Part X - Minimum Investment Return

Who must complete this section?   All domestic foundations must complete Part X.

Foreign foundations that checked box D2 on page 1 do not have to complete Part X unless claiming status as a private operating foundation.

Private operating foundations, described in sections 4942(j)(3) or 4942(j)(5), must complete Part X in order to complete Part XIV.

Overview.   A private foundation that is not a private operating foundation must pay out, as qualifying distributions, its minimum investment return. This is generally 5% of the total fair market value of its noncharitable assets, subject to further adjustments as explained in the instructions for Part XI. The amount of this minimum investment return is figured in Part X and is used in Part XI to figure the amount that is required to be paid out (the distributable amount).

Minimum investment return.   In figuring the minimum investment return, include only those assets that are not actually used or held for use by the organization for a charitable, educational, or other similar function that contributed to the charitable status of the foundation. Cash on hand and on deposit is considered used or held for use for charitable purposes only to the extent of the reasonable cash balances reported in Part X, line 4. See the instructions for lines 1b and 4 below.

Assets that are held for the production of income or for investment are not considered to be used directly for charitable functions even though the income from the assets is used for the charitable functions. It is a factual question whether an asset is held for the production of income or for investment rather than used or held for use directly by the foundation for charitable purposes.

For example, an office building that is used to provide offices for employees engaged in managing endowment funds for the foundation is not considered an asset used for charitable purposes.

Dual-use property.   When property is used both for charitable and other purposes, the property is considered used entirely for charitable purposes if 95% or more of its total use is for that purpose. If less than 95% of its total use is for charitable purposes, a reasonable allocation must be made between charitable and noncharitable use.

Excluded property.   Certain assets are excluded entirely from the computation of the minimum investment return. These include pledges of grants and contributions to be received in the future and future interests in estates and trusts. See Pub. 578, chapter VII, for more details.

Line 1a - Average monthly fair market value of securities.   If market quotations are readily available, a foundation may use any reasonable method to determine the average monthly fair market value of securities such as common and preferred stock, bonds, and mutual fund shares, as long as that method is consistently used. For example, a value for a particular month might be determined by the closing price on the first or last trading days of the month or an average of the closing prices on the first and last trading days of the month. Market quotations are considered readily available if a security is any of the following:

• Listed on the New York or American Stock Exchange or any city or regional exchange in which quotations appear on a daily basis, including foreign securities listed on a recognized foreign national or regional exchange.
• Regularly traded in the national or regional over-the-counter market for which published quotations are available.
• Locally traded, for which quotations can be readily obtained from established brokerage firms.

If securities are held in trust for, or on behalf of, a foundation by a bank or other financial institution that values those securities periodically using a computer pricing system, a foundation may use that system to determine the value of the securities. The system must be acceptable to the IRS for Federal estate tax purposes.

The foundation may reduce the fair market value of securities only to the extent that it can establish that the securities could only be liquidated in a reasonable period of time at a price less than the fair market value because of:

• The size of the block of the securities;
• The fact that the securities held are securities in a closely held corporation; or
• The fact that the sale of the securities would result in a forced or distress sale.

Any reduction in value allowed under these provisions may not be more than 10% of the fair market value (determined without regard to any reduction in value).

Also, see Regulations sections 53.4942(a)-2(c)(4)(i)(b), (c), and (iv)(a).

Line 1b - Average of monthly cash balances.   Compute cash balances on a monthly basis by averaging the amount of cash on hand on the first and last days of each month. Include all cash balances and amounts that may be used for charitable purposes (see line 4 on page 22) or set aside and taken as a qualifying distribution (see Part XII).

Line 1c - Fair market value of all other assets.   The fair market value of assets other than securities is determined annually except as described below. The valuation may be made by private foundation employees or by any other person even if that person is a disqualified person. If the IRS accepts the valuation, it is valid only for the tax year for which it is made. A new valuation is required for the next tax year.

5-year valuation.   A written, certified, and independent appraisal of the fair market value of any real estate, including any improvements, may be determined on a 5-year basis by a qualified person.

The qualified person may not be a disqualified person (see General Instruction C) with respect to the private foundation or an employee of the foundation.

Commonly accepted valuation methods must be used in making the appraisal. A valuation based on acceptable methods of valuing property for Federal estate tax purposes will be considered acceptable.

