enterprise by a
private foundation pursuant to the terms of a trust, the five-year period under section
4943(c)(6) begins on the date of distribution of such holdings from the trust to the
foundation. To the extent that an interest to which section 4943(c)(6) applies (as here
where Foundation is receiving excess business holdings from Trust other than by
purchase) is constructively held by a private foundation under section 4943(d)(1) and
§ 53.4943-8 prior to the date of distribution, the interest is treated as held by a
disqualified person prior to such date by reason of section 4943(c)(6), and the
foundation has five years to eliminate the excess business holdings.


Distribution is deemed to occur once the trust is deemed terminated for federal income
tax purposes, as provided in Treas. Reg. § 1.641(b)-3. Different rules apply in the case
of property acquired by an estate after the decedent’s death—the five-year period
begins on the date of acquisition. It is represented that all assets of Trust will be
includable in Spouse’s estate at death. Thus, for purposes of section 4943(c), Spouse
should be treated as the decedent with respect to Trust's interest in Corp3, and to the
extent Foundation acquires excess business holdings in Corp3 from Trust after
Spouse's death, the five-year period set forth in section 4943(c)(6) will commence at the
time of such distribution.

Corp3, a stock corporation engaged in the management of residential real estate
properties, is a business enterprise for purposes of section 4943. If Trust distributed the
stock in Corp3 directly to Foundation, the stock would be an excess business holding of
Foundation. Thus, assuming that holdings in Corp3 or other entities distributed from
Trust to Foundation constitute excess business holdings (or an increase in excess
business holdings) directly or constructively held by Foundation, taking into account the
rules for constructive ownership under Treas. Reg. § 53.4943-8, Foundation will have
five years to eliminate the excess (or the increase in excess).

Ruling 4.
Foundation's primary charitable activity is to make distributions to other charities in
furtherance of Foundation’s charitable purposes. Income received by Foundation from
LLC3 would be unrelated business taxable income unless excluded under section 512.
Section 512(b)(3) and (4) exclude from the computation of unrelated business taxable
income all rents from real property, except to the extent treated as unrelated debt-
financed income under section 514.

LLC3 owns an apartment complex. Treas. Reg. § 1.512(b)-1(c)(5) provides, in pertinent
part, that payments for the use or occupancy of rooms and other space where services
are also rendered to the occupant, such as for the use or occupancy of rooms or other
quarters in hotels, boarding houses, or apartment houses furnishing hotel services, or in
tourist camps or tourist homes, motor courts, or motels, do not constitute rent from real
property. Generally, services are considered rendered to the occupant if they are
primarily for his convenience and are other than those usually or customarily rendered
in connection with the rental of rooms or other space for occupancy only. The supplying
of maid service, for example, constitutes such service; whereas the furnishing of heat
and light, the cleaning of public entrances, exists, stairways, and lobbies, the collection
of trash, etc., are not considered as services rendered to the occupant. Payments for
the use or occupancy of entire private residences or living quarters in multiple housing
units are generally treated as rent from real property.

Under the circumstances described, payments from tenants received by LLC3, and
indirectly by Foundation, will appropriately be treated as rents from real property as
described in section 512(b)(3)(A)(i), excludible from unrelated business income under
section 512(a)(1), except to the extent attributable to debt-financed property under
sections 512(b)(4) and 514.



Ruling 5.
Under section 512, rents from real property are included in unrelated business income
to the extent they are attributable to debt-financed property, defined as property held to
produce income and with respect to which there is acquisition indebtedness.

Under section 514(c)(2)(A), where an exempt organization acquires property subject to
a mortgage, the amount of indebtedness secured by such mortgage will be considered
acquisition indebtedness even if the organization did not assume or agree to pay the
indebtedness. LLC3 owns real property subject to mortgage debt. Upon distribution of
Trust's interest in LLC3 to Foundation after Spouse's death, under section 514(c)(2)(A)
Foundation would have "acquisition indebtedness" equal to its share of any outstanding
indebtedness encumbering real property owned by the companies, determined at the
time the interest is transferred to Foundation (as provided in Treas. Reg. § 1.514(c)-
1(b)(3)).

