[Federal Register Volume 62, Number 11 (Thursday, January 16, 1997)]
[Rules and Regulations]
[Pages 2275-2305]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-710]
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DEPARTMENT OF THE TREASURY
26 CFR Parts 1 and 602
[TD 8712]
RIN 1545-AU62
Definition of Private Activity Bonds
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations on the definition of
private activity bonds applicable to tax-exempt bonds issued by state
and local governments. These final regulations reflect changes to the
applicable law that were made by the Technical and Miscellaneous
Revenue Act of 1988. These regulations affect issuers of tax-exempt
bonds and provide needed guidance for applying the private activity
bond restrictions.
DATES: These regulations are effective May 16, 1997.
For dates of applicability of these regulations, see Secs. 1.141-
15, 1.141-16, 1.148-6(a)(3) and 1.148-6(d)(1)(iii) of these
regulations.
FOR FURTHER INFORMATION CONTACT: Loretta J. Finger or Nancy M.
Lashnits, (202) 622-3980 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1451. Responses to these collections of information
are mandatory. Pursuant to comments received, the collections of
information have been amended, but the estimated annual burden per
respondent/recordkeeper has not changed.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated average annual burden hours per respondent/
recordkeeper: 3 hours.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20024, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Books or records relating to collections of information must be
retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Removal of Existing Regulations for Repealed Sections
Prior to the enactment of the Tax Reduction and Simplification Act
of 1977 (Pub. L. 95-30), sections 141 through 144 contained provisions
of the Internal Revenue Code of 1954 relating to the standard
deduction. Sections 141 (``Standard Deduction''), 142 (``Individuals
Not Eligible for Standard Deduction''), and 144 (``Election of Standard
Deduction'') were repealed by section 101(d)(1) of that act. Section
143 (''Determination of Marital Status'') was redesignated section 7703
by section 1301(j)(2) of the Tax Reform Act of 1986 (Pub. L. 99-514).
Therefore, existing regulations Secs. 1.141-1, 1.142-1, 1.142-2, 1.144-
1, 1.144-2, and 1.144-3 are being removed from the Code of Federal
Regulations (CFR), and regulation Sec. 1.143-1 is being redesignated
Sec. 1.7703-1.
Proposed Regulations
On December 30, 1994, proposed regulations (FI-72-88) were
published in the Federal Register (59 FR 67658) to provide guidance
under the Internal Revenue Code of 1986 (Code) in sections 141
(relating to private activity bonds and to qualified bonds), 142
(relating to exempt-facility bonds), 145 (relating to qualified
501(c)(3) bonds), 147 (relating to other requirements applicable to
certain private activity bonds), 148 (relating to arbitrage), 150
(relating to change of use), and 1394 (relating to enterprise zone
facility bonds). All subsequent references in this preamble to Code
sections are to the Internal Revenue Code of 1986. On June 8, 1995, the
IRS held a public hearing on the proposed regulations. Written comments
responding to the proposed regulations were received.
On May 31, 1996, final regulations (FI-72-88) were published in the
Federal Register (61 FR 106) to provide guidance under Code section
1394 to address the issues relating to enterprise zone facility bonds.
After consideration of all the comments, certain of the proposed
regulations under Code sections 141, 142, 144, 145, 147, 148, and 150
are adopted as revised by this Treasury decision. The principal
revisions to the proposed regulations are discussed below.
Explanation of Provisions
Certain commentators suggested that the proposed regulations, with
certain modifications, be published again as proposed regulations. A
number of other commentators suggested that the proposed regulations,
with certain modifications, should be promulgated as final regulations
to provide certainty at the earliest possible time. After considering
these comments, the IRS and Treasury concluded that state and local
government issuers would benefit from the adoption of the proposed
regulations, with certain modifications made in response to comments,
as final regulations.
A. Section 1.141-1 Definitions and rules of general application.
Replaced amounts. The proposed regulations provide that the
proceeds taken into account under the private activity bond tests
include certain replacement proceeds that are reasonably expected to be
available during the project period.
The final regulations treat replaced amounts also as arising to the
extent that the issuer reasonably expects that the term of the issue
will be longer than is reasonably necessary for the governmental
purposes of the issue, in the same manner as replacement proceeds arise
under the arbitrage regulations under Code section 148. Thus, replaced
amounts may arise under the private activity bond tests if an issuer
reasonably expects that there will be available amounts during the
period that the bonds remain outstanding longer than necessary for the
governmental purposes of the issue and if those amounts are used for
purposes that are inconsistent with the private activity bond tests.
B. Section 1.141-2 Private activity bond tests.
1. Clarification of reasonable expectations test. Under the
proposed regulations the private activity bond tests depend on both
reasonable expectations as of the issue date and
[[Page 2276]]
subsequent deliberate actions of the issuer.
The final regulations clarify that, in general, the reasonable
expectations test is met only if the issuer reasonably expects, as of
the issue date, that no action or event during the entire term of the
bonds will cause either the private business tests or the private loan
financing test to be met. The final regulations further provide,
however, that, if certain conditions are met, the period of expected
compliance needs to extend only to a mandatory redemption date. This
special rule is intended to accommodate issuers that reasonably expect
that bond-financed property may be used by nongovernmental persons
during the stated term of the issue, but have not entered into any
arrangement with a nongovernmental person that will use the property
and are unable to predict the timing of that nongovernmental use. This
special rule does not permit, however, reasonably expected
``recycling'' of disposition proceeds because the special rule requires
redemption of all nonqualified bonds.
2. Definition of deliberate action. The proposed regulations
generally provide that any action within the control of an issuer is
treated as a deliberate action and that, if the financed property was
designed differently than is reasonably necessary for the governmental
purposes of the issuer, an action with respect to that property is
treated as deliberate, even if it is not within the issuer's control.
Commentators suggested that deliberate action should be more narrowly
defined.
The final regulations make certain changes that narrow the scope of
the deliberate action rule to minimize administrative burden on state
and local governments. First, the special rule for property that is
``designed differently'' is deleted. The reasonable expectations test
adequately addresses the concerns of this special rule. Second, the
final regulations clarify that an action taken by a state or local
government in response to a regulatory directive of the federal
government is not a deliberate action. Finally, the final regulations
provide that, if certain conditions are met, dispositions of personal
property in the ordinary course of an established governmental program
are not treated as a deliberate action.
3. Special rule for general obligation bond programs that finance a
large number of separate purposes. The proposed regulations provide a
special exception to the definition of disposition proceeds that is
intended to minimize the administrative burden of tracing the use of
proceeds of general obligation bonds that finance a large number of
projects. Commentators suggested that this exception should be
available for other types of bonds and that fewer conditions should
apply to the exception.
The final regulations provide a similar rule that is broadly stated
as an exception to the rule that a deliberate action after the issue
date can cause an issue to meet the private activity bond tests. This
exception is intended to provide relief for ``cash flow'' general
obligation programs, where issuers use the proceeds of an issue for a
large number of projects and spend proceeds promptly. These programs
merit special treatment in part because they further the purposes of
the arbitrage rules.
4. When a deliberate action occurs. The proposed regulations
provide that a deliberate action occurs on the earlier of the date the
parties agree on the consideration for the new use or the date on which
the new use occurs. Commentators suggested that the regulations should
not treat a deliberate action as occurring before the date on which new
private business use actually commences, in part because it may not be
possible to take a remedial action with disposition proceeds before the
date on which the disposition proceeds are received.
The final regulations provide in general that a deliberate action
occurs on the date the issuer enters into a binding contract with a
nongovernmental person for use of the financed property that is not
subject to any material contingencies. In most cases, material
conditions to closing a transaction that results in private business
use will be treated as material contingencies so that this date will
not occur before the date of receipt of disposition proceeds.
C. Section 1.141-3 Definition of private business use.
1. Economic benefit as private business use. Under the proposed
regulations, economic benefit to a nongovernmental person may be
treated as private business use, even if the nongovernmental person has
no special legal rights to use the financed property.
