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Stepped-up basis to apply to gains when computing educational institution tax

June 11, 2018

In a Notice and accompanying News Release,  IRS has announced that it will be issuing proposed regs with respect to the 1.4% excise tax on net investment income that applies to certain educational institutions for tax years that begin after Dec. 31, 2017. Among the rules in those proposed regs is a rule that provides that, for purposes of the 1.4% tax, an institution that sells property at a gain generally may use the property’s fair market value (FMV) at the end of 2017 as its basis for figuring the tax on any resulting gain. Taxpayers may rely on some of the rules contained in the Notice until the proposed regs are issued.

Background. For tax years beginning after Dec. 31, 2017, an excise tax equal to 1.4% is imposed on net investment income of certain private colleges and universities. (Code Sec. 4968(a)) The tax applies only to private colleges and universities with at least 500 students, more than 50% of the students of which are located in the U.S., and with assets (other than those used directly in carrying out the institution’s exempt purpose) of at least $500,000 per student. (Code Sec. 4968(b)) Code Sec. 4968(d)(1) provides that certain assets and net investment income of related organizations described in Code Sec. 4968(d)(2) are treated as assets and net investment income of the educational institution.

Code Sec. 4968(c) provides that net investment income is to be determined under rules similar to the rules of Code Sec. 4940(c).Code Sec. 4940 is the excise tax on the investment income of tax-exempt foundations.

Under Code Sec. 4940(c)(1), net investment income is the amount by which the sum of gross investment income and capital gain net income exceeds allowable deductions.

Code Sec. 4940(c)(2) provides that, for purposes of Code Sec. 4940(c)(1), gross investment income means the gross amount of income from interest, dividends, rents, payments with respect to securities loans, and royalties, but not including any such income to the extent included in computing the tax imposed by Code Sec. 511.

For purposes of Code Sec. 4940(c)(1)Code Sec. 4940(c)(4) provides that: (A) no gain or loss from the sale or other disposition of property is taken into account to the extent that any such gain or loss is taken into account for purposes of computing the tax imposed by Code Sec. 511; (B) in the case of property held by a private foundation on Dec. 31, ’69 and continuously thereafter to the date of its disposition, the basis for determining gain is deemed to be not less than the FMV of such property on Dec. 31, ’69; and (C) losses from sales or other dispositions of property are allowed only to the extent of gains from such sales or other dispositions, and there are no capital loss carryovers or carrybacks.

Under Reg § 53.4940-1(f)(2)(i), for purposes of determining gain from the sale or other disposition of property, basis is the greater of: (A) FMV on Dec. 31, ’69, plus or minus all adjustments after Dec. 31, ’69, and before the date of disposition under the rules of Part II of Subchapter O of Chapter 1, provided that the property was held by the private foundation on Dec. 31, ’69 and continuously thereafter to the date of disposition, or (B) basis as determined under the rules of Part II of Subchapter O of Chapter 1.Reg. § 53.4940-1(f)(2)(ii) provides that for purposes of determining loss from the sale or other disposition of property, basis is determined under the rules of Part II of Subchapter O of Chapter 1.

Proposed regs will be similar to the Sec. 4940 rules. In the Notice and Information Release, IRS has provided that, similar to the rules found in Code Sec. 4940(c), IRS intends to propose regs stating that, in the case of property held by an applicable educational institution on Dec. 31, 2017 and continuously thereafter to the date of its disposition, basis of such property for determining gain is deemed to be not less than the FMV of such property on Dec. 31, 2017, plus or minus all adjustments after Dec. 31, 2017 and before the date of disposition consistent with the regs under Code Sec. 4940(c). In addition, for purposes of determining loss, basis rules that are consistent with the regs under Code Sec. 4940(c) will apply. (Notice 2018-55, Sec. 3)

Before the issuance of the proposed regs, applicable educational institutions described in Code Sec. 4968(b)(1) may rely on the rules described in section 3 of the Notice.

Similar to the rules found in Code Sec. 4940(c)(4)(C), IRS intends to propose regs stating that losses from sales or other dispositions of property generally are to be allowed only to the extent of gains from such sales or other dispositions, and there are no capital loss carryovers or carrybacks. IRS also expects that, with respect to related organizations described in Code Sec. 4968(d)(2), overall net losses from sales or other dispositions of property in one related organization (or from the applicable educational institution) will be allowed to offset overall net gains from such sales or other dispositions from other related organizations (or from the applicable educational institution), but request comments on this issue. (Notice 2018-55, Sec. 4)

References: For the excise tax on investment income of private colleges and universities, see FTC 2d/FIN ¶D-8170 et seq.; United States Tax Reporter ¶49,684.

Notice 2018-55, 2018-26 IRBIR 2018-134, 6/8/2018

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