June 13, 2018 Colleges subject to new investment income tax may use stepped-up basis for property sold for gain, IRS announces In Notice 2018-55 (the Notice), the IRS has announced that it plans to issue proposed regulations stating that, for property held by an applicable educational institution on December 31, 2017, and continuously thereafter to the date of its disposition, the basis of such property for determining gain shall be deemed to be not less than the fair market value of such property on December 31, 2017, plus or minus all adjustments after December 31, 2017, and before the date of disposition consistent with the regulations under Section 4940(c). Background Section 4968, added by the Tax Cuts and Jobs Act (TCJA), imposes a 1.4% excise tax for each tax year on the net investment income of an "applicable educational institution." In general, the tax applies to private colleges or universities with at least 500 full-time tuition-paying students (more than half of whom are located in the US) that have endowments of at least $500,000 per student. Net investment income for purposes of Section 4968 is determined using rules similar to the rules of Section 4940(c) that relate to the tax imposed on net investment income of private foundations. For additional background, see Tax Alerts 2017-2142 on the TCJA's exempt organization provisions and 2018-0356 on amendments to Section 4968 made by the Bipartisan Budget Act of 2018. The Notice The Notice states that forthcoming proposed regulations will provide that an applicable educational institution subject to the 1.4% excise tax on net investment income on property that it sells for a gain may generally use the property's fair market value as of December 31, 2017, as its basis for calculating the tax on the gain. For basis adjustments occurring after December 31, 2017, rules consistent with the regulations under Section 4940(c) will apply. In addition, normal basis rules under the Section 4940(c) regulations will apply for calculating losses. The Notice states that taxpayers may rely on the stepped-up basis rule described therein until further guidance is issued. The Notice also announces that the IRS expects that the proposed regulations will allow losses to offset net gains, but that the proposed regulations will not allow capital loss carryovers or carrybacks. The Notice adds that the proposed regulations may also allow losses from property sales realized by one organization to offset gains realized by a related organization; the IRS requests comments on this issue. The Notice requests comments in general on all issues addressed therein, as well as on any additional guidance needed under Section 4968(c), including with respect to transitional relief. Implications Although Notice 2018-55 will certainly help applicable educational institutions to determine their investment basis in order to calculate capital gains for purposes of Section 4968, the provisions will require some additional analysis. Specifically, the fair market value of each investment will be another datapoint that applicable educational institutions will have to address as they develop accounting systems that will track the tax basis of investment assets. Historically, colleges and universities have not had to separate investment income from capital gains and losses. Now, with the addition of Section 4968, it will become important for entities subject to the provision to monitor the tax basis of their investments, whether at cost or fair market value as of December 31, 2017, as well as any investments made after that date, in order to properly calculate the net investment income subject to the excise tax. The Notice also directs applicable educational institutions, and other interested parties, to submit comments on the issues addressed in the Notice. Colleges and universities subject to Section 4968 should take full advantage of this opportunity by working with similarly situated institutions to prepare comments addressing: (1) whether the content of the proposed regulations will help in determining Section 4968 net investment income and (2) what additional guidance is needed on Section 4968 matters that the IRS has not yet raised (e.g., the calculation of partnership basis and the allocation of distributions). ——————————————— — For more information about EY's Exempt Organization Tax Services group, visit us at www.ey.com/ExemptOrg ———————————————
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