Commentators suggested that the private business use test should
not be met unless special legal rights are provided to a
nongovernmental person pursuant to an arrangement, and that mere
economic benefit is insufficient to give rise to private business use.
The final regulations largely adopt these suggestions. The final
regulations provide, however, that, if the financed property is not
available for use by the general public, a nongovernmental person may
be treated as a private business user of the property based on all of
the facts and circumstances, even if that nongovernmental person has no
special legal entitlements to use of the property.
2. Ownership. The proposed regulations provide that ownership of
property by a nongovernmental person is private business use of that
property.
Commentators suggested that ownership for this purpose should be
defined to mean ownership for general federal income tax purposes and
that mere holding of title to property by a nongovernmental person
should not necessarily give rise to private business use. Commentators
further suggested that certain customary financing structures that
require a nongovernmental person to be a nominal owner of financed
property should be accommodated.
The final regulations adopt these suggestions.
3. Discharge of a primary legal obligation. The proposed
regulations provide that the use of bond proceeds to provide property
that discharges a primary and unconditional legal obligation of a
nongovernmental person results in private business use of that
property.
Commentators suggested that this rule be deleted from the final
regulations. Many commentators indicated that this rule would interfere
with traditional tax assessment bond financings for governmental
projects such as roads and sidewalks. Some commentators also indicated
that certain state and local governments may be required or encouraged
under state law to enter into development agreements with private
developers that could result in private business use of governmental
projects under the discharge of a primary legal obligation rule.
The final regulations adopt this comment by deleting this rule.
4. Management contracts. The proposed regulations provide that
management contracts other than qualified management contracts result
in private business use of the managed property.
Commentators suggested that the qualified management contract rules
should be safe harbors, not substantive rules, and that a management
contract should give rise to private business use only if it transfers
a proprietary interest in financed property to a manager that is a
nongovernmental person. Commentators suggested that the permissible
contract terms for qualified management contracts should be further
extended and that limitations on the contract term based on useful life
of the
[[Page 2277]]
financed property should be deleted. In addition, commentators
suggested that contracts for incidental services, such as janitorial
and equipment repair services, should never give rise to private
business use of financed property.
The final regulations provide more flexible accommodation for
management contracts that implement cost-saving ``privatization''
measures for state and local governments, but continue to reflect the
view that Congress intended that a management contract can give rise to
private business use even if it does not in substance transfer a
leasehold or ownership interest to a nongovernmental person for general
federal income tax purposes. Thus, the final regulations do not adopt
the rule that a management contract gives rise to private business use
only if it transfers a proprietary interest to a nongovernmental
service provider. The final regulations provide that the determination
of whether a management contract that does not meet the qualified
management contract safe harbors gives rise to private business use is
based on all of the facts and circumstances. In general, a management
contract gives rise to private business use if the compensation under
the contract is based on net profits. The final regulations further
provide, however, that contracts for services solely incidental to the
primary governmental function or functions of a financed facility do
not otherwise give rise to private business use under the management
contract rules. In addition, the final regulations clarify the
standards to be applied in determining whether a management contract is
properly characterized as a lease.
A separate revenue procedure establishes safe harbors which expand
the types of management contracts that do not result in private
business use. This revenue procedure in particular permits longer term
management contracts for public utility facilities and systems, relaxes
certain of the requirements for permitted compensation arrangements,
and deletes the requirement that the issuer not control the service
provider.
5. Research agreements. The proposed regulations set forth bright
line rules for determining when corporate-sponsored research agreements
and cooperative research agreements do not give rise to private
business use. These rules apply only to basic research.
The final regulations provide a facts and circumstances rule, and a
separate revenue procedure establishes safe harbors for determining
when corporate-sponsored research agreements and cooperative research
agreements do not give rise to private business use. This revenue
procedure also expands the definition of basic research, for purposes
of Code section 141, to include any original investigation for the
advancement of scientific knowledge not having a specific commercial
objective.
6. Exception for general public use. The proposed regulations
contain detailed quantitative rules for determining when use of
financed property by a nongovernmental person is disregarded because
the nongovernmental person is treated as using the property as a member
of the general public. The proposed regulations also provide that use
by a nongovernmental person of financed property is not treated as
general public use if the property provides a significant economic
benefit to the nongovernmental person because it is functionally and
integrally related to other property used by the nongovernmental
person.
Commentators suggested that the quantitative rules for defining
general public use should be deleted, because they are not sufficiently
flexible to accommodate the wide variety of state and local government
financings and because they disproportionately affect small local
governments.
The final regulations largely delete the quantitative approach in
the proposed regulations for general public use. Instead, the final
regulations adopt a more qualitative test focusing on whether financed
property is intended to be available and in fact is reasonably
available for use on the same basis by natural persons not engaged in a
trade or business. This approach is more consistent with the
requirement in Code section 141 that any activity carried on by a
person that is not a natural person is treated as a trade or business
activity. Because the final regulations generally do not treat mere
economic benefit as private business use, the rules for functionally
and integrally related property are deleted. In light of this narrower
definition of private business use, the special system improvement
rules have also been deleted. The final regulations retain the rule in
the proposed regulations that use under an arrangement that conveys
priority rights is not used on the same basis as the general public and
clarifies that an arrangement for long-term use (defined as more than
180 days) is not treated as general public use. The final regulations
provide that use of financed property by a nongovernmental person that
is not general public use is not necessarily private business use.
Under the approach taken in the final regulations, the definition of
general public use is significant for determining when economic benefit
alone can give rise to private business use and for determining the
permitted terms of short-term arrangements that are not treated as
private business use.
7. Exceptions for short-term arrangements. The proposed regulations
provide that a lease or similar arrangement that has a term of 1 year
or less and that is not renewed or renewable is generally disregarded.
Commentators suggested that longer term arrangements should be
disregarded.
The final regulations provide different exceptions for various
short-term contracts. The exceptions for short-term contracts are based
on a hierarchy depending on how broadly contracts with the same terms
are offered to other users. Under this approach, a contract that is
available to the general public may have a term up to 180 days; a
contract not treated as general public use, but offered on the basis of
generally applicable or uniformly applied rates, may have a term of up
to 90 days; and a specially negotiated contract that provides fair
market value compensation may have a term of up to 30 days. In each
case, the exception applies only if the property is not financed for a
principal purpose of providing that property for use by the
nongovernmental person entering into the contract. The final
regulations delete the 1-year exception for non-renewable short-term
contracts because the final regulations adopt a more flexible rule for
measuring private business use, as discussed below.
8. Exception for temporary use by developers. The proposed
regulations provide an exception for temporary use by a developer of an
improvement that carries out an essential governmental function during
an initial development period not exceeding 3 years.
Commentators suggested that the 3-year limitation on the exception
is too short for many developments and that a requirement that
development proceed with reasonable speed should suffice.
The final regulations largely adopt this comment. This approach
focuses more on whether financed property serving an essential
governmental function is transferred to a governmental person with
reasonable speed than on a specific time frame for development of the
property benefited by the improvement.
9. Exceptions for incidental use and qualified improvements. The
final regulations remove certain conditions to exceptions for
incidental use and qualified improvements.
[[Page 2278]]
10. Measurement of private business use. The proposed regulations
generally provide that private business use is measured on an annual
basis, except for private business use of output facilities.
Commentators suggested that private business use should be measured on
an average or cumulative basis over the term of an issue. The final
regulations largely adopt the suggestion that private business use
should be measured over the term of an issue. In general, the
percentage of private business use of financed property is determined
according to the average annual private business use of that property
over the measurement period. The measurement period begins on the later
of the issue date of the issue or the date the property is placed in
service and ends on the earlier of the last date of the reasonably
expected economic life of the property or the latest maturity date of
any bond of the issue. For certain bonds that are issued in
contemplation of refinancing, such as bond anticipation notes, the
measurement period is based on the final maturity date of any bond of
the refunding issue. Under an anti-abuse rule, however, if an issuer
extends the term of an issue for a principal purpose of increasing the
permitted amount of private business use, the Commissioner may
determine the amount of private business use according to the greatest
percentage of private business use in any 1-year period. Further, if an
issuer reasonably expects on the issue date that bonds will be redeemed
before the final maturity of the issue because of a deliberate action,
the measurement period ends on the reasonably expected date of
redemption. In addition, for arrangements that result in ownership of
financed property by a nongovernmental person, the amount of private
business use is the greatest percentage of private business use in any
1-year period.
