Private foundations are charitable organizations exempt from federal income tax and, consequently, do not pay traditional capital gains tax. Instead, they are subject to a 1.39% excise tax on net investment income, which includes capital gains on assets sold at a profit. This excise tax effectively replaces the capital gains tax, providing a tax-advantaged environment for the foundation's assets to grow. Therefore, when a private foundation sells stock or other assets at a gain, it only pays the nominal excise tax of 1.39% on the net capital gains, not the traditional capital gains tax that might apply to other entities or individuals.
For private foundations, capital losses can be used to offset capital gains, but they cannot be deducted against other net investment income like dividends and interest. Furthermore, capital losses cannot be carried forward to future years. Therefore, strategic timing is crucial for foundations to maximize tax efficiency. By aligning the realization of capital losses with capital gains, they can effectively use the losses to offset the gains, thereby optimizing their tax position.
Throughout the year, private foundations should review their investment portfolios to decide if any capital sales should be made to increase tax efficiency. If the foundation has excess realized capital losses, it may be beneficial to sell a security with a gain to absorb the losses. The cash from the sale can then be used to repurchase the same security, resetting the tax basis at a higher level (this reduces potential future gains). On the other hand, if the foundation has excess capital gains, capital loss harvesting can be done to offset the gains.
It is worthwhile to note that private foundations are subject to the wash sale rules. A wash sale occurs when a security is sold at a loss and a substantially identical security is acquired within 30 days before or 30 days after the sale date. With wash sales, the loss recognized from the security sale is disallowed and cannot be used to offset other capital gains. Instead, the wash sale loss will be added to the basis of the repurchased securities. Wash sales can be avoided by purchasing a replacement security that is not substantially identical or by simply waiting out the 30-day time period to buy back the security.
Seeking expert guidance? We're here to help!
At CPA KPA, we're passionate about magnifying the positive impact of family foundations. Feel free to reach out to us anytime at 888-402-1780 for a complimentary and obligation-free conversation. You can also conveniently submit your questions and inquiries through our contact page. Let's connect today and explore how we can help your foundation have a lasting and meaningful impact!
