C.5. Deduction Modifications

(1) The following are modifications of the deductions otherwise allowable with

respect to gross investment income:

a. The depreciation deduction is allowed, but only based on the straight-line

method provided in Section 167(b)(1). Use of the accelerated cost recovery system of Section 168 isn’t permitted.

b. The depletion deduction is allowed but is determined without regard to

Section 613, relating to percentage depletion.

c. The basis for purposes of the deduction allowed for depreciation or depletion

is the basis as determined under the normal basis rules of part II of subchapter O of Chapter 1, subject to the provisions of Section 4940(c)(3)(B) and without regard to Section 4940(c)(4)(B) or Section 362(c). Thus, a private foundation must reduce the cost or other substituted or transferred basis by an amount equal to the straight-line depreciation or cost depletion, without regard to whether the foundation deducted such depreciation or depletion during the period prior to its first taxable year beginning after December 31, 1969. However, where a private foundation has previously taken depreciation or depletion deductions in excess of the amount which would have been taken had the straight line or cost method been employed, such excess depreciation or depletion is also taken into account to reduce basis. The excess wasn’t taken into consideration when a private foundation used the percentage depletion method to record depletion on its books and records but took no deduction for depletion because it paid no income tax. See Rev. Rul. 79-200, 1979-1 C.B.364. If the facts necessary to determine the basis of property in the hands of the donor or last preceding owner by whom it was acquired by gift are unknown to a donee private foundation, then the original basis to such foundation of such property is determined under the rules of Treas. Reg. 1.1015-1(a)(3).

d. A deduction for expenses paid or incurred in any taxable year for the

production of gross investment income earned as an incident to a charitable function may not be greater than the income earned from such charitable function which is includible in gross investment income for such year. For example, in a taxable year where rental income is incidentally realized from historic buildings held open to the public, deductions paid or incurred in such year for the production of such income are limited to the amount of rental

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income from such buildings includible as gross investment income for such year. See Treas. Reg. 53.4940-1(e)(2). However, rental income and potential admission fees must be distinguished because income from potential admission fees doesn’t constitute rents received for the use of a portion of a building. See Historic House Museum Corp. v. Commissioner, 70 T.C. 12 (1978).