Starting a Private Foundation in California: Tax Rules, Filing Requirements and Common Mistakes to Avoid

Starting a private foundation can be an effective way to support charitable causes, create a long-term philanthropic legacy and potentially receive valuable tax benefits.

But a private foundation comes with significantly more tax and reporting requirements than simply making a large donation to an existing charity.

Consider a California taxpayer establishing a new private foundation with several million dollars in funding. In addition to cash, the taxpayer owns highly appreciated California real estate and is considering contributing that property directly to the foundation.

That raises some important questions:

• How much of the contribution can be deducted?
• Can donating appreciated property avoid capital gains tax?
• What happens if the private foundation later sells that property?
• What federal and California filings are required?
• What transactions between the foundation and its founder are prohibited?

These questions are especially important for anyone considering a substantial contribution of cash, real estate or investments to a private foundation.

Here is what California private foundation founders should know.

Who Regulates a Private Foundation in California?

A California private foundation generally has reporting and compliance obligations involving three different government agencies.

1. The IRS

The IRS oversees the foundation’s federal tax-exempt status and enforces the special federal tax rules that apply to private foundations.

Most private foundations must file Form 990-PF every year, regardless of their size.

Form 990-PF reports information about the foundation’s finances and activities and helps determine whether the foundation has complied with rules involving:

• Required charitable distributions
• Investment income
• Self-dealing
• Excess business holdings
• Jeopardizing investments
• Taxable expenditures

Unlike many small public charities, private foundations generally cannot use the simplified Form 990-N e-Postcard instead of filing a full annual return.

2. California Franchise Tax Board

A California private foundation also needs to establish and maintain its state tax-exempt status.

An organization that has already received a favorable federal determination letter may generally request California recognition of its exemption using FTB Form 3500A. Other organizations may need to use Form 3500. After its California exemption is established, a private foundation generally files Form 199 annually with the Franchise Tax Board.

Importantly, California private foundations must file the full Form 199 regardless of gross receipts. The Form 199N e-Postcard available to certain smaller nonprofit organizations is not available to private foundations. If a foundation has sufficient unrelated business taxable income, additional filings such as California Form 109 may also be required.

3. California Attorney General

California charities are also regulated by the California Attorney General’s Registry of Charities and Fundraisers. Generally, a charitable organization must register with the Registry within 30 days after it first receives charitable assets.

After registration, a California private foundation generally files Form RRF-1 annually with the Registry, together with a copy of its Form 990-PF.

The Attorney General’s oversight is particularly important because it focuses on how charitable assets are being managed and whether charitable property is being improperly diverted or used for the benefit of insiders.

When Is Form 990-PF Due?

For a calendar-year private foundation, Form 990-PF is generally due May 15, the 15th day of the fifth month following the end of the tax year. An extension may generally be requested using Form 8868.

Form 990-PF is generally required to be filed electronically.

California’s Form 199 and Attorney General annual reporting requirements generally follow similar annual filing cycles, although extensions and special filing relief can affect the actual deadlines.

California has also been transitioning charity registration and reporting functions to online systems. Foundations should therefore confirm the current Attorney General filing procedures and deadlines each year rather than assuming the process has remained unchanged.

How Much Can You Deduct When Funding a Private Foundation?

This is where private foundation tax planning becomes particularly important. A contribution to a private foundation may be tax deductible, but the deduction rules are not necessarily the same as they would be if the donor made the same contribution to a public charity. For a typical private non-operating foundation, cash contributions by an individual are generally subject to a deduction limitation of 30% of adjusted gross income (AGI).

Example: Funding a Private Foundation With Several Million Dollars

Suppose a taxpayer wants to contribute $4 million in cash to a newly established private non-operating foundation.

The fact that the taxpayer contributes $4 million does not necessarily mean the entire $4 million can be deducted on that year’s individual income tax return. For example, if the taxpayer’s applicable 30% AGI limitation allows a $1.2 million deduction that year, the remaining contribution is not necessarily lost.

Unused charitable contributions can generally be carried forward for as many as five additional tax years, subject to the applicable deduction limitations in those years. Any remaining contribution that cannot be used before the carryforward period expires may be lost as an income tax deduction.

For someone planning to fund a private foundation with several million dollars, that makes multi-year tax planning extremely important. The amount contributed, the donor’s expected AGI and other charitable contributions can all affect how much of the deduction can ultimately be used.

A New Charitable Deduction Rule Beginning in 2026

Beginning with the 2026 tax year, taxpayers who itemize generally may deduct charitable contributions only to the extent their contributions exceed 0.5% of AGI.

For someone making a multimillion-dollar charitable contribution, this may represent only a portion of the overall tax benefit, but it should still be included when calculating the actual value and timing of the deduction. This is another reason large charitable contributions should be modeled before the transaction takes place rather than simply addressed when the individual income tax return is prepared.