This approach of looking to the average amount of private business
use over the expected economic life of financed property is more
consistent with the approach adopted for measuring private payments and
security, which also in effect looks over the term of an issue. This
approach also provides issuers with significantly greater flexibility
to spread out de minimis private business use over the term of an
issue.
The final regulations adopt the measurement-over-the-term rule for
private business use, however, only for purposes of determining whether
an issue has no more than the permitted amount of private business use
(that is, in most cases, the 10 percent threshold). This general
approach reflects the view that adoption of the measurement-over-the-
term rule for purposes other than the de minimis rules would be unduly
complex to administer and could distort the economic substance.
This general approach also simplifies the regulations by providing
a single rule for measuring private business use that applies to both
output facilities and other governmental facilities. The final
regulations reflect the view that all governmental facilities generally
would benefit from more flexible private business use measurement
rules.
11. Determining average use within an annual period. The proposed
regulations generally provide that the average amount of private
business use within a year is based on the amount of time financed
property is actually used for private business use as a percentage of
total time for all actual use, provided that significant differences in
fair market value of different times of use must be taken into account.
Some commentators suggested that the average amount of private
business use should be based on a comparison of time of private
business use to time the financed property is available for use, not to
time it is actually used.
The final regulations continue to determine private business use
for certain purposes as a percentage of actual use. This method more
accurately reflects economic substance. The final regulations also
clarify that, in certain cases, the determination of fair market value
of private business use must take into account the amount of private
payments for that use.
D. Section 1.141-4 Private security or payment test.
1. Payments not directly made by private business users. The
proposed regulations provide that payments made with respect to
property used for a private business use are taken into account under
the private payment test, even if not made by persons that are private
business users of proceeds. Commentators suggested that payments by
persons that are not private business users should be taken into
account only if they can be imputed to a private business user of
proceeds.
The final regulations retain the general rule in the proposed
regulations but clarify that only payments made for the period of
private business use are taken into account. The definition of private
business use in the final regulations narrows the application of this
general rule.
2. Allocation of private payments to different sources of funding.
The proposed regulations provide that a payment from a private business
user of property may be allocated first to repay any costs of the
property paid by the issuer from a source other than a borrowing
(``equity''). The proposed regulations also provide, however, that, if
a payment is made for property financed with two or more issues
(including issues that are not tax-exempt), the payment must be
allocated among those issues according to the relative amount of
proceeds of those issues used to finance the property. Commentators
generally favored the rule permitting allocations first to equity, but
suggested that the same rule should apply to costs financed with
taxable bonds.
The final regulations provide a more general facts and
circumstances test for the allocation of private payments that looks to
the nexus between the private payment and both the property financed
and the source of funding. Thus, under the approach of the final
regulations, allocations of private payments first to equity before
other sources of funding are generally permitted only to the extent
that there is a specific nexus between the payment and a prior
expenditure. The final regulations do not adopt the recommendation that
issuers also be permitted in all cases to allocate private payments
first to repayment of taxable bonds, but treat the obligation to pay
debt service in future years under the taxable debt as establishing a
nexus to future private payments. The final regulations retain the rule
that allocations of private payments among issues according to relative
amounts of those sources of funding that are expended on the property
is generally appropriate, but the final regulations provide issuers
with more flexibility to match these allocations to debt service
payments associated with various sources of funding.
3. Allocation of private security among issues. The proposed
regulations provide that, for bonds other than parity bonds, property
or payments securing more than one issue must be fully allocated to
each issue under the private security test. Commentators suggested that
the rule for allocation of private security among issues should
reasonably reflect foreclosure and default scenarios under the bond
documents. The final regulations in general adopt this comment.
4. Limitations on private security. The proposed regulations
provide that any property that is used for a private business use is
taken into account under the private security test if it secures
payment of debt service on an issue.
The final regulations provide that
[[Page 2279]]
only financed property and property that is provided directly or
indirectly by a nongovernmental person that is treated as a user of
proceeds are taken into account under the private security test.
5. Exception for generally applicable taxes. The proposed
regulations contain specific rules for when a special agreement with
respect to a generally applicable tax may cause tax payments to be
treated as private payments.
In response to comments, the final regulations are more flexible
for arrangements that reduce the amount of tax paid and permit a wider
range of tax equivalency payments. The final regulations also clarify
that an impermissible agreement entered into by one taxpayer does not
affect whether payments made by other taxpayers are treated as
generally applicable taxes.
E. Section 1.141-5 Private loan financing test.
1. Definition of proceeds for purposes of the private loan
financing test. The proposed regulations provide that the private loan
financing test is met if more than the lesser of 5 percent of the
``proceeds'' or $5 million of ``sale proceeds'' is used to make or
finance loans to nongovernmental persons. Commentators suggested that
the definition of proceeds for purposes of the test should be
consistent.
The final regulations apply the general private activity bond
definition of ``proceeds'' to both parts of the test. This approach
reflects the view that investment proceeds that are used to make or
finance loans should be taken into account in determining whether the
private loan financing test is met.
2. Requirements for the ``tax assessment loan'' exception. The
proposed regulations provide that a number of special requirements
apply to the exception in Code section 141(c)(2) from the private loan
financing test for loans that enable the borrower to finance a
governmental tax or assessment of general application for a specific
essential governmental function. Commentators suggested that these
requirements would improperly restrict traditional special tax and
assessment tax-exempt financing for governmental infrastructure in some
states.
In general, special state law restrictions (for example, state
constitutional limitations on issuing general obligation bonds) should
not necessarily foreclose state and local governments from access to
tax-exempt financing for traditional governmental infrastructure
projects. Accordingly, the final regulations relax the requirements for
the tax assessment bond exception. The requirement that a tax or
assessment of general application be proportionate to the benefit to
the taxpayer is deleted. Further, the definition of improvements that
serve essential governmental functions is expanded. Under the new
definition, all improvements to utilities and systems that are owned by
a governmental person and that are available for use by the general
public serve essential governmental functions for this purpose. In
addition, the final regulations provide that guarantees provided by
persons treated as borrowers in most cases will not cause taxes or
assessments to fail to qualify for the tax assessment bond exception.
F. Section 1.141-6 Allocation and accounting rules.
1. Allocations of proceeds to expenditures. The proposed
regulations in general provide that proceeds must be allocated to
expenditures consistently for private activity bond purposes and
arbitrage purposes. Commentators suggested that, in light of the
different purposes of the private activity bond rules and the arbitrage
rules, this consistency should not be required.
The final regulations continue the approach of the proposed
regulations. Final regulations are also adopted under Code section 148
clarifying that allocations of proceeds to expenditures for both
purposes must be made by a definite time (in no event later than the
date that rebate is, or would be, due).
2. Other allocation rules. The proposed regulations contain
detailed rules in Secs. 1.141-1 and 1.141-6 for allocations of proceeds
and bonds, including rules for mixed use facilities and partnerships.
The final regulations reserve these provisions. The IRS and
Treasury are considering more flexible rules to accommodate public/
private partnerships.
G. Section 1.141-7 Special rules for output contracts.
The proposed regulations contain detailed rules in Sec. 1.141-7 for
determining the private business use and private payments resulting
from output contracts.
Regulatory changes are dramatically affecting the electric power
industry. In order to further consider the issues raised by these
changes, the final regulations reserve this section. The final
regulations, however, otherwise apply to bonds issued to finance output
facilities.
H. Section 1.141-8 $15 million limitation for output facilities.
Clarification of computation of nonqualified amount. The proposed
regulations provide guidance on the special $15 million limitation on
output facilities of Code section 141(b)(4). The final regulations
reserve this section.
