Nonprofits owning for-profits: Recent IRS guidance on “excess business holdings”

Private foundations (as well as donor-advised funds – or DAFs) are prohibited from (together with the organization’s “disqualified persons”) holding more than 20 percent of a non-exempt business. This rule prevents affected organizations from purchasing such a prohibited interest, but can also be problematic when affected organizations are gifted a prohibited business interest.

The tax code provides a 5-year period for affected organizations to dispose of a prohibited business interest that they acquired by gift, as well as an additional 5 years where agreed to by the IRS. In a recent IRS publication, the agency provides a little additional detail about the circumstances where it grants this second, 5-year extension that tolls the “excess business holdings” rules:

• Business interests received in connection with the dissolution of other tax-exempt organizations may qualify for the 5-year grace periods, as well as business interests received as charitable contributions;
• In an example, an organization ownings interests in a business holding substantial real estate qualified for the second 5-year extension, at least partially due to difficulty in disposing the interest caused by turbulence in the applicable real estate markets;
• In another example, an organization qualified for the second 5-year extension where it demonstrated efforts to dispose of the excess business holdings in the first 5-year period, but that any sale in that period would have been at a price lower than fair market value, and that the organization had retained the services of an investment management firm to assist with a fair market value sale in the second 5-year period.

The IRS requires that organizations apply for the second 5-year grace period through the IRS private letter ruling process.