02 August 2016 Foundation's payment to disqualified person for real estate management services is not self-dealing, IRS rules In PLR 201630009, the IRS has ruled that a payment of compensation by a private foundation (PF) to a disqualified person for services relating to the management of commercial real estate owned by the foundation will not constitute an act of self-dealing so long as the compensation paid is not excessive. PF is a tax-exempt private foundation under Section 509(a) that distributes funds to various charities. PF's funding has come solely from Decedent and it has invested in cash and publicly traded bonds and securities. Decedent's will left certain commercial real estate properties to PF. Any debt on the commercial real estate is to be paid by the Decedent's estate prior to, or simultaneously with, the transfer of the properties to PF. In the near-term, PF generally intends to hold the income-producing properties, which are primarily office rentals, as part of a diversified investment portfolio, which will also include cash and publicly traded securities. It may sell some of the properties, at the discretion of its Board of Directors, based on the facts and circumstances, but it anticipates such sales, as well as any acquisitions of additional real estate, would be sporadic and occasional. PF intends to form a new limited liability company, X, to manage the real estate properties. PF will be the sole member of X, which will be treated as a disregarded entity for tax purposes. X will provide any of the following services with respect to the management of the real estate properties held for investment by PF: 14. Supervision and administration of legal and tax services and other incidental and ancillary activities associated with the ownership of passive rental real property 15. Supervision and administration of a risk management program to frequently review PF's real estate investments, including identification and analysis of potential real estate acquisitions and services relating to the disposition of property Regarding other types of services, such as landscaping and maintenance of the common areas of the properties, X may hire third parties that are not disqualified persons to perform such services, but it will not perform them itself. PF expects to appoint one or more disqualified persons to act as managers of X (and thereby the properties that PF holds). It will provide them with reasonable compensation for their management services. In this regard, as the IRS noted in a footnote, PF gave no indication that any such managers will provide any services in managing X other than the management of the real estate properties. Y, a management company owned partially by Decedent and partially by Decedent's family, managed the properties during Decedent's lifetime. Decedent's interest in Y will not pass to PF but will be redeemed upon approval by the Surrogate Court. X will share certain employees with Y, including a manager that is a disqualified person with respect to PF. The other shared employees will not be disqualified persons. X will have a separate employment contract with each shared employee to provide reasonable compensation to that employee for services provided to X. The employees and manager will assist X with property management services, and will only be compensated by X for work they perform for X, as confirmed by detailed time records, which will require the shared employees and manager to log the time spent for X and Y on a daily basis. The IRS ruled that PF's contracting with X — although managed by one or more disqualified persons — to provide real property investment management services will not constitute an act of self-dealing under Section 4941. The IRS noted that payment of compensation by a private foundation to a disqualified person is generally an act of self-dealing under Section 4941(d)(1)(D). There is an exception under Section 4941(d)(2)(E), however, for such payments if they are for "personal services" and are reasonable and necessary for carrying out the foundation's exempt purpose. The term "personal services," for purposes of the exception to self-dealing, is not defined in the statute. The regulations, however, include as examples of personal services: legal services, investment counseling services and general banking services. To further interpret the meaning of "personal services," the IRS referred to Madden v. Commissioner, T.C. Memo 1997-395. In Madden, the Tax Court held that personal services for purposes of the self-dealing rules do not include maintenance, janitorial or security services. The court cited the legislative history in concluding that the term should be construed narrowly, and, in its interpretation, limited to personal services that are professional and managerial in nature. The IRS determined that, in accordance with the reasoning in Madden, the services to be provided by the disqualified persons serving as managers of X are of a professional and managerial nature. Moreover, they are reasonable and necessary for carrying out PF's exempt purposes. Accordingly, even though the managers are disqualified persons with respect to PF (and X is a disregarded entity with respect to PF), the payment of compensation from PF/X to those managers will not be an act of self-dealing so long as the compensation is not excessive. The IRS further ruled that the sharing of employees between X and Y will not constitute an act of self-dealing under Section 4941 (provided the compensation relates to the services provided to X and is not excessive). In reaching this conclusion, the IRS noted that the use of detailed time records by employees to log the time spent for X and Y on a daily basis supported a finding that compensation was based on a reasonable determination of the value of each employee's services and was not an act of self-dealing. In addition, although not analyzed in this Alert, the IRS ruled: (1) rental income from the properties will not constitute unrelated business taxable income, (2) income from the sale of the properties will not constitute unrelated business taxable income, (3) X will not constitute an excess business holding under Section 4943, and (4) the properties will not be considered jeopardizing investments under Section 4944. Since the Madden case was decided in 1997, the IRS has provided very little guidance as to the boundaries of the "personal services" exception of Section 4941(d)(2)(E). PLR 201630009 suggests that real estate management services may now (potentially) be considered "personal services." In keeping with the holding of Madden, the personal services to be provided are real estate management services that include contract negotiations, financial management, leasing and collection of rents. Services such as landscaping and maintenance of the common areas of the properties are not covered by this PLR, and would likely not be considered professional and managerial in nature. PLR 201630009 is also within the confines of Treas. Reg. Section 53.4941(d)-3(c)(1), which states that the term "personal services" includes "the services of a broker serving as agent for the private foundation, but not the services of a dealer who buys from the private foundation as principal and resells to third parties." Treas. Reg. Section 53.4941(d)-3(c)(2) provides the following example: "C, a manager of private foundation X, owns an investment counseling business. Acting in his capacity as an investment counselor, C manages X's investment portfolio for which he receives an amount which is determined to be not excessive. The payment of such compensation to C shall not constitute an act of self-dealing." Private foundations should monitor the activities of any disqualified persons providing personal services and limit them to providing professional and management services only. Moreover, payment for those services must not be excessive and the services provided must be reasonable and necessary for carrying out the private foundation's exempt purpose(s). A private letter ruling is a written statement issued to a particular taxpayer that interprets and applies tax laws to the taxpayer's specific, represented set of facts, and may not be used or cited as precedent by other taxpayers or by IRS personnel. Thus, although the ruling is instructive on how the IRS might rule regarding a particular matter, organizations are cautioned not to rely on the ruling as authority, but should consult with their tax advisors to determine the tax consequences of their own facts and circumstances. — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg.
Document ID: 2016-1324 | ||||||||||||||||||||||||||||||