I. Section 1.141-12 Remedial actions.
1. Remedial actions generally. The proposed regulations provide
that an action that causes the private business tests or the private
loan financing test to be met is not treated as a deliberate action if
the issuer takes an appropriate remedial action.
The final regulations clarify that a remedial action affects only
compliance with the private activity bond rules relating to use of
proceeds and does not affect compliance with rules relating to security
or payment. This clarification is important for purposes of determining
the amount of ``nonqualified bonds'' with respect to which a remedial
action must be taken.
2. Relationship of disposition proceeds and remedial actions. The
proposed regulations contain separate rules for use of proceeds derived
from the disposition of bond-financed property (``disposition
proceeds'') and remedial actions. Commentators suggested that the
relationship between the disposition proceeds rules and the remedial
action rules should be clarified and that, in particular, additional
rules should be provided indicating when it is appropriate to treat an
issue as financing disposition proceeds rather than the transferred
property.
The final regulations take the view that, if an issuer disposes of
bond-financed property, it is generally appropriate under Code section
141 for the Commissioner to treat the issue as financing either the
transferred property or the disposition proceeds. This is because any
disposition of bond-financed property has the potential to transfer the
benefits of tax-exempt financing to the purchaser, and the private
activity bond rules extend to transactions that have significant
potential to transfer these benefits, as well as transactions that
actually transfer these benefits. As a matter of administrative
convenience, however, the final regulations in certain cases permit an
issuer to choose to treat an issue as financing either the transferred
property or the disposition proceeds, provided that certain conditions
are met that protect against abuse. The final regulations accordingly
treat the disposition proceeds rules as conditions to taking certain
remedial actions. For
[[Page 2280]]
example, in order for an issue to be eligible for a remedial action,
the disposition proceeds of an issue must generally be treated as
proceeds for purposes of the arbitrage regulations.
3. Conditions to taking a remedial action. The proposed regulations
provide that an issuer may take a remedial action to prevent bonds of
an issue from becoming private activity bonds only if it made certain
covenants and certifications on the issue date. Commentators suggested
that these specific requirements should be deleted because they are
unnecessary in light of standard industry practice to require similar
covenants and certifications. The final regulations adopt this comment.
4. Maturity limitations and remedial actions. The proposed
regulations provide that an issuer cannot take advantage of certain
favorable rules involving disposition proceeds if the weighted average
maturity of an issue is greater than 120 percent of the economic life
of the financed property. Commentators suggested that use of this 120
percent maturity limitation as a condition to favorable treatment in
taking remedial actions is burdensome for issuers of governmental
bonds.
The final regulations provide that an issue is eligible for the
remedial action rules only if the term of the issue is not longer than
is reasonably necessary for the governmental purposes of the issue. To
determine whether the term of an issue is unreasonably long, the final
regulations adopt the same standard that is used for purposes of
determining whether replacement proceeds arise because the term of an
issue is unreasonably long under Sec. 1.148-1(c)(4). This standard
provides that the 120 percent maturity limitation is a safe harbor,
rather than a requirement in all cases.
5. Special rules for identifying disposition proceeds. Under the
proposed regulations, many of the rules for remedial actions depend on
identification of disposition proceeds. The final regulations clarify
how disposition proceeds are to be allocated to an issue when the
transferred property has been financed with different sources of
funding. In general, the final regulations provide that disposition
proceeds should be allocated first to the outstanding bonds that
financed the property (both tax-exempt and taxable) in proportion to
the outstanding principal amounts of those outstanding bonds. Only
amounts in excess of these outstanding principal amounts may be
allocated to other sources of funding, such as equity of an issuer or
bonds that are no longer outstanding.
6. Redemption and defeasance as remedial actions. The proposed
regulations generally provide that redemption and defeasance of
nonqualified bonds are permitted remedial actions. In cases where the
disposition is exclusively for cash, only the disposition proceeds need
to be used to redeem or defease bonds; in other cases, the entire
amount of nonqualified bonds is required to be redeemed or defeased.
The proposed regulations also provide, however, that defeasance of
bonds to a date that is more than six months from the date of a
deliberate action is permitted only if the possibility of a disposition
was remote as of the issue date of the bonds. Commentators suggested
that this special limitation should be deleted because the remoteness
standard is vague and would require governmental issuers to use special
call provisions that would substantially increase borrowing costs.
The final regulations delete the ``remote possibility'' limitation
on use of defeasance as a remedial action. Instead, the final
regulations permit defeasance as a remedial action only if the first
call date of the nonqualified bonds is not greater than 10\1/2\ years
from the issue date. This limitation presents an administrable standard
that will not unduly interfere with customary financing practices of
state and local governments, while at the same time preventing improper
use of defeasance as a remedial action for bonds that cannot be called
for an extended period of time.
7. Alternative qualifying use of a facility as a remedial action.
The proposed regulations provide that alternative qualifying use of a
bond-financed facility is a permitted remedial action if the facility
is used in a manner that meets the requirements for any type of
qualified private activity bonds and the bonds are treated as reissued
as of the date of the deliberate action for purposes of the tax-exempt
bond rules concerning use of bond-financed property. Commentators
suggested that for purposes of determining whether bonds that are
treated as reissued as of the date of the deliberate action satisfy all
of the applicable requirements for qualified bonds, the rules contained
in Code section 146 relating to volume cap and the rules contained in
Code sections 55 and 57 should not apply. Commentators also suggested
that the regulations should clarify whether any limitations are placed
on an issuer's use of disposition proceeds when it chooses to use this
remedial action.
The final regulations provide that, in order to qualify for this
remedial action, an issuer must deposit any disposition proceeds that
it receives into a yield-restricted escrow to pay the nonqualified
bonds. This requirement is different than the defeasance remedial
action, because an issuer is permitted to leave bonds outstanding until
maturity (rather than the first call date) and is not subject to the
special 10 \1/2\-year call protection limitation on the defeasance
remedial action. Also, if an issuer chooses to use this rule, it may
receive compensation in installments and use any payments received
either to pay debt service or to deposit into a yield-restricted escrow
to pay debt service. This requirement is appropriate because it
establishes the necessary nexus between the new user and the
nonqualified bonds. In effect, the new user is treated, as far as is
reasonably practicable, as if it were the conduit borrower of the bond
proceeds.
The final regulations also clarify that, for purposes of
determining whether nonqualified bonds that are deemed to be reissued
meet all of the requirements for qualified private activity bonds, the
law in effect on the date of the deliberate action applies. The final
regulations do not adopt the suggestion that the rules contained in
Code section 146 relating to volume cap and the rules contained in Code
sections 55 and 57 should not apply. The IRS and Treasury are issuing a
revenue procedure (discussed in paragraph 10 below) to address the
change in status of bonds from governmental bonds to qualified private
activity bonds and the application of the alternative minimum tax
provisions. The final regulations provide that the rules contained in
Code section 147(d) relating to the acquisition of existing property do
not apply to this remedial action.
8. Nonqualified bonds. The proposed regulations permit an issuer to
take a remedial action with respect to a portion of the bonds of an
issue, rather than the entire issue. In general, the proposed
regulations require that these ``nonqualified bonds'' be a pro rata
portion (among the maturities) of the outstanding bonds of an issue.
Commentators suggested that issuers should have greater flexibility to
allocate uses of proceeds to bonds when a deliberate action occurs.
The final regulations permit an issuer to redeem or defease bonds
with longer maturities than the nonqualified bonds in a remedial
action, but in general continue to require that nonqualified bonds be
identified on a pro rata basis. Issuers have significant flexibility to
allocate bonds of an issue to separate
[[Page 2281]]
purposes on or before the issue date under Sec. 1.150-1(c)(3).
Under the final regulations, the percentage of outstanding bonds
that are nonqualified bonds is equal to the highest percentage of
private business use in any 1-year period commencing with the
deliberate action.
9. Effect of deliberate actions and remedial actions on bonds that
have been advance refunded. The proposed regulations do not
specifically address how deliberate actions and remedial actions affect
bonds that have been advance refunded. Commentators suggested that a
deliberate action should not affect the status of an advance refunded
bond under Code section 141.