The appraisal must include a closing statement that, in the appraiser's opinion, the appraised assets were valued according to valuation principles regularly employed in making appraisals of such property, using all reasonable valuation methods. The foundation must keep a copy of the independent appraisal for its records. If a valuation is reasonable, the foundation may use it for the tax year for which the valuation is made and for each of the 4 following tax years.

Any valuation of real estate by a certified independent appraisal may be replaced during the 5-year period by a subsequent 5-year certified independent appraisal or by an annual valuation as described above. The most recent valuation should be used to compute the foundation's minimum investment return.

If the valuation is made according to the above rules, the IRS will continue to accept it during the 5-year period for which it applies even if the actual fair market value of the property changes during the period.

Valuation date.   An asset required to be valued annually may be valued as of any day in the private foundation's tax year, provided the foundation values the asset as of that date in all tax years. However, a valuation of real estate determined on a 5-year basis by a certified, independent appraisal may be made as of any day in the first tax year of the foundation to which the valuation applies.

Assets held for less than a tax year.   To determine the value of an asset held less than 1 tax year, divide the number of days the foundation held the asset by the number of days in the tax year. Multiply the result by the fair market value of the asset.

Line 1e - Reduction claimed for blockage or other factors.   If the fair market value of any securities, real estate holdings, or other assets reported on lines 1a and 1c reflects a blockage discount, marketability discount, or other reduction from full fair market value because of the size of the asset holding or any other factor, enter on line 1e the aggregate amount of the discounts claimed. Attach an explanation that includes the following information for each asset or group of assets involved:

1. A description of the asset or asset group (e.g., 20,000 shares of XYZ, Inc., common stock);
2. For securities, the percentage of the total issued and outstanding securities of the same class that is represented by the foundation's holding;
3. The fair market value of the asset or asset group before any claimed blockage discount or other reduction;
4. The amount of the discount claimed; and
5. A statement that explains why the claimed discount is appropriate in valuing the asset or group of assets for section 4942 purposes.

In the case of securities, there are certain limitations on the size of the reduction in value that can be claimed. See the instructions for Part X, line 1a.

Line 2 - Acquisition indebtedness.   Enter the total acquisition indebtedness that applies to assets included on line 1. For details, see section 514(c)(1).

Line 4 - Cash deemed held for charitable activities.   Foundations may exclude from the assets used in the minimum investment return computation the reasonable cash balances necessary to cover current administrative expenses and other normal and current disbursements directly connected with the charitable, educational, or other similar activities. The amount of cash that may be excluded is generally 1½% of the fair market value of all assets (minus any acquisition indebtedness) as computed in Part X, line 3. However, if under the facts and circumstances an amount larger than the deemed amount is necessary to pay expenses and disbursements, then you may enter the larger amount instead of 1½% of the fair market value on line 4. If you use a larger amount, attach an explanation.

Line 6 - Short tax periods.   If the foundation's tax period is less than 12 months, determine the applicable percentage by dividing the number of days in the short tax period by 365 (or 366 in a leap year). Multiply the result by 5%. Then multiply the modified percentage by the amount on line 5 and enter the result on line 6.

Part XI - Distributable Amount

If the organization is claiming status as a private operating foundation described in section 4942(j)(3) or (j)(5) or if it is a foreign foundation that checked box D2 on page 1, check the box in the heading for Part XI. You do not need to complete this part. See the Part XIV instructions for more details on private operating foundations.

Section 4942(j)(5) organizations are classified as private operating foundations for purposes of section 4942 only if they meet the requirements of Regulations section 53.4942(b)-1(a)(2).

The distributable amount for 2002 is the amount that the foundation must distribute by the end of 2003 as qualifying distributions to avoid the 15% tax on the undistributed portion.

Line 4a.   Enter the total of recoveries of amounts treated as qualifying distributions for any year under section 4942(g). Include recoveries of part or all (as applicable) of grants previously made; proceeds from the sale or other disposition of property whose cost was treated as a qualifying distribution when the property was acquired; and any amount set aside under section 4942(g) to the extent it is determined that this amount is not necessary for the purposes of the set-aside.

Line 4b - Income distributions from section 4947(a)(2) trusts.   The income portion of distributions from split-interest trusts on amounts placed in trust after May 26, 1969, must be added to the distributable amount, subject to the limitation of Regulations section 53.4942(a)-2(b)(2)(iii).

