IRS approves a private foundation's additional set-aside for delayed renovation project

Plain-English summary

A private foundation that runs artist and writer residencies asked the
IRS to bless a "set-aside" of funds for a specific project: extensive
renovations to its property. Private foundations must pay out a minimum
amount each year (their "qualifying distributions") or face an excise
tax under Code § 4942. Section 4942(g)(2) lets a foundation count money
it earmarks for a specific future project as a qualifying distribution
now, as long as the money is actually paid out within 60 months and the
project is better accomplished by setting funds aside than by paying
immediately. The foundation had already received set-asides for two
earlier years but hit permit delays and scope changes, so it sought an
additional set-aside for a later year. The IRS approved it, finding the
long-term renovation met the § 4942(g)(2)(B)(i) suitability test (it
would be imprudent to prepay contractors before work begins). The
practical effect: the earmarked amount counts toward the foundation's
required annual payout without triggering the § 4942 tax.

Ruling snapshot

• Question: May the foundation treat an additional amount set aside
  for its multi-year renovation project as a qualifying distribution
  under § 4942(g)(2)?
• Outcome: Approved (set-aside must be paid within the 60-month
  period)
• Key authorities: IRC § 4942(g)(2)(A), (B)(i); Treas. Reg.
  § 53.4942(a)-3(b)(1), (b)(2); Rev. Rul. 74-450

Full text (IRS public release)

Internal Revenue Service                 Department of the Treasury
P.O. Box 2508
Cincinnati, OH 45201

Date: September 15, 2020

Number: 202050018
Release Date: 12/11/2020

Employer Identification Number:
Contact Person - ID Number:
Contact Telephone Number:

LEGEND: UIL: 4942.03-07
C = State
D = Year
E = Year
F = Year
G = Year
m dollars = Amount
n dollars = Amount
p dollars = Amount
q dollars = Amount
r dollars = Amount

Dear

Why you are receiving this letter

This is our response to your December 16, 2019 letter requesting approval of a
set-aside under Internal Revenue Code Section 4942(g)(2). You've been
recognized as tax-exempt under Section 501(c)(3) of the Code and have been
determined to be a private foundation under Section 509(a).

Our determination

Based on the information furnished, your set-aside program is approved under
Internal Revenue Code Section 4942(g)(2). As required under Section 4942(g)(2),
the set-aside amount must be paid within the 60-month period after the date of the
first set-aside.

Description of set-aside request

You were formed in the state of C. Your purpose is to provide

. Further, the property requires extensive renovations and upgrades.

You have already requested and received set-asides for year D for p dollars and
for year E for q dollars to fund these renovations. You originally anticipated that
the plans for the renovation would be completed in the middle of D, and the
renovation work to start in late D, and take approximately twelve to eighteen
months to finish. However, there have been significant delays beyond your control
in trying to obtain the proper permits as well as changes in the scope of the
project; consequently, you now expect construction to start late this year.
Therefore, you are requesting an additional set-aside for year F in the amount of r
dollars.

You will use the set-asides for the renovations which will dramatically upgrade the
current conditions and add additional space. This will allow you to extend the
length of the residencies during the year and improve the ambiance of the property
for the artists and writers.

During years G and H, you should complete the set-aside of p dollars, the set-
aside of q dollars, and the requested set-aside of r dollars with the project costs for
the renovation, which will be less than 60 months after the first set-aside. You
believe that this project can be best accomplished by a set-aside rather than an
immediate payment of funds, since it would be imprudent for you to prepay funds
to contractors and professionals for work that has not commenced yet. The set-
aside approach will allow you to maximize control over the project, with the goal of
achieving a better result.

Basis for our determination

Internal Revenue Code Section 4942(g)(2)(A) states that an amount set-aside for
a specific project, which includes one or more purposes described in Section
170(c)(2)(B), may be treated as a qualifying distribution if it meets the
requirements of Section 4942(g)(2)(B).

Section 4942(g)(2)(B) of the Code states that an amount set-aside for a specific
project will meet the requirements of this subparagraph if, at the time of the set-
aside, the foundation establishes that the amount will be paid within five years and
either clause (i) or (ii) are satisfied.

Section 4942(g)(2)(B)(i) of the Code is satisfied if, at the time of the set-aside, the
private foundation establishes that the project can better be accomplished using
the set-aside than by making an immediate payment.

Section 53.4942(a)-3(b)(1) of the Foundations and Similar Excise Taxes
Regulations provides that a private foundation may establish a project as better
accomplished by a set-aside than by immediate payment if the set-aside satisfies
the suitability test described in Section 53.4942(a)-3(b)(2).

Section 53.4942(a)-3(b)(2) of the Foundations and Similar Excise Taxes
Regulations provides that specific projects better accomplished using a set-aside
include, but are not limited to, projects where relatively long-term expenditures
must be made requiring more than one year's income to assure their continuity.

In Revenue Ruling 74-450, 1974-2 C.B. 388, an operating foundation converted a
portion of newly acquired land into a public park under a four-year construction
contract. The construction contract payments were to be made mainly during the
final two years. This constituted a "specific project." The foundation's set-aside of
all its excess earnings for four years was treated as a qualifying distribution under
Internal Revenue Code Section 4942(g)(2).

What you must do

Your approved set-aside(s) will be documented on your records as pledges or
obligations to be paid by the date specified. The amounts set-aside will be taken
into account to determine your minimum investment return under Internal Revenue
Code Section 4942(e)(1)(A), and the income attributable to your set-aside(s) will
also be taken into account in computing your adjusted net income under Section
4942(f) of the Code.

Additional information

This determination is directed only to the organization that requested it. Internal
Revenue Code Section 6110(k)(3) provides that it may not be used or cited as a
precedent.

Please keep a copy of this letter in your records.

If you have any questions, please contact the person listed in the heading of this
letter.

Sincerely,

Stephen A. Martin
Director, Exempt Organizations
Rulings and Agreements

Enclosure