The final regulations provide that a remedial action taken with
respect to advance refunding bonds proportionately ``cures'' the bonds
that have been advance refunded.
10. Remedial payment revenue procedure. The preamble to the
proposed regulations indicates that the IRS and Treasury are
considering issuance of a revenue procedure pursuant to which an issuer
may request a closing agreement with respect to outstanding bonds.
Under the closing agreement, the issuer would make a payment to the IRS
to prevent the interest on bonds from being includible in gross income
of bondholders as a result of a deliberate action that results in
satisfaction of the private activity bond test. In general, the payment
would be based on the difference between applicable federal rates for
taxable and tax-exempt obligations. The preamble to the proposed
regulations indicates that this revenue procedure is being considered
in lieu of permitting defeasance as a remedial action. Commentators
generally favored the publication of such a revenue procedure but
suggested that it should apply in addition to defeasance as a remedial
action.
Commentators also suggested that an issuer should be permitted to
make a payment to the IRS in those cases where the bonds were issued as
governmental bonds, the interest on which was not treated as an item of
tax preference for purposes of the alternative minimum tax provisions,
but the bonds become qualified private activity bonds, the interest on
which is treated as an item of tax preference for purposes of the
alternative minimum tax provisions as a consequence of a remedial
action taken by the issuer.
The IRS and Treasury are issuing a revenue procedure in addition to
permitting defeasance as a remedial action. Under this revenue
procedure the amount of the remedial payment is based on a factor that
roughly approximates revenue loss to the United States rather than the
difference between taxable and tax-exempt applicable federal rates.
While this approach may in many cases require greater remedial payments
than under the approach described in the proposed regulations, the
fluctuation in the difference between taxable and tax-exempt applicable
federal rates would result in inconsistent treatment of issuers.
Further, a more rigorous standard for determining the remedial payment
is appropriate because the revenue procedure is adopted in addition to
all of the remedial actions set forth in the final regulations.
In response to comments, this revenue procedure also provides that
an issuer may make a payment to prevent the application of the
alternative minimum tax provisions to interest payable on bonds that
were issued as governmental bonds but, as a consequence of a remedial
action taken by an issuer, are qualified private activity bonds. This
approach recognizes the difficulty state and local government issuers
may have in notifying bondholders of this change in status.
J. Section 1.141-13 Refunding issues.
The final regulations reserve on the treatment of refunding bonds
under Code section 141.
K. Section 1.141-14 Anti-abuse rules.
Application of the rule to override specific tracing. The proposed
regulations provide that if an issuer enters into a transaction or
series of transactions with a principal purpose of transferring to
nongovernmental persons (other than as members of the general public)
significant benefits of tax-exempt financing in a manner that is
inconsistent with the purposes of Code section 141, the Commissioner
may take any action to reflect the substance of the transaction or
transactions.
The final regulations adopt this rule and add examples to clarify
that it may be invoked in appropriate cases to override specific
tracing of the use of proceeds.
L. Section 1.145-1 Special rules for qualified 501(c)(3) bonds.
1. Application of private activity bond rules to Code section
145(a). The proposed regulations provide that the regulations under
Code section 141 interpreting the private activity bond tests apply for
purposes of Code section 145(a)(2).
The final regulations in general continue this approach but also
provide that certain provisions under Code section 141, which are
intended to apply only to governmental programs, do not apply to
qualified 501(c)(3) bonds. The final regulations also clarify that
regulations under Code section 141 apply in the same manner to the
ownership test of Code section 145(a)(1) and to the modified private
activity bond test of Code section 145(a)(2).
2. Application of deliberate action and remedial action rules to
other provisions of Code section 145. The proposed regulations provide
that the deliberate action rules of Sec. 1.141-2 and the remedial
action rules of Sec. 1.141-12 generally apply to Code section 145.
The final regulations do not apply to Code sections 145(b), (c), or
(d). The $150 million limitation on bonds other than hospital bonds of
Code sections 145(b) and (c) involves a number of special
considerations, which the IRS and Treasury believe would be more
appropriate to consider in a project comprehensively interpreting the
operation of the special volume cap rules. Similarly, the restrictions
on bonds used to provide residential rental housing for family units of
Code section 145(d) involve a number of special considerations, which
the IRS and Treasury believe would be more appropriate to consider in a
project comprehensively interpreting the special rules for bonds
financing residential rental housing.
M. Special rules for other qualified bonds.
1. General standard for compliance. The proposed regulations
provide that the requirements for qualified bonds (other than qualified
501(c)(3) bonds) generally must be actually met throughout the term of
an issue. Commentators suggested that this rule should be deleted
because the compliance standard for each type of qualified bond should
be separately considered. Other commentators suggested that the
compliance standard applicable to governmental bonds, looking to
reasonable expectations and deliberate actions, is generally
appropriate for qualified bonds.
The final regulations do not address the general compliance
standard for qualified bonds (other than qualified 501(c)(3) bonds).
The IRS and Treasury believe that further consideration should be given
to whether special rules apply to different types of qualified bonds.
Accordingly, the final regulations address only whether remedial
actions may be taken to prevent certain types of qualified bonds from
failing to meet requirements relating to use of proceeds. Thus, no
implication is intended that the
[[Page 2282]]
measurement-over-the-term rule for private business use under Code
sections 141 and 145 applies in any manner to other qualified bonds.
2. Remedial actions for change in use. The proposed regulations in
general provide that, if an action results in nonqualified use of
proceeds, the remedial actions that apply to governmental bonds also
apply to qualified bonds. The permitted remedial actions include
redemption and defeasance of bonds and alternative qualifying use of a
facility.
The final regulations address only whether remedial actions may be
taken for exempt facility bonds under Code section 142 and qualified
small issue bonds under Code section 144(a) and with respect to certain
provisions of 147. The final regulations continue to provide that
redemption and defeasance are permitted remedial actions for these
types of issues, under rules that are similar to the remedial action
rules that apply to governmental bonds. The requirements for these
types of qualified bonds focus on the use of a particular facility for
a particular qualifying use, and, unlike governmental bonds and
qualified 501(c)(3) bonds, do not generally focus on the status of the
borrower. For this reason, the final regulations generally do not
permit an issuer of exempt facility bonds or qualified small issue
bonds to take a remedial action based on use of disposition proceeds.
Accordingly, the final regulations clarify that the amount of bonds
required to be redeemed or defeased under a remedial action is not
limited to the amount of disposition proceeds. For administrative
convenience, however, the final regulations permit the use of
disposition proceeds from the sale of personal property that is
incidental to a qualifying facility to replace the personal property
that is sold. The final regulations do not permit alternative
qualifying use of a facility as a remedial action for exempt facility
bonds or qualified small issue bonds.
3. Remedial actions for failure to spend proceeds. The proposed
regulations provide that a remedial action may be taken to correct a
failure to spend proceeds as required under Code sections 142 and 144.
This rule replaces Rev. Proc. 79-5, 1979-1 C.B. 485, and Rev. Proc. 81-
22, 1981-1 C.B. 692, which provide guidance on how the requirement in
the predecessor to Code section 142 that substantially all of the
proceeds be spent for a qualifying purpose is met when excess bond
proceeds remain on hand after acquisition or construction has been
completed.
The final regulations clarify that the requirements for remedial
action in the case of failure to spend proceeds for a qualifying
purpose are comparable to the requirements for remedial action in the
case of change in use of a qualifying facility. Accordingly, the final
regulations require that nonqualified bonds must be redeemed at their
first call date, regardless of the amount of call premium that is
required to be paid, and that defeasance is permitted only if the first
call date is no later than 10\1/2\ years after the issue date.
4. Refundings of qualified bonds. The final regulations reserve on
the treatment of refundings of qualified bonds.
N. Section 1.150-4 Statutory change of use rules for qualified
private activity bonds.
The proposed regulations provide that the change of use provisions
of Code section 150(b) apply even if an issuer takes a remedial action
that enables an issue of qualified private activity bonds to continue
to meet use of proceeds requirements. Commentators suggested that a
remedial action that preserves the tax-exempt status of a qualified
private activity bond should also prevent application of the interest
deduction denial and imputed unrelated business income provisions of
Code section 150(b).
