Noninterest-bearing loan to exempt foundation may be characterized as "property held for investment."

A noncorporate taxpayer's deduction for investment interest is limited to the taxpayer's net investment income for the tax year. The term "investment interest" is defined in Sec. 163(d)(3)(A) as interest paid or accrued on indebtedness properly allocable to property held for investment. The Service has ruled in Letter Ruling (TAM) 9526003 that interest-free loans to a Sec. 501(c)(3) exempt foundation were deemed to yield imputed interest income under Sec. 7872 and constituted "property held for investment" under Sec. 163(d)(5).

As of Jan. 1, 1988, taxpayers had made interest-free demand loans to a foundation with a total unpaid balance of $352x. All such loans had been funded with proceeds of loans obtained pursuant to a line of credit from commercial banks. During 1988, the foundation repaid $121x, reducing the balance as of Dec. 31, 1988 to $231x. The average balance during 1988 was $292x.

During 1988, the taxpayers paid an average annual rate of interest on their line of credit indebtedness of 8.6%.

Under Sec. 7872, the loans were gift loans. The forgone interest was treated as interest received by the lender and repaid to the foundation as a charitable gift. The taxpayers accordingly reported $23x of imputed interest income ($292x X 7.8075%, the average applicable Federal short-term rate f or 19 8 8) and claimed an offsetting charitable deduction in the same amount.

The issue in the TAM was whether "property held for investment" included "interest-free loans to a tax exempt organization which are deemed to yield gross income as a result of interest imputed under section 7872 of the internal Revenue Code."

The statutory definition of property held for investment requires only that the property be of the type that produces interest, dividends, annuities or royalties not derived in the ordinary course of a trade or business. The IRS cited Rev. Rul. 93-68 for the rule that "even stock in a company which had never paid a dividend was deemed property held for investment ... because stock generally produces dividend income. " Thus, the Service concluded that "[t]he f act that a loan is productive of interest income that is taxable to a taxpayer as income is a sufficient basis for characterizing such a loan as property held for investment."

However, the TAM does not address the issue of whether a loan of less than $250,000 would be characterized as "property held for in vestment," since such a loan is not subject to the imputed interest rules of Sec. 7872. Temp. Regs. Sec. 1.7872-5T(a)(9) provides that a loan not greater than $250,000 to a charitable organization is exempt from the imputed interest rules. Therefore, it is not clear whether a noninterest-bearing loan of less than $250,000 to a foundation is "property held for investment" under Sec. 163(d)(5).

From Sidney W. Leibowitz, CPA, MS, Holtz Rubenstein & Co., LLP, Melville, N.Y.