Conservation land's exempt-use value is excluded from a foundation's investment return

Plain-English summary

A private foundation owned conservation land containing threatened plants, endangered bird habitat, native forests, and other natural resources protected by a conservation easement. It managed the property for conservation, research, education, and landowner outreach, while allowing controlled hunting and conservation-focused timbering. Because two hunting leases and related improvements were nonexempt uses, the foundation defined an exempt-use portion by subtracting their fair market values from the property's value. The IRS ruled that the foundation could exclude the fair market value of that exempt-use portion when calculating its minimum investment return under section 4942(e). It also ruled that reasonable and necessary expenses for operating and maintaining that portion were qualifying distributions under section 4942(g)(1), without deciding the property's value or whether the easement was a qualified conservation contribution.

Ruling snapshot

• Question: Could the foundation exclude the conservation property's exempt-use value from its minimum investment return and count related operating expenses as qualifying distributions?
• Outcome: approved (both requested section 4942 rulings were favorable)
• Key authorities: IRC §§ 170(c)(2)(B), 4942(e), 4942(g)(1), 501(c)(3); Treas. Reg. §§ 53.4942(a)-2, 53.4942(a)-3

Full text (IRS public release)

 Internal Revenue Service                                      Department of the Treasury
                                                               Washington, DC 20224

 Number: 202024014                                             Third Party Communication: None
 Release Date: 6/12/2020                                       Date of Communication: Not Applicable
 Index Number: 4942.03-03, 4942.03-05
                                                               Person To Contact:
 ----------------------------------                            -----------------------ID No. -----------------
 ---------------------------------                             Telephone Number:
 --------------------------                                    --------------------
 -----------------------------                                 Refer Reply To:
 -------------------------                                     CC:EEE:EOET:EO3
                                                               PLR-130310-18
                                                               Date:
                                                               June 04, 2019


 Foundation                           = ----------------------------------
 State                                = --------
 Conservation Property                = --------------------------------------------------
 Endangered Bird Species              = --------------------------------------
 X                                    = ---------

Dear ---------------:

This letter responds to a request for a ruling from your authorized representatives dated
October 1, 2018, that a portion of real property owned by Foundation is used or held for
use directly in carrying out Foundation’s exempt purpose and, therefore, (i) Foundation
can exclude the fair market value of the exempt use portion of the property, as defined
below, for purposes of determining its minimum investment return under section
4942(e); and (ii) the expenses incurred in operating and maintaining the exempt use
portion of the property constitute qualifying distributions within the meaning of section
4942(g)(1).

FACTS

Foundation is a State law charitable trust, which is recognized as a tax-exempt
organization described in section 501(c)(3) and classified as a private foundation under
section 509(a).

Foundation’s charitable purposes include conservation and the protection of natural
resources. Foundation acquired Conservation Property approximately five years prior to
submitting this request for rulings. Conservation Property consists of approximately X
acres located in State and is home to many native varieties of trees threatened by non-
native invasive species, and several types of at-risk plants, including two wildflower
species, one of which is listed as threatened and the other as endangered under the
Endangered Species Act, which is administered by the U.S. Fish and Wildlife Service
and the Commerce Department’s National Marine Fisheries Service. Conservation
Property also is an important habitat for various animals that roam the property,
including two clusters of an Endangered Bird Species.
PLR-130310-18                                2

Foundation granted a conservation easement on Conservation Property to a tax-exempt
organization recognized as described in section 501(c)(3) and classified as a public
charity under section 509(a)(1). The purposes of the conservation easement include to
“conserve and enhance the character of the Protected Property as predominantly
hardwood bottomland and upland pine forests, wildlife and game habitat, biological
diversity, scenic quality, unique historical and cultural features, native flora and fauna,
rare species and communities protection, water quality and watershed protection” of the
river running through Conservation Property and its “perennial tributaries, wetlands, and
riparian zones, and the ecological processes which support them….” The conservation
easement also prohibits any uses or activities that may threaten the viability of any
species listed as threatened or endangered by State or the federal government.

Foundation’s trustees adopted a “Timber Management Plan” and a “Strategic Vision,”
which provide a framework for managing Conservation Property, including monitoring
stands of trees for insect and disease occurrences in conjunction with ongoing herbicide
applications to eradicate non-native invasive species of plants and promoting the
regeneration of native hardwood plant species. Low-intensity prescribed burn
applications will be conducted to increase plant and animal diversity, promote plant
growth, increase light availability, and help control invasive plants. Conservation
Property also includes two habitat management areas which provide a high-quality
habitat for Endangered Bird Species and will be operated in a manner that complies
with a habitat conservation program established by a partnership between a State
agency and a program operated by a university to conserve and protect the resources
and lands of State. Foundation conducts timbering activity solely in furtherance of
conservation initiatives, and income received from removed trees is used to pay for
prescribed burns, maintenance of access roads, and the purchase of herbicides and
other expenses related to conservation and natural resource protection objectives.