A split-interest trust is defined in section 4947(a)(2) as a trust that is not exempt from tax under section 501(a), not all of the unexpired interests of which are devoted to charitable, religious, educational, and like purposes, and that has amounts in trust for which a charitable contributions deduction has been allowed.

If the foundation receives distributions that include amounts placed in trust before May 27, 1969, and amounts placed in trust after May 26, 1969, these distributions must be allocated between those amounts to determine the extent to which the distributions are included in the foundation's distributable amount.

Line 6 - Deduction from distributable amount.   If the foundation was organized before May 27, 1969, and its governing instrument or any other instrument continues to require the accumulation of income after a judicial proceeding to reform the instrument has terminated, then the amount of the income required to be accumulated must be subtracted from the distributable amount beginning with the first tax year after the tax year in which the judicial proceeding was terminated. (See the instructions for Part VII-A, line 6.)

Part XII - Qualifying Distributions

Qualifying distributions are amounts spent or set aside for religious, educational, or similar charitable purposes. The total amount of qualifying distributions for any year is used to reduce the distributable amount for specified years to arrive at the undistributed income (if any) for those years.

Line 1a - Expenses, contributions, gifts, etc.   Enter the amount from Part I, column (d), line 26. However, if the borrowed funds election applies, add the total of the repayments during the year to the amount from Part I, column (d), line 26, and enter it on line 1a.

Borrowed funds.   If the foundation borrowed money in a tax year beginning before January 1, 1970, or later borrows money under a written commitment binding on December 31, 1969, the foundation may elect to treat any repayments of the loan principal after December 31, 1969, as qualifying distributions at the time of repayment, rather than at the earlier time that the borrowed funds were actually distributed, only if:

1. The money is used to make expenditures for a charitable or similar purpose and
2. Repayment on the loan did not start until a year beginning after 1969.

On these loans, deduct any interest payment from gross income to compute adjusted net income in the year paid.

Election.   To make this election, attach a statement to Form 990-PF for the first tax year beginning after 1969 in which a repayment of loan principal is made and for each tax year after that in which any repayment of loan principal is made. The statement should show:

• The lender's name and address.
• The amount borrowed.
• The specific use of the borrowed funds.
• The private foundation's election to treat repayments of loan principal as qualifying distributions.

Line 1b - Program-related investments.   Enter the total of the Amount column from Part IX-B. See the Part IX-B instructions for the definition of program-related investments.

Line 3 - Amounts set aside.   Amounts set aside may be treated as qualifying distributions only if the private foundation establishes to the satisfaction of the IRS that the amount will be paid for the specific project within 60 months from the date of the first set-aside and meets 1 or 2 below.

1. The project can be better accomplished by a set-aside than by the immediate payment of funds (suitability test) or
2. The private foundation meets the requirements of section 4942(g)(2)(B)(ii) (cash distribution test).

Set-aside under item 1.   For any set-aside under 1 above, the private foundation must apply for IRS approval by the end of the tax year in which the amount is set aside. Send the application for approval to the Internal Revenue Service, P.O. Box 27720, McPherson Station, Washington, DC 20038.

The application for approval must give all of the following information:

• The nature and purposes of the specific project and the amount of the set-aside for which approval is requested;
• The amounts and approximate dates of any planned additions to the set-aside after its initial establishment;
• The reasons why the project can be better accomplished by the set-aside than by the immediate payment of funds;
• A detailed description of the project, including estimated costs, sources of any future funds expected to be used for completion of the project, and the location(s) (general or specific) of any physical facilities to be acquired or constructed as part of the project; and
• A statement of an appropriate foundation manager that the amounts set aside will actually be paid for the specific project within a specified period of time ending within 60 months after the date of the first set-aside; or a statement explaining why the period for paying the amount set aside should be extended and indicating the extension of time requested. (Include in this statement the reason why the proposed project could not be divided into two or more projects covering periods of no more than 60 months each.)

Set-aside under item 2.   For any set-aside under 2 above, the private foundation must attach a schedule to its annual information return showing how the requirements are met. A schedule is required for the year of the set-aside and for each subsequent year until the set-aside amount has been distributed. See Regulations section 53.4942(a)-3(b)(7)(ii) for specific requirements.

Line 5 - Reduced tax on investment income under section 4940(e).   If the organization does not qualify for the 1% tax under section 4940(e), enter zero. See Parts V and VI of the instructions.

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