Case of the Week

Case:

Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now only manages her own large personal portfolio. Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and has learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market. After reading in her favorite charity's weekly enewsletter about the need for housing in a low-income area that had been destroyed by a flood, Lucy called Clara Johnson, the charity's gift planner.

Lucy had invested $1,000,000 in stock in a renewable energy company with the name Northern Long Shot, Inc. This company designs and manufactures energy solutions for companies across the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy thinks that this stock should be sold as soon as possible, but she would like to receive a deduction this year. In addition, she thought that the $5,000,000 could be placed in a private foundation to make loans to low-income individuals who otherwise could not afford to rebuild their homes. Since she wanted to have direct influence over the program, Lucy called her attorney Susan White to discuss a potential major gift to a private foundation for low-income housing loans.

Question:

Would this plan work? Can the private foundation receive the gift and sell the Northern Long Shot, Inc. stock? May the funds be used to offer housing loans to low-income individuals? Is there a better plan?

Solution:

There are several potential issues with Lucy's plan. First, a private foundation could receive the Northern Long Shot stock and immediately sell the stock. The cash would then be available for use by the private foundation.

However, to consider if offering housing loans to low-income individuals is permissible, the private foundation must consider the Sec. 4944 rules on investments that jeopardize the charitable interest. Section 4944 imposes a tax on investments that jeopardize the carrying out of any of the exempt purposes of a private foundation. Regulation 53.4944-1(a)(2)(i) states that an investment shall be considered jeopardizing if the foundation managers have failed to exercise ordinary business care and prudence under the facts and circumstances prevailing at the time the investment is made. Since the loans may be quite risky and some low-income homeowners are at a higher risk of default, will these loans be permitted?

Since the loans are related to the private foundation's exempt purpose, this program may be permissible if the foundation's counsel makes that determination. Counsel must find that the program passes both requirements for a program-related investment. First, the primary purpose of the investment must be to accomplish one or more of the purposes described in Sec. 170(c)(2)(B). Here, the primary purpose of the loans is to combat community deterioration in a manner that is considered charitable within the meaning of Sec. 501(c)(3). Thus, the foundation's counsel believes such loans accomplish a purpose described in Sec. 170(c)(2)(B).

Second, the loans must not have the production of income or the appreciation of property as a significant purpose. The funds invested by the private foundation will be used to provide financing for low-income persons and will not produce major income or appreciation. Thus, counsel may find that this is appropriate use of the private foundation's investments.

Lucy decided to fund the private foundation. With $5,000,000 in funding and the foundation's counsel approving the structure of the loans, many low-income persons are now rebuilding both their homes and their lives.