Set-Aside Wasn't Allowed For Conditional Option To Reacquire Hospital Assets

PLR 201128033

In a private letter ruling (PLR), which was accompanied by a Technical Advice Memorandum (TAM), IRS has ruled that a private foundation's proposal to repurchase a healthcare facility didn't meet the Code Sec. 4942(g)(2)(B) set-aside requirements because the foundation couldn't show that the amount set aside would be paid within five years. The repurchase was based on a contingent event, and it was speculative whether it would occur within five years. But, the foundation's alternate proposal to relocate and expand clinics qualified as a set-aside under Code Sec. 4942(g)(2)(A).

Background. Under Code Sec. 4942(g)(2), a tax is imposed on the undistributed income of a private foundation for any tax year, which has not been distributed before the first day of the second (or any succeeding) tax year following the tax year (if the first day falls within the tax period). An amount set aside for a specific project that is for one or more of the purposes described in Code Sec. 170(c)(2)(B) (i.e., religious, charitable, scientific, etc.) may be treated as a qualifying distribution (Code Sec. 4942(g)(2)(A)), but only if: (1) at the time of the set-aside, the private foundation establishes to IRS's satisfaction that the amount will be paid for the specific project within five years; and (2) the foundation meets either a suitability test or a cash distribution test. (Code Sec. 4942(g)(2)(B)) An amount set aside for a specific project is treated as a qualifying distribution if, at the time of the set-side, the private foundation establishes to IRS's satisfaction that the project is one that can be better accomplished by the set-aside than by immediate payment of funds. (Code Sec. 4942(g)(2)(B)(i))

Projects that can be better accomplished by the use of a set-aside include projects in which relatively long-term grants or expenditures must be made in order to assure the continuity of particular charitable projects or program-related investments, or where grants are made as part of a matching-grant program. Examples: a plan to erect a building to house the direct charitable, educational, or similar exempt activity of the private foundation; or a plan to fund a specific research program that is of such magnitude as to require an accumulation of funds before beginning the research, even though not all of the details of the program have been finalized. Reg. §53.4942(a)-3(b)(2))

In Rev Rul 77-7, 1977-1 CB 354, IRS held that a private foundation's set-aside of accumulated funds to endow a specific building project of an unrelated public charity was a set-aside of funds for a specific project under Reg. §53.4942(a)-3(b)(2).

In Rev Rul 74-450, 1974-2 CB 388, IRS held that a private operating foundation's set-aside of excess earnings for four years to fund a four-year construction plan, which converted a part of its newly acquired land into an extension of its existing wildlife sanctuary and the remainder into a public park, was a specific project for which an amount may be set aside and treated as a qualifying distribution under Code Sec. 4942(g)(2).

Facts. Taxpayer, which was exempt under Code Sec. 501(c)(3) and classified as a private foundation under Code Sec. 509(a), was formed to facilitate and support healthcare services and programs in City and Counties. Taxpayer was funded by the proceeds of the sale of a hospital facility by a City healthcare provider to a regional health care provider (Hospital 1 located in City sold all of its operating assets to Hospital 2, a multiple facilities healthcare provider in the region). The sales agreement guaranteed that Hospital 2 would continue healthcare operations in City for five years, and gave Taxpayer the right and option to repurchase the assets at fair market value if Hospital 2 proposes to close the healthcare facility in City. The option to repurchase terminated fifteen years after the sale. A primary purpose of Taxpayer was to exercise the option, if the opportunity arose, to ensure that the healthcare facility continued to operate in the community.

Taxpayer requested a set-aside to be used in exercising its option to reacquire the healthcare facility if Hospital 2 decides to close the facility. The reacquisition would enable Taxpayer to maintain hospital and other healthcare services for residents of City and Counties. If the healthcare facility isn't purchased, Taxpayer would use the set-aside amounts to assist in funding the relocation and expansion of Clinic, a medical clinic of Medical Center, which is owned and operated by Hospital 2. Taxpayer will distribute the total amount set aside within 60 months after the date of the first set-aside.

TAM's conclusion. In the TAM, IRS concluded that Taxpayer's proposal to repurchase the healthcare facility was a contingent proposal that didn't qualify as a set-aside. The repurchase couldn't be accomplished by immediate payment of funds, but it was speculative whether the repurchase would occur within five years, or even within the 15-year period. Thus, the repurchase didn't meet the requirement that the foundation establish that the amount set aside will be paid within five years.

On the other hand, Taxpayer's proposed project for the relocation and expansion of the Clinic was like the charitable projects described in Rev Rul 74-450 and Rev Rul 77-7 and qualified as a set-aside under Code Sec. 4942(g)(2)(A). IRS determined that Taxpayer had established to its satisfaction that the relocation and improvement were better accomplished by a set-aside than by immediate payment of funds, and that the amount of the set-aside would be paid within five years unless some or all of such funds were first utilized for the repurchase of the healthcare facility.

IRS's conclusion that the Clinic project qualified as a set aside under Code Sec. 4942(g)(2)(A) wasn't altered by the fact that the contingency may occur that would cause Taxpayer to use some or all of the Clinic set aside funds to repurchase the healthcare facility before use for Clinic under the five-year requirement. IRS determined that the facts established to its satisfaction that the Clinic project was a serious and significant charitable endeavor of Taxpayer that would be fulfilled barring the occurrence of a double contingency: (1) the closing of a hospital; and (2) the Taxpayer's decision to exercise an option to purchase used assets at fair market value.

References: For set-asides under Code Sec. 4942(g)(2), see FTC 2d/FIN ¶D-7712; United States Tax Reporter ¶49,424.03; TaxDesk ¶685,012; TG ¶20960.