The final regulations more specifically address the effect of each
type of remedial action on the application of the Code section 150(b)
consequences. In general, defeasance of bonds does not prevent
application of Code section 150(b). If other remedial actions are taken
promptly after the date of the remedial action, however, Code section
150(b) does not apply.
O. Effective dates.
The final regulations generally apply to bonds issued after May 16,
1997. To promote compliance, the final regulations generally permit
elective, retroactive application of the regulations in whole, but not
in part, to outstanding issues. In addition, the final regulations
permit elective, retroactive application to outstanding issues of any
of the following sections of the regulations: Sec. 1.141-12 (the
remedial action rules); Sec. 1.141-3(b)(4) (the management contract
rules); and Sec. 1.141-3(b)(6) (the research agreement rules).
Effect on Other Documents
In part because the existing industrial development bond
regulations under Sec. 1.103-7 may continue to apply to refunding bonds
issued after the effective date of the private activity bond
regulations, Sec. 1.103-7 is not being removed from the Code of Federal
Regulations.
For bonds to which the final regulations apply, the following
publications are obsolete:
Notice 87-69, 1987-2 C.B. 378.
Notice 89-9, 1989-1 C.B. 630.
For actions that occur on or after May 16, 1997, the following
publications are obsolete:
Rev. Proc. 93-17, 1993-1 C.B. 507.
Rev. Proc. 81-22, 1981-1 C.B. 692.
Rev. Proc. 79-5, 1979-1 C.B. 485.
Special Analyses
It has been determined that this Treasury decision is not a
significant regulatory action as defined in EO 12866. Therefore, a
regulatory assessment is not required. It also has been determined that
section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)
does not apply to these regulations, and because the notice of proposed
rulemaking preceding the regulations was issued prior to March 29,
1996, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Internal Revenue Code, the
notice of proposed rulemaking preceding these regulations was submitted
to the Chief Counsel for Advocacy of the Small Business Administration
for comment on its impact on small business.
Drafting Information
The principal authors of these regulations are Michael G. Bailey,
Loretta J. Finger, and Nancy M. Lashnits, Office of Assistant Chief
Counsel (Financial Institutions and Products), and Linda B. Schakel of
the Office of Tax Legislative Counsel. However, other personnel from
the IRS and Treasury Department participated in their development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602 are amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 is amended by adding
an entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
[[Page 2283]]
Section 1.148-6 also issued under 26 U.S.C. 148(f), (g), and (i). *
* *
Section 1.150-4 also issued under 26 U.S.C. 150(c)(5). * * *
Par. 2. The center heading immediately preceding Sec. 1.141-1 is
revised to read as follows:
Tax Exemption Requirements for State and Local Bonds
Par. 3. Section 1.141-1 is revised.
Sec. 1.143-1 [Redesignated as Sec. 1.7703-1]
Par. 4. Section 1.143-1 is redesignated as Sec. 1.7703-1.
Sec. 1.144-3 [Removed]
Par. 5. Section 1.144-3 is removed.
Par. 6. Sections 1.141-0 and 1.141-2 through 1.141-16 are added.
The revised and added sections read as follows:
Sec. 1.141-0 Table of contents.
This section lists the captioned paragraphs contained in
Secs. 1.141-1 through 1.141-16.
Sec. 1.141-1 Definitions and rules of general application.
(a) In general.
(b) Certain general definitions.
(c) Elections.
(d) Related parties.
Sec. 1.141-2 Private activity bond tests.
(a) Overview.
(b) Scope.
(c) General definition of private activity bond.
(d) Reasonable expectations and deliberate actions.
(1) In general.
(2) Reasonable expectations test.
(3) Deliberate action defined.
(4) Special rule for dispositions of personal property in the
ordinary course of an established governmental program.
(5) Special rule for general obligation bond programs that
finance a large number of separate purposes.
(e) When a deliberate action occurs.
(f) Certain remedial actions.
(g) Examples.
Sec. 1.141-3 Definition of private business use.
(a) General rule.
(1) In general.
(2) Indirect use.
(3) Aggregation of private business use.
(b) Types of private business use arrangements.
(1) In general.
(2) Ownership.
(3) Leases.
(4) Management contracts.
(5) Output contracts.
(6) Research agreements.
(7) Other actual or beneficial use.
(c) Exception for general public use.
(1) In general.
(2) Use on the same basis.
(3) Long-term arrangements not treated as general public use.
(4) Relation to other use.
(d) Other exceptions.
(1) Agents.
(2) Use incidental to financing arrangements.
(3) Exceptions for arrangements other than arrangements
resulting in ownership of financed property by a nongovernmental
person.
(4) Temporary use by developers.
(5) Incidental use.
(6) Qualified improvements.
(e) Special rule for tax assessment bonds.
(f) Examples.
(g) Measurement of private business use.
(1) In general.
(2) Measurement period.
(3) Determining average percentage of private business use.
(4) Determining the average amount of private business use for a
1-year period.
(5) Common areas.
(6) Allocation of neutral costs.
(7) Commencement of measurement of private business use.
(8) Examples.
Sec. 1.141-4 Private security or payment test.
(a) General rule.
(1) Private security or payment.
(2) Aggregation of private payments and security.
(3) Underlying arrangement.
(b) Measurement of private payments and security.
(1) Scope.
(2) Present value measurement.
(c) Private payments.
(1) In general.
(2) Payments taken into account.
(3) Allocation of payments.
(d) Private security.
(1) In general.
(2) Security taken into account.
(3) Pledge of unexpended proceeds.
(4) Secured by any interest in property or payments.
(5) Payments in respect of property.
(6) Allocation of security among issues.
(e) Generally applicable taxes.
(1) General rule.
(2) Definition of generally applicable taxes.
(3) Special charges.
(4) Manner of determination and collection.
(5) Payments in lieu of taxes.
(f) Certain waste remediation bonds.
(1) Scope.
(2) Persons that are not private users.
(3) Persons that are private users.
(g) Examples.
Sec. 1.141-5 Private loan financing test.
(a) In general.
(b) Measurement of test.
(c) Definition of private loan.
(1) In general.
(2) Application only to purpose investments.
(3) Grants.
(4) Hazardous waste remediation bonds.
(d) Tax assessment loan exception.
(1) General rule.
(2) Tax assessment loan defined.
(3) Mandatory tax or other assessment.
(4) Specific essential governmental function.
(5) Equal basis requirement.
(6) Coordination with private business tests.
(e) Examples.
Sec. 1.141-6 Allocation and accounting rules.
(a) Allocation of proceeds to expenditures.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds. [Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
Sec. 1.141-7 Special rules for output contracts.
[Reserved]
Sec. 1.141-8 $15 million limitation for output facilities.
[Reserved]
Sec. 1.141-9 Unrelated or disproportionate use test.
(a) General rules.
(1) Description of test.
(2) Application of unrelated or disproportionate use test.
(b) Unrelated use.
(1) In general.
(2) Use for the same purpose as government use.
(c) Disproportionate use.
(1) Definition of disproportionate use.
(2) Aggregation of related uses.
(3) Allocation rule.
(d) Maximum use taken into account.
(e) Examples.
Sec. 1.141-10 Coordination with volume cap.
[Reserved]
Sec. 1.141-11 Acquisition of nongovernmental output property.
[Reserved]
Sec. 1.141-12 Remedial actions.
(a) Conditions to taking remedial action.
(1) Reasonable expectations test met.
(2) Maturity not unreasonably long.
(3) Fair market value consideration.
(4) Disposition proceeds treated as gross proceeds for arbitrage
purposes.
(5) Proceeds expended on a governmental purpose.
(b) Effect of a remedial action.
(1) In general.
(2) Effect on bonds that have been advance refunded.
(c) Disposition proceeds.
(1) Definition.
(2) Allocating disposition proceeds to an issue.
(3) Allocating disposition proceeds to different sources of
funding.
(d) Redemption or defeasance of nonqualified bonds.