However, section 514(c)(2)(B) excepts from this rule any such mortgaged property that
is acquired by an organization by devise or bequest. In such case, the indebtedness
secured by the mortgage is not treated as acquisition indebtedness for a period of ten
years following the date of the acquisition, provided the organization did not assume
and agree to pay the indebtedness incurred by the mortgage, or make any payment for
the equity in the property owned by the donor.

It is represented that all assets of Trust will be includable in Spouse's estate at death
under section 2044. Accordingly, for purposes of the exception to acquisition
indebtedness under section 514(c)(2)(B), the distribution of Trust's interest in LLC3 to
Foundation after Spouse's death should be treated as a devise from Spouse rather than
as a gift from Spouse during Spouse’s life. As a result, for purposes of determining
unrelated business taxable income under section 512, and pursuant to section
514(c)(2)(B), any indebtedness secured by mortgages against real property owned by
LLC3 will not be treated as acquisition indebtedness for purposes of section 514(a)
during a period of ten years following the date of acquisition by Foundation of any
interest in the company, provided that (1) Foundation does not assume and agree to
pay the indebtedness secured by the mortgages and (2) Foundation does not make any
payment for the equity in the property.

Rulings

Based solely on the facts and representations submitted by Foundation, we rule as
follows:

1. After the death of Spouse, the estate administration exception to indirect self-dealing
under Treas. Reg. § 53.4941(d)-1(b)(3) will be available with respect to transactions
between Trust and disqualified persons during a reasonable period of settlement within
the meaning of Treas. Reg. § 53.4947-1(b)(2)(v).


2. Trust's stock in Corp3 will constitute an excess business holding under section
4943(c) upon distribution to Foundation.

3. Foundation will have a period of five years within which to dispose of Corp3 stock or
other excess business holdings (within the meaning of section 4943(c)) distributed from
Trust to Foundation after the death of Spouse, commencing on the date of distribution
to Foundation, provided that (a) the Corp3 stock or other excess business holding was
held by Trust at Spouse's death and (b) the Corp3 stock or other excess business
holding is distributed to Foundation within a reasonable period of settlement of Trust
under Treas. Reg. § 53.4947-1(b)(2)(v).

4. Foundation‘s share of rental income received by LLC3 will constitute "rents from real
property" under section 512(b)(3)(A)(i), excludible from unrelated business taxable
income under section 512(a)(1), except to the extent attributable to debt-financed
property under sections 512(b)(4) and 514.

5. For purposes of determining unrelated business taxable income under section 512,
and pursuant to section 514(c)(2)(B), any indebtedness secured by mortgages against
real property owned by LLC3 will not be treated as acquisition indebtedness for
purposes of section 514(a) during a period of ten years following the date of acquisition
by Foundation of any interest in LLC3, provided that (a) Foundation does not assume
and agree to pay the indebtedness secured by the mortgages and (b) Foundation does
not make any payment for the equity in the property.

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of Foundation and accompanied by a penalty of perjury
statement executed by an appropriate party, as specified in Rev. Proc. 2018-1, 2018-1
I.R.B. 1, § 7.01(15)(b). This office has not verified any of the material submitted in
support of the request for ruling, and such material is subject to verification on
examination. The Associate Office will revoke or modify a letter ruling and apply the
revocation retroactively if: (1) there has been a misstatement or omission of controlling
facts; (2) the facts at the time of the transaction are materially different from the
controlling facts on which the ruling is based; or (3) the transaction involves a
continuing action or series of actions and the controlling facts change during the
course of the transaction. See Rev. Proc. 2018-1, § 11.05.

No ruling is granted as to whether Foundation qualifies as an organization described in
section 501(c) or section 509(a). Except as expressly provided above, no opinion is
expressed or implied concerning the federal income or estate tax consequences of any
aspects of any transaction or item of income described in this letter ruling, including
the allowability of an estate tax charitable deduction under section 2055 upon
Spouse’s death.

This letter is directed only to Foundation. Section 6110(k)(3) provides that it may not be
used or cited as precedent.



In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to Foundation’s authorized representatives.

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.


                                       Sincerely,



                                       Mary Jo Salins
                                       Chief
                                       (Tax Exempt & Government Entities)




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