Foundation employs an executive director to develop and implement research,
conservation, and outreach programs. The purpose of the research program is to build
academic networks and promote scientific research on Conservation Property.
Foundation provides access to Conservation Property at no cost to groups from local
universities, government agencies, and other organizations for research and
educational purposes. Foundation anticipates making grants (and exercising
expenditure responsibility, if required) to academic institutions to support one or more
researchers whose work will focus on specific questions related to Conservation
Property ecosystems, and creating an internship program with one or more local
universities to provide experience and training opportunities for college students
majoring in natural resources and/or environmental sciences to receive valuable training
specific to conservation and land management. Ultimately, Foundation anticipates
creating an organization to oversee Conservation Property operations and also a
research institute. Foundation’s outreach program intends to find creative ways to
translate knowledge from complex properties like Conservation Property to small,
family-owned properties by sponsoring regional stewardship events, with Conservation
Property serving as a setting for regional policy workshops. The events will focus on
PLR-130310-18                                 3

specific issues related to conservation, water policy, prescribed fire, air quality, and
other needs.

Foundation is the lessor of two hunting leases on Conservation Property, both of which
are subject to the conservation easement. Foundation represents that hunting is an
extremely important aspect of land conservation and maintaining a healthy ecosystem.
Both leases follow a game management plan prepared annually by the property
manager, strict adherence to which ensures that only certain mature animals are
targeted so that the health and quality of wildlife on Conservation Property improve over
time. Foundation ensures that safe hunting practices and operational procedures are
followed by meeting with hunters daily during hunting season and providing content to
hunters regarding harvest goals, safety reminders, and concerns regarding actions by
hunters. One of the lessees has a full-time employee trained in conservation and wildlife
management who acts as a liaison to Foundation to ensure that the game management
plan is followed.

Foundation states that but for the leases, it would be required to expend tremendous
resources to hire a large enough staff to perform the hunting activities necessary to
maintain a healthy ecosystem on Conservation Property. Other benefits of permitting
controlled hunting include having extra sets of eyes and ears on the property to observe
and record the number and types of species encountered, as well as detect the need for
fence, road, and culvert repair, and to identify fallen trees and incidents of trespassing.

Accordingly, Foundation represents that, except for the fair market values of the two
hunting leases and of the lodge and other improvements located on land subject to one
of the leases, Conservation Property is used exclusively for exempt purposes (“Exempt
Use Portion”).

RULINGS REQUESTED

Foundation requests the following rulings:

    1. Foundation may exclude the fair market value of the Exempt Use Portion of
      Conservation Property for purposes of determining Foundation’s minimum
      investment return pursuant to section 4942(e).

    2. Foundation may treat the payment of expenses incurred in operating and
      maintaining the Exempt Use Portion of Conservation Property as qualifying
      distributions within the meaning of section 4942(g)(1).

LAW

Section 4942(a) generally imposes on the undistributed income of a private foundation
for any taxable year, which has not been distributed before the first day of the second
(or any succeeding) taxable year following such taxable year (if such first day falls within
PLR-130310-18                                4

the taxable period), a tax equal to 30 percent of the amount of such income remaining
undistributed at the beginning of such second (or succeeding) taxable year.

Section 4942(c) provides that “undistributed income” is the amount by which the
distributable amount for such taxable year exceeds the qualifying distributions made out
of such distributable amount.

Section 4942(d) defines “distributable amount” as an amount equal to the sum of the
minimum investment return plus the amounts described in section 4942(f)(2)(C),
reduced by the sum of the taxes imposed on the private foundation for the taxable year
under subtitle A and section 4940.

Section 4942(e)(1) defines the term “minimum investment return” as five percent of the
excess of the aggregate of fair market value of all assets of the private foundation other
than those which are used (or held for use) directly in carrying out the foundation's
exempt purposes, over the acquisition indebtedness (determined under section
514(c)(1) without regard to the taxable year in which the indebtedness was incurred).

Section 4942(g)(1) defines “qualifying distribution” as any amount (including that portion
of reasonable and necessary administrative expenses) paid to accomplish one or more
purposes described in section 170(c)(2)(B), other than contributions to certain other
organizations, or any amount paid to acquire an asset used (or held for use) directly in
carrying out one or more purposes described in section 170(c)(2)(B).

Treas. Reg. § 53.4942(a)-2(c)(2)(v) provides that the assets taken into account in
determining minimum investment return shall not include any assets used (or held for
use) directly in carrying out the foundation’s exempt purpose.

