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February 9, 2022

IRS memorandum analyzes basis determination for assets held by former public charity

In an IRS Chief Counsel Memorandum, the IRS has concluded that the basis of property held by a public charity is not stepped up to fair market value (FMV) when the entity becomes a private foundation. Specifically, the IRS states that the property basis must be determined under IRC Section 4940(c)(3)(B) and without regard to IRC Section 362(c).


When an IRC Section 501(c)(3) organization ceased to qualify as a public charity and became a private foundation, the tax-exempt organization became subject to excise tax under IRC Section 4940(a) and was therefore required to determine the basis of its property to determine gain or loss from the property's sale or disposition.

Law and IRS analysis

The net investment income (NII) of a private foundation is generally subject to excise tax under IRC Section 4940(a) equal to 1.39% of NII. NII is defined as gross investment income plus capital gain net income less certain deductions (IRC Section 4940(c)(1)).

Under IRC Section 4940(c)(4)(B), basis used in calculating capital gain net income in property that a private foundation has held continuously from December 31, 1969, to the date of disposition may not be less than the property's FMV on December 31, 1969.

Under Treas. Reg. Section 53.4940-1(f)(2)(i), basis used in calculating gain from the sale or other disposition of property equals the greater of either:

  • FMV on December 31, 1969, plus/minus all adjustments thereafter to the date of disposition under the rules of Part II, Subchapter O of IRC Chapter 1, if the property was in fact held by the private foundation on December 31, 1969, and continuously thereafter until the date of sale/disposition
  • Basis, as determined under the general rules for determining basis (see IRC Sections 1011—1023), subject to the special rules under IRC Section 4940(c)(3)(B) for depreciation and depletion deductions

Under Treas. Reg. Section 53.4940-1(f)(2)(ii), basis for determining loss from the sale or other disposition of the property is determined under the general rules for determining basis (see IRC Sections 1011—1023).

The Chief Counsel Memorandum cited a Tax Court opinion from 1978 (Friedman Foundation Inc. v. Commissioner, 71 TC 40 (1978)), which held that a private foundation's basis in stock contributed to it on November 14, 1973, equaled the basis of the stock in the donors' hands under IRC Sections 1011 and 1015, not the FMV of the stock on either December 31, 1969 or November 14, 1973.

Considering the IRC provisions, regulations and caselaw, the IRS concludes in the Memorandum that, "for purposes of determining gain or loss from the sale or other distribution of property, the usual income tax rules of Part II of Subchapter O of Chapter 1 [IRC Sections 1011—1023] apply in determining basis, subject to the special rules of [IRC Section] 4940(c)(3)(B) and disregarding [IRC Section] 362(c)." Further, the memo notes that the IRS found "no provision in the law" that would allow the basis of the entity's assets to be stepped up to FMV on the date the entity was classified as a private foundation. Although IRC Section 4940(c)(4)(B) provides an exception and a one-time step-up in basis, this is only available for property held by private foundations when IRC Section 4940 went into effect, as of December 31, 1969.

IRS Chief Counsel noted in the Memorandum that it believes PLR 9852023 is incorrect. That ruling had concluded that the basis of property held by a public charity that became a private foundation should be the property's FMV on the date the organization ceased to be a public charity, for purposes of determining capital gain subject to tax under IRC Section 4940(a).


Chief Counsel Memorandum 2022-01 serves as a reminder that public charities and private foundations should monitor the basis of any investment property they hold, and public charities should apply normal rules for determining the basis of their investment property upon conversion to private foundations, rather than stepping up basis to FMV at the time of conversion.

The Memorandum also underscores that exempt organization should not rely on private letter rulings issued to other taxpayers (e.g., PLR 9852023), as such rulings are not precedential. An organization that seeks assurance regarding the tax implications of a proposed change in its activities can request its own private letter ruling from the IRS, on which it could rely.

Please contact your EY Tax professional with any questions.



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Contact Information
For additional information concerning this Alert, please contact:
Tax Exempt Organization Services
   • Stephen Clarke (
   • Melanie McPeak (
   • Morgan Moran (
   • Tiyesha Johnson (