A new private ruling may be of great interest to clients with substantial real estate interests who wish to contribute one or more properties to a family foundation. The ruling suggests that payment by the foundation to a property management entity controlled by the donor may be permissible under the personal services exception.
As a general rule, compensation paid by a private foundation to a disqualified person is an act of self-dealing and results in the imposition of excise taxes (Disqualified persons include substantial contributors to a foundation, directors and officers, and certain family members). However, there is an exception to this general rule for certain “personal services” provided by a disqualified person to a private foundation.
The exception will be met if the following are true:
- The payment is for “personal services” that are “reasonable and necessary to carrying out the exempt purpose” of the foundation;
- The amount paid is “not excessive”; and
- The disqualified person is not a government official.
The Treasury Regulations include examples of services which qualify as such personal services. The example list includes legal services, investment counseling services, and general banking services. It has been unclear whether various real estate management services would qualify as personal services.
In the oft-cited 1997 case of Madden v. Commissioner, the Tax Court strictly construed the meaning of personal services to include only those services that are “professional and managerial in nature.” The Court held that general maintenance, janitorial and custodial services would not qualify because they were of a different character than those provided in the regulations. Furthermore, the Tax Court expressed its general view that “exceptions to the self-dealing transactions rules should be construed narrowly.”
The new private ruling (PLR 2016300009) considered the following fact situation: A decedent’s will directed several commercial real estate properties to be contributed to the private foundation that he formed and funded during his life. The directors of the foundation intended to hold the properties as part of the foundation’s diversified investment portfolio. To manage the properties, the foundation would contract with a property management company, which would provide a variety of services, including contract negotiations, accounting, supervision of property operations, advertising, and collection of rents. The contemplated property management company was a disregarded entity and would be managed by disqualified persons.
The ruling request asked the Service to determine whether contracting with the property management company, a disregarded entity which is managed by disqualified persons, to provide various property management services would constitute an act of self-dealing. The ruling concluded that the property management services qualify as “personal services” within the meaning of the statute and, accordingly, the payments would not constitute self-dealing.