Temp. Reg. § 53-4958-7T(b)(4)—Correction by return of specific property
The temporary regulations provide that, with the agreement of the applicable tax-exempt organization, a disqualified person may correct a transaction by returning specific property that was the subject of an excess benefit transaction. However, the applicable tax-exempt organization cannot force the disqualified person to correct the transaction in this manner. If the subject property, such as a painting, has appreciated in value since the excess benefit transaction, the temporary regulations give the disqualified person an incentive to sell the property rather than returning it to the tax-exempt organization because the property is valued, for correction purposes, at the lesser of its value at the time of the excess benefit transaction or the time of its return. See Temp. Reg. § 53.4958-7T(b)(4)(i). The temporary regulations do, however, provide that if the property in question has decreased in value, the disqualified person must make a cash payment to make the tax-exempt organization whole. See Temp. Reg. § 53.4958-7T(b)(4)(ii).

The regulations should be modified to require, if the tax-exempt organization so desires, the return of the specific property in question. Section 4958(f)(6) defines "correction" as "undoing the excess benefit to the extent possible, and taking any additional measures necessary to place the organization in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards." This definition is similar to the Code definition with respect to the correction of self-dealing transactions under section 4941. Section 4941(e)(3) requires "undoing the transaction to the extent possible, but in any case placing the private foundation in a financial position not worse than that in which it would be if the disqualified person were dealing under the highest fiduciary standards."

We believe that the "highest fiduciary standards" require the return of specific property if the tax-exempt organization desires. For example, suppose that a museum director, a disqualified person with respect to the museum, purchased a painting from the museum for less than its fair market value because the artist was not well known to the museum staff and the true value of the painting was known only by the museum director. Assume further that, after the transaction is discovered, but before it is corrected, the painting suddenly increased in value because the artist acquired greater fame. Under the temporary regulations, the museum would not be entitled to a return of the painting without making an additional cash payment to the disqualified person to cover the difference between its current market value and the fair market value at the time of the excess benefit transaction. In such a case, the temporary regulations permit the disqualified person to profit from the excess benefit transaction. We believe that, in order to prevent the tax-exempt organization from being placed in a place worse than it would otherwise be if the disqualified person were dealing under the highest fiduciary standards, the section 4941 correction standards should also be applied to section 4958. These standards generally require the rescission of the transaction where possible. See Treas. Reg. § 53.4941(e)-1(c)(2)(i).