Treas. Reg. § 53.4942(a)-2(c)(3)(i) provides, in part, that an asset is used (or held for
use) directly in carrying out a foundation’s exempt purpose only if the asset is actually
used by the foundation in carrying out the charitable, educational, or other similar
purpose which gives rise to the exempt status of the foundation. Consequently, assets
which are held for the production of income or for investment (for example, stocks,
bonds, interest-bearing notes, endowment funds, or, generally, leased real estate) are
not being used (or held for use) directly in carrying out the foundation’s exempt purpose,
even though the income from such assets is used to carry out the foundation’s exempt
purpose. Whether an asset is held for the production of income or for investment rather
than used (or held for use) directly by the foundation to carry out its exempt purpose is a
question of fact. However, where exempt use of property represents less than 95
percent of the property’s total use, a reasonable allocation between such exempt and
nonexempt use must be made.

Treas. Reg. § 53.4942(a)-2(c)(3)(ii) gives examples of assets which are “used (or held
for use) directly in carrying out the foundation’s exempt purpose,” including real estate
PLR-130310-18                                 5

or the portion of a building used by a foundation directly in its charitable, educational, or
other similar exempt activities.

Treas. Reg. § 53.4942(a)-3(a)(8), Example (1) provides for illustration of what
constitutes a “qualifying distribution” that payments of compensation to employees of a
private foundation for performing work on activities in furtherance of an exempt purpose
and of items of overhead attributable to the activities of such employees in furtherance
of an exempt purpose are qualifying distributions as payments of reasonable
administrative expenses paid by the foundation to accomplish section 170(c)(1) or
(2)(B) purposes under section 4942(g)(1).

Rev. Rul. 67-292, 1967-2 C.B. 184, provides that an organization formed to purchase
and maintain a large tract of land as a forest to be reserved as a sanctuary for wild birds
and animals and to be open to the public for educational purposes is exempt from
federal income tax and described in section 501(c)(3).

Rev. Rul. 70-186, 1970-1 C.B. 129, provides that an organization formed to preserve a
large lake as a public recreational facility and to improve the condition of the water in
the lake to enhance its recreational features is exempt from federal income tax and
described in section 501(c)(3). Any private benefits derived by the lake front property
owners do not lessen the public benefits flowing from the organization’s operations.

Rev. Rul. 75-207, 1975-1 C.B. 361, describes a private foundation formed to further
conservation, education, and the arts. The foundation owns and maintains an island
dedicated to preserving the natural ecosystems and historical and archaeological
remains on the island, which has no residential use. Access is limited to invited public
and private researchers. The ruling holds that the island is being used directly to carry
out the foundation’s exempt purpose in the manner indicated in the regulations under
section 4942. Accordingly, the foundation may exclude the value of the island in
computing its minimum investment return under section 4942(e).

Rev. Rul. 76-204, 1976-1 C.B. 152, describes an organization formed by scientists,
conservationists, and other community representatives for the purpose of preserving the
environment. It accomplishes this purpose by acquiring and maintaining (or transferring
to a governmental agency) ecologically significant undeveloped land such as swamps,
marshes, forests, wilderness tracts, and other natural areas. Generally, public access to
such land is limited so that the delicate balance of the ecosystem remains undisturbed.
In these situations, the organization will allow educational and scientific research or
study, as long as such use will not disrupt the particular ecosystem. The ruling
concludes that the organization is enhancing the accomplishment of an express national
policy of conserving the nation’s unique natural resources and, in this sense, is
advancing education and science and benefiting the public in a manner that the law
regards as charitable. Furthermore, the restrictions on current access to the lands
maintained by the organization are essential to the preservation of their natural state,
and are therefore essential to the fulfillment of the organization’s charitable purpose.
PLR-130310-18                                 6

Public benefit from environmental conservation derives not merely from the current
educational, scientific, and recreational uses that are made of natural resources, but
also from their preservation.

Rev. Rul. 82-137, 1982-2 C.B. 303, holds that the percentage of exempt use of a
building owned by a private foundation, a portion of which is leased to commercial
tenants, should be determined by dividing the fair rental value of that portion of the
building used for exempt purposes by the fair rental value of the entire building.