What Happens If You Donate Appreciated Real Estate to a Private Foundation?

Real estate can create a significant planning opportunity, but it also adds another layer of complexity.

Imagine a taxpayer owns California investment property that was purchased years ago and has appreciated substantially. There are two very different ways the taxpayer might fund the foundation with that asset. The taxpayer could sell the property personally and contribute the resulting cash to the foundation. Or the taxpayer could contribute the property itself directly to the private foundation. Those choices can have dramatically different tax consequences.

Selling the Property First

If the owner sells highly appreciated property personally, the owner will generally recognize the taxable capital gain resulting from that sale. The taxpayer can then contribute the cash proceeds to the private foundation, subject to the applicable charitable deduction rules.

Donating the Property Directly

If the owner instead contributes the appreciated property directly to the private foundation, the charitable contribution itself generally does not cause the donor to recognize the property’s built-in capital gain. That can be a substantial benefit.

For example, consider an investment property worth approximately $2 million with an adjusted tax basis of approximately $300,000. If the owner sold the property personally, there could potentially be approximately $1.7 million of built-in gain before considering selling expenses and other tax adjustments.

If the property is instead contributed directly to the foundation in a qualifying charitable transfer, the donor generally does not recognize that $1.7 million of appreciation merely because the property was donated. However, there is an important tradeoff.

The Charitable Deduction May Be Limited to the Property’s Tax Basis

When appreciated real estate is donated to a typical private non-operating foundation, the charitable deduction generally is not based on the property’s full fair market value. Instead, the deduction may have to be reduced by the appreciation in the property, effectively limiting the deductible contribution to the donor’s adjusted basis.

Using our simplified example, property with a fair market value of approximately $2 million and an adjusted basis of approximately $300,000 could potentially leave the donor with a charitable deduction based on the $300,000 basis rather than the $2 million fair market value. At the same time, contributing the property directly may avoid recognizing the approximately $1.7 million of built-in appreciation on the donor’s individual return.

That tradeoff between avoiding capital gain and receiving a potentially smaller charitable deduction is one of the most important issues to model before transferring appreciated property to a private foundation. For capital-gain property contributed to a typical private non-operating foundation, additional percentage limitations may also apply. Depending on the contribution and the donor’s other charitable gifts, the applicable limitation can be as low as 20% of AGI. Large noncash contributions can also require additional substantiation, including Form 8283 and, in many circumstances, a qualified independent appraisal. The tax consequences should therefore be analyzed before the deed is transferred, not when the tax return is being prepared months later.

What Happens When the Private Foundation Sells the Donated Property?

This is another area where private foundation founders can be surprised.

A private foundation may be tax exempt, but that does not mean it never pays tax. Most domestic tax-exempt private foundations are subject to a 1.39% federal excise tax on net investment income under Internal Revenue Code Section 4940. Net investment income can include capital gain from the sale of investment property.

For property acquired by gift, the foundation generally takes the donor’s basis into account when determining the gain. Highly appreciated property can therefore generate a significant gain when the foundation eventually sells it.

What If the Foundation Uses All of the Money for Charity?

Using the sale proceeds for charitable purposes does not automatically eliminate the foundation’s excise tax on its net investment income. The sale of the investment and the foundation’s later use of the proceeds for grants or other charitable purposes involve separate tax rules. For example, if a foundation receives highly appreciated property, later sells it and then uses the cash to fund charitable grants, the grants may help fulfill the foundation’s charitable mission.

But that does not necessarily make the investment gain disappear for purposes of the 1.39% excise tax.

What About Annual Distribution Requirements?

Private non-operating foundations are also subject to annual minimum distribution requirements under federal tax law, commonly referred to as the “5% rule.”

The calculation and timing of those required distributions involve additional rules that are beyond the scope of this article. Anyone establishing or funding a private foundation should account for those requirements as part of the foundation’s ongoing tax and compliance planning.

One of the Biggest Private Foundation Risks: Self-Dealing

For family foundations in particular, one of the greatest compliance risks is self-dealing. Private foundation rules impose strict limitations on transactions between the foundation and people known as disqualified persons.

Depending on the circumstances, disqualified persons can include:

• Substantial contributors to the foundation
• Foundation managers
• Certain family members
• Businesses and entities controlled by those individuals

The surprising part is that a transaction does not necessarily become permissible simply because everyone involved believes the terms are fair. A transaction that would be perfectly ordinary between two unrelated businesses may be prohibited when a private foundation and its founder are involved. For example, a foundation generally cannot simply purchase property from its founder or sell foundation property back to the founder, even if the transaction occurs at fair market value. Loans, leases and the personal use of foundation property can create similar problems.