(1) In general.
(2) Special rule for dispositions for cash.
(3) Notice of defeasance.
(4) Special limitation.
(5) Defeasance escrow defined.
(e) Alternative use of disposition proceeds.
(1) In general.
[[Page 2284]]
(2) Special rule for use by 501(c)(3) organizations.
(f) Alternative use of facility.
(g) Rules for deemed reissuance.
(h) Authority of Commissioner to provide for additional remedial
actions.
(i) Effect of remedial action on continuing compliance.
(j) Nonqualified bonds.
(1) Amount of nonqualified bonds.
(2) Allocation of nonqualified bonds.
(k) Examples.
Sec. 1.141-13 Refunding issues.
[Reserved]
Sec. 1.141-14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of
transactions.
(b) Examples.
Sec. 1.141-15 Effective dates.
(a) Scope.
(b) Effective dates.
(c) Refunding bonds.
(d) Permissive application of regulations.
(e) Permissive retroactive application of certain sections.
Sec. 1.141-16 Effective dates for qualified private activity bond
provisions.
(a) Scope.
(b) Effective dates.
(c) Permissive application.
Sec. 1.141-1 Definitions and rules of general application.
(a) In general. For purposes of Secs. 1.141-0 through 1.141-16, the
following definitions and rules apply: the definitions in this section,
the definitions in Sec. 1.150-1, the definition of placed in service
under Sec. 1.150-2(c), the definition of grant under Sec. 1.148-
6(d)(4)(iii), the definition of reasonably required reserve or
replacement fund in Sec. 1.148-2(f), and the following definitions
under Sec. 1.148-1: bond year, commingled fund, fixed yield issue,
higher yielding investments, investment, investment proceeds, issue
price, issuer, nonpurpose investment, purpose investment, qualified
guarantee, qualified hedge, reasonable expectations or reasonableness,
rebate amount, replacement proceeds, sale proceeds, variable yield
issue, and yield.
(b) Certain general definitions.
Common areas means portions of a facility that are equally
available to all users of a facility on the same basis for uses that
are incidental to the primary use of the facility. For example,
hallways and elevators generally are treated as common areas if they
are used by the different lessees of a facility in connection with the
primary use of that facility.
Consistently applied means applied uniformly to account for
proceeds and other amounts.
Deliberate action is defined in Sec. 1.141-2(d)(3).
Discrete portion means a portion of a facility that consists of any
separate and discrete portion of a facility to which use is limited,
other than common areas. A floor of a building and a portion of a
building separated by walls, partitions, or other physical barriers are
examples of a discrete portion.
Disposition is defined in Sec. 1.141-12(c)(1).
Disposition proceeds is defined in Sec. 1.141-12(c)(1).
Essential governmental function is defined in Sec. 1.141-
5(d)(4)(ii).
Financed means constructed, reconstructed, or acquired with
proceeds of an issue.
Governmental bond means a bond issued as part of an issue no
portion of which consists of private activity bonds.
Governmental person means a state or local governmental unit as
defined in Sec. 1.103-1 or any instrumentality thereof. It does not
include the United States or any agency or instrumentality thereof.
Hazardous waste remediation bonds is defined in Sec. 1.141-4(f)(1).
Measurement period is defined in Sec. 1.141-3(g)(2).
Nongovernmental person means a person other than a governmental
person.
Output facility means electric and gas generation, transmission,
distribution, and related facilities, and water collection, storage,
and distribution facilities.
Private business tests means the private business use test and the
private security or payment test of section 141(b).
Proceeds means the sale proceeds of an issue (other than those sale
proceeds used to retire bonds of the issue that are not deposited in a
reasonably required reserve or replacement fund). Proceeds also include
any investment proceeds from investments that accrue during the project
period (net of rebate amounts attributable to the project period).
Disposition proceeds of an issue are treated as proceeds to the extent
provided in Sec. 1.141-12. The Commissioner may treat any replaced
amounts as proceeds.
Project period means the period beginning on the issue date and
ending on the date that the project is placed in service. In the case
of a multipurpose issue, the issuer may elect to treat the project
period for the entire issue as ending on either the expiration of the
temporary period described in Sec. 1.148-2(e)(2) or the end of the
fifth bond year after the issue date.
Public utility property means public utility property as defined in
section 168(i)(10).
Qualified bond means a qualified bond as defined in section 141(e).
Renewal option means a provision under which either party has a
legally enforceable right to renew the contract. Thus, for example, a
provision under which a contract is automatically renewed for 1-year
periods absent cancellation by either party is not a renewal option
(even if it is expected to be renewed).
Replaced amounts means replacement proceeds other than amounts that
are treated as replacement proceeds solely because they are sinking
funds or pledged funds.
Weighted average maturity is determined under section 147(b).
Weighted average reasonably expected economic life is determined
under section 147(b). The reasonably expected economic life of property
may be determined by reference to the class life of the property under
section 168.
(c) Elections. Elections must be made in writing on or before the
issue date and retained as part of the bond documents, and, once made,
may not be revoked without the permission of the Commissioner.
(d) Related parties. Except as otherwise provided, all related
parties are treated as one person and any reference to ''person''
includes any related party.
Sec. 1.141-2 Private activity bond tests.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. The purpose of the private activity bond tests of section 141 is
to limit the volume of tax-exempt bonds that finance the activities of
nongovernmental persons, without regard to whether a financing actually
transfers benefits of tax-exempt financing to a nongovernmental person.
The private activity bond tests serve to identify arrangements that
have the potential to transfer the benefits of tax-exempt financing, as
well as arrangements that actually transfer these benefits. The
regulations under section 141 may not be applied in a manner that is
inconsistent with these purposes.
(b) Scope. Sections 1.141-0 through 1.141-16 apply generally for
purposes of the private activity bond limitations under section 141.
(c) General definition of private activity bond. Under section 141,
bonds are private activity bonds if they meet either the private
business use test and private security or payment test of
[[Page 2285]]
section 141(b) or the private loan financing test of section 141(c).
The private business use and private security or payment tests are
described in Secs. 1.141-3 and 1.141-4. The private loan financing test
is described in Sec. 1.141-5.
(d) Reasonable expectations and deliberate actions--(1) In general.
An issue is an issue of private activity bonds if the issuer reasonably
expects, as of the issue date, that the issue will meet either the
private business tests or the private loan financing test. An issue is
also an issue of private activity bonds if the issuer takes a
deliberate action, subsequent to the issue date, that causes the
conditions of either the private business tests or the private loan
financing test to be met.
(2) Reasonable expectations test--(i) In general. In general, the
reasonable expectations test must take into account reasonable
expectations about events and actions over the entire stated term of an
issue.
(ii) Special rule for issues with mandatory redemption provisions.
An action that is reasonably expected, as of the issue date, to occur
after the issue date and to cause either the private business tests or
the private loan financing test to be met may be disregarded for
purposes of those tests if--
(A) The issuer reasonably expects, as of the issue date, that the
financed property will be used for a governmental purpose for a
substantial period before the action;
(B) The issuer is required to redeem all nonqualifying bonds
(regardless of the amount of disposition proceeds actually received)
within 6 months of the date of the action;
(C) The issuer does not enter into any arrangement with a
nongovernmental person, as of the issue date, with respect to that
specific action; and
(D) The mandatory redemption of bonds meets all of the conditions
for remedial action under Sec. 1.141-12(a).
(3) Deliberate action defined--(i) In general. Except as otherwise
provided in this paragraph (d)(3), a deliberate action is any action
taken by the issuer that is within its control. An intent to violate
the requirements of section 141 is not necessary for an action to be
deliberate.
(ii) Safe harbor exceptions. An action is not treated as a
deliberate action if--
(A) It would be treated as an involuntary or compulsory conversion
under section 1033; or
(B) It is taken in response to a regulatory directive made by the
federal government.
(4) Special rule for dispositions of personal property in the
ordinary course of an established governmental program--(i) In general.