ANALYSIS

Ruling 1

Foundation has been implementing its Strategic Vision to conserve and protect the
natural resources, including threatened and endangered plant and animal species, of
Conservation Property, which is subject to a conservation easement granted to and
enforceable by a public charity. Conservation of natural resources and preservation of
the environment, including forests, ecologically significant undeveloped land, and
wildlife sanctuaries, is a recognized exempt purpose under section 501(c)(3). See Rev.
Rul. 67-292, Rev. Rul. 70-186, and Rev. Rul. 76-204. Similar to the organization in Rev.
Rul. 75-207, Foundation has consistently provided access to Conservation Property to
groups from local universities and other organizations for research and educational
purposes. Foundation also has an outreach program directed to educating other
landowners in the region and sponsoring events and workshops related to conservation
and other issues. Hunting is permitted on the property pursuant to a game management
plan and only to the extent necessary to maintain a healthy ecosystem on Conservation
Property, while the only timbering activity Foundation conducts is focused solely on
conservation initiatives.

A private foundation’s “distributable amount” under section 4942(d) is defined in
reference to its minimum investment return, the calculation of which, under section
4942(e)(1), begins with a determination of the fair market value of all assets other than
those which are used (or held for use) directly in carrying out the foundation’s exempt
purposes. Thus, a private foundation may exclude from its calculation of minimum
investment return the value of assets which are used (or held for use) directly in
carrying out the foundation’s exempt purpose. See Treas. Reg. § 53.4942(a)-2(c)(2)(v).
Under Treas. Reg. § 53.4942(a)-2(c)(3)(i), an asset is used (or held for use) directly in
carrying out a foundation’s exempt purpose only if the asset is actually used by the
foundation in carrying out the charitable, educational, or other similar purpose which
gives rise to the exempt status of the foundation. If exempt use of property represents
less than 95 percent of the property’s total use, a reasonable allocation between such
exempt and nonexempt use must be made. A reasonable allocation between exempt
and nonexempt use may be determined, in some cases, by dividing the fair rental value
of a portion of a building used for exempt purposes by the fair rental value of the entire
building. See Rev. Rul. 82-137.
PLR-130310-18                                 7


Foundation is using Conservation Property directly in carrying out its exempt purposes
by using the land for conservation, research, and educational purposes, although such
use represents less than 95 percent of the property’s total use. As represented by
Foundation, the Exempt Use Portion of Conservation Property is its fair market value,
reduced by the fair market values of the leases and of the lodge and other
improvements located on land subject to one of the leases. Accordingly, the fair market
value of the Exempt Use Portion of Conservation Property may be excluded from the
calculation of Foundation’s minimum investment return.

Ruling 2

Foundation is using Conservation Property for exempt purposes described in section
170(c)(2)(B), as explained above. Under section 4942(g)(1), a “qualifying distribution”
includes any amount (including that portion of reasonable and necessary administrative
expenses) paid to accomplish one or more purposes described in section 170(c)(2)(B).
See Treas. Reg. § 53.4942(a)-3(a)(8), Example (1). Foundation’s reasonable and
necessary expenses it incurs in operating and maintaining the Exempt Use Portion of
Conservation Property may be treated as qualifying distributions.

RULINGS

Based solely on the facts and representations submitted by Foundation, we rule as
follows:

1. Foundation can exclude the fair market value of the Exempt Use Portion of
Conservation Property for purposes of determining its minimum investment return
pursuant to section 4942(e).

2. Foundation can treat the payment of reasonable and necessary expenses incurred in
operating and maintaining the Exempt Use Portion of Conservation Property as
qualifying distributions within the meaning of section 4942(g)(1).

The rulings contained in this letter are based upon information and representations
submitted by or on behalf of Foundation and accompanied by a penalty of perjury
statement executed by an appropriate party, as specified in Rev. Proc. 2019-1, 2019-1
I.R.B. 1, § 7.01(16)(b). This office has not verified any of the material submitted in
support of the request for ruling, and such material is subject to verification on
examination. The Associate Office will revoke or modify a letter ruling and apply the
revocation retroactively if: (1) there has been a misstatement or omission of controlling
facts; (2) the facts at the time of the transaction are materially different from the
controlling facts on which the ruling is based; or (3) the transaction involves a continuing
action or series of actions and the controlling facts change during the course of the
transaction. See Rev. Proc. 2019-1, § 11.05.
PLR-130310-18                                     8

Except as specifically set forth above, no opinion is expressed or implied concerning the
federal tax consequences of the proposed transaction under any other provision of the
Code or regulations, including the determination of the fair market value of the Exempt
Use Portion and whether the grant of the conservation easement was a qualified
conservation contribution within the meaning of section 170(h).

This letter is directed only to Foundation. Section 6110(k)(3) provides that it may not be
used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to Foundation’s authorized representatives.

If you have any questions about this ruling, please contact the person whose name and
telephone number are shown in the heading of this letter.

                                            Sincerely,



                                            Mike Repass
                                            Senior Technician Reviewer
                                            Exempt Organizations Branch 3
                                            (Employee Benefits, Exempt Organizations, and
                                            Employment Taxes)



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