There are exceptions to certain private foundation restrictions, including rules that can permit reasonable compensation for some necessary personal services. But founders should never assume an arm’s-length transaction is automatically permissible.

Be Extremely Careful With Mortgaged Real Estate

Real estate subject to debt deserves particular attention before it is contributed to a private foundation.

Under the private foundation self-dealing rules, transferring property can potentially be treated as a prohibited sale or exchange if the foundation assumes certain debt or takes the property subject to certain mortgages or similar liens.

That means the tax and legal review of a proposed real estate contribution should include questions such as:

• Is there a mortgage or deed of trust on the property?
• Will the foundation assume any debt?
• Are there liens against the property?
• Is the property currently leased?
• Is the founder or a related party involved in the lease?
• Will a family member or related business manage the property?
• Is there already a prospective buyer?
• Is that buyer related in any way to the donor or foundation?

These issues should be addressed before the property is transferred to the foundation.

Other Private Foundation Rules Founders Should Know

Self-dealing is only one of several special restrictions imposed on private foundations.

Excess Business Holdings

Federal tax law can limit how much of a business a private foundation and its related parties may own. This becomes especially important when someone wants to contribute an interest in a closely held or family-owned business to a foundation.

Jeopardizing Investments

Foundation managers must exercise appropriate care when investing charitable assets. Highly speculative investments or investment decisions made without appropriate consideration of the foundation’s charitable purposes can potentially create excise tax exposure.

Taxable Expenditures

Private foundation funds must be used in accordance with the rules governing charitable expenditures. Certain improper grants, political expenditures and other prohibited uses of foundation assets can become taxable expenditures and lead to excise taxes.

California Private Foundation Compliance Checklist

Someone establishing or funding a California private foundation should generally make sure the following issues have been addressed:

• Federal recognition of tax-exempt status
• California recognition of tax-exempt status
• Registration with the California Attorney General
• Annual Form 990-PF filing
• Annual California Form 199 filing
• Annual California Attorney General Form RRF-1 filing with a copy of Form 990-PF
• The 1.39% net investment income excise tax
• Annual minimum distribution requirements
• Charitable contribution deduction limitations
• Carryforward of unused charitable deductions
• Qualified appraisal requirements for applicable noncash gifts
• Form 8283 reporting
• Self-dealing restrictions
• Mortgages and liens on contributed real estate
• Excess business holdings
• Investment policies and documentation
• Records supporting grants and charitable expenditures

For a foundation holding several million dollars in assets, these should be treated as ongoing compliance responsibilities rather than once-a-year tax-return questions.

Should You Contribute Cash or Appreciated Property to a Private Foundation?

There is no universal answer.

Cash can offer a larger percentage-of-AGI deduction limitation and is straightforward for the foundation to use. Highly appreciated property can provide another potential advantage: transferring the property directly may allow the donor to avoid personally recognizing substantial built-in capital gain. But that benefit can come with a lower charitable deduction, additional appraisal requirements, potential liquidity issues for the foundation and tax consequences when the foundation eventually sells the asset.

For a taxpayer deciding between contributing cash, appreciated real estate, securities or other investments, the best choice depends on the taxpayer’s basis, fair market value, AGI, other charitable contributions and long-term plans for the foundation. That analysis should happen before the assets move.

The Bottom Line

A private foundation can be a powerful tool for individuals and families who want to build a long-term charitable legacy.

But tax exempt does not mean tax simple. A California private foundation can have simultaneous responsibilities to the IRS, the California Franchise Tax Board and the California Attorney General. The person funding the foundation may also face very different tax consequences depending on whether the contribution consists of cash, appreciated real estate, securities or other property. For someone considering a multimillion-dollar contribution, those differences can be significant.

A direct contribution of appreciated real estate, for example, may allow the donor to avoid recognizing substantial capital gain personally. But the charitable deduction may be limited to the property’s adjusted basis, additional AGI limitations may apply and the foundation may eventually owe the 1.39% excise tax when the property is sold. Just as importantly, transactions involving the founder, family members or related businesses can trigger strict private foundation self-dealing rules even when a transaction appears reasonable or is conducted at fair market value.

The best time to identify those issues is before money or property changes hands.

Tax Crisis Institute has been representing taxpayers in crisis since 1983. We help individuals and businesses navigate complex federal and California tax matters, including situations involving significant assets, tax exposure and complicated IRS requirements.

If you are considering a transaction with significant tax consequences or are already facing an IRS or California tax problem, getting the right advice early can help prevent an expensive tax issue from becoming an even larger one.

This article is for general informational purposes only and does not constitute legal or tax advice. Private foundation and charitable contribution rules are highly fact-specific. Taxpayers should consult qualified tax and legal professionals regarding their individual circumstances.