Dispositions of personal property in the ordinary course of an
established governmental program are not treated as deliberate actions
if--
(A) The weighted average maturity of the bonds financing that
personal property is not greater than 120 percent of the reasonably
expected actual use of that property for governmental purposes;
(B) The issuer reasonably expects on the issue date that the fair
market value of that property on the date of disposition will be not
greater than 25 percent of its cost; and
(C) The property is no longer suitable for its governmental
purposes on the date of disposition.
(ii) Reasonable expectations test. The reasonable expectation that
a disposition described in paragraph (d)(4)(i) of this section may
occur in the ordinary course while the bonds are outstanding will not
cause the issue to meet the private activity bond tests if the issuer
is required to deposit amounts received from the disposition in a
commingled fund with substantial tax or other governmental revenues and
the issuer reasonably expects to spend the amounts on governmental
programs within 6 months from the date of commingling.
(iii) Separate issue treatment. An issuer may treat the bonds
properly allocable to the personal property eligible for this exception
as a separate issue under Sec. 1.150-1(c)(3).
(5) Special rule for general obligation bond programs that finance
a large number of separate purposes. The determination of whether bonds
of an issue are private activity bonds may be based solely on the
issuer's reasonable expectations as of the issue date if all of the
requirements of paragraphs (d)(5) (i) through (vii) of this section are
met.
(i) The issue is an issue of general obligation bonds of a general
purpose governmental unit that finances at least 25 separate purposes
(as defined in Sec. 1.150-1(c)(3)) and does not predominantly finance
fewer than 4 separate purposes.
(ii) The issuer has adopted a fund method of accounting for its
general governmental purposes that makes tracing the bond proceeds to
specific expenditures unreasonably burdensome.
(iii) The issuer reasonably expects on the issue date to allocate
all of the net proceeds of the issue to capital expenditures within 6
months of the issue date and adopts reasonable procedures to verify
that net proceeds are in fact so expended. A program to randomly spot
check that 10 percent of the net proceeds were so expended generally is
a reasonable verification procedure for this purpose.
(iv) The issuer reasonably expects on the issue date to expend all
of the net proceeds of the issue before expending proceeds of a
subsequent issue of similar general obligation bonds.
(v) The issuer reasonably expects on the issue date that it will
not make any loans to nongovernmental persons with the proceeds of the
issue.
(vi) The issuer reasonably expects on the issue date that the
capital expenditures that it could make during the 6-month period
beginning on the issue date with the net proceeds of the issue that
would not meet the private business tests are not less than 125 percent
of the capital expenditures to be financed with the net proceeds of the
issue.
(vii) The issuer reasonably expects on the issue date that the
weighted average maturity of the issue is not greater than 120 percent
of the weighted average reasonably expected economic life of the
capital expenditures financed with the issue. To determine reasonably
expected economic life for this purpose an issuer may use reasonable
estimates based on the type of expenditures made from a fund.
(e) When a deliberate action occurs. A deliberate action occurs on
the date the issuer enters into a binding contract with a
nongovernmental person for use of the financed property that is not
subject to any material contingencies.
(f) Certain remedial actions. See Sec. 1.141-12 for certain
remedial actions that prevent a deliberate action with respect to
property financed by an issue from causing that issue to meet the
private business use test or the private loan financing test.
(g) Examples. The following examples illustrate the application of
this section:
Example 1. Involuntary action. City B issues bonds to finance
the purchase of land. On the issue date, B reasonably expects that
it will be the sole user of the land for the entire term of the
bonds. Subsequently, the federal government acquires the land in a
condemnation action. B sets aside the condemnation proceeds to pay
debt service on the bonds but does not redeem them on their first
call date. The bonds are not private activity bonds because B has
not taken a deliberate action after the issue date. See, however,
Sec. 1.141-14(b), Example 2.
Example 2. Reasonable expectations test--involuntary action. The
facts are the same as in Example 1, except that, on the issue date,
B reasonably expects that the federal government will acquire the
land in a condemnation action during the term of the bonds. On the
issue date, the present value of the amount that B reasonably
expects to
[[Page 2286]]
receive from the federal government is greater than 10 percent of
the present value of the debt service on the bonds. The terms of the
bonds do not require that the bonds be redeemed within 6 months of
the acquisition by the federal government. The bonds are private
activity bonds because the issuer expects as of the issue date that
the private business tests will be met.
Example 3. Reasonable expectations test--mandatory redemption.
City C issues bonds to rehabilitate an existing hospital that it
currently owns. On the issue date of the bonds, C reasonably expects
that the hospital will be used for a governmental purpose for a
substantial period. On the issue date, C also plans to construct a
new hospital, but the placed in service date of that new hospital is
uncertain. C reasonably expects that, when the new hospital is
placed in service, it will sell or lease the rehabilitated hospital
to a private hospital corporation. The bond documents require that
the bonds must be redeemed within 6 months of the sale or lease of
the rehabilitated hospital (regardless of the amount actually
received from the sale). The bonds meet the reasonable expectations
requirement of the private activity bond tests if the mandatory
redemption of bonds meets all of the conditions for a remedial
action under Sec. 1.141-12(a).
Example 4. Dispositions in the ordinary course of an established
governmental program. City D issues bonds with a weighted average
maturity of 6 years for the acquisition of police cars. D reasonably
expects on the issue date that the police cars will be used solely
by its police department, except that, in the ordinary course of its
police operations, D sells its police cars to a taxicab corporation
after 5 years of use because they are no longer suitable for police
use. Further, D reasonably expects that the value of the police cars
when they are no longer suitable for police use will be no more than
25 percent of cost. D subsequently sells 20 percent of the police
cars after only 3 years of actual use. At that time, D deposits the
proceeds from the sale of the police cars in a commingled fund with
substantial tax revenues and reasonably expects to spend the
proceeds on governmental programs within 6 months of the date of
deposit. D does not trace the actual use of these commingled
amounts. The sale of the police cars does not cause the private
activity bond tests to be met because the requirements of paragraph
(d)(4) of this section are met.
Sec. 1.141-3 Definition of private business use.
(a) General rule--(1) In general. The private business use test
relates to the use of the proceeds of an issue. The 10 percent private
business use test of section 141(b)(1) is met if more than 10 percent
of the proceeds of an issue is used in a trade or business of a
nongovernmental person. For this purpose, the use of financed property
is treated as the direct use of proceeds. Any activity carried on by a
person other than a natural person is treated as a trade or business.
Unless the context or a provision clearly requires otherwise, this
section also applies to the private business use test under sections
141(b)(3) (unrelated or disproportionate use), 141(b)(4) ($15 million
limitation for certain output facilities), and 141(b)(5) (the
coordination with the volume cap where the nonqualified amount exceeds
$15 million).
(2) Indirect use. In determining whether an issue meets the private
business use test, it is necessary to look to both the indirect and
direct uses of proceeds. For example, a facility is treated as being
used for a private business use if it is leased to a nongovernmental
person and subleased to a governmental person or if it is leased to a
governmental person and then subleased to a nongovernmental person,
provided that in each case the nongovernmental person's use is in a
trade or business. Similarly, the issuer's use of the proceeds to
engage in a series of financing transactions for property to be used by
nongovernmental persons in their trades or businesses may cause the
private business use test to be met. In addition, proceeds are treated
as used in the trade or business of a nongovernmental person if a
nongovernmental person, as a result of a single transaction or a series
of related transactions, uses property acquired with the proceeds of an
issue.
(3) Aggregation of private business use. The use of proceeds by all
nongovernmental persons is aggregated to determine whether the private
business use test is met.
(b) Types of private business use arrangements--(1) In general.
Both actual and beneficial use by a nongovernmental person may be
treated as private business use. In most cases, the private business
use test is met only if a nongovernmental person has special legal
entitlements to use the financed property under an arrangement with the
issuer. In general, a nongovernmental person is treated as a private
business user of proceeds and financed property as a result of
ownership; actual or beneficial use of property pursuant to a lease, or
a management or incentive payment contract; or certain other
arrangements such as a take or pay or other output-type contract.
(2) Ownership. Except as provided in paragraph (d)(1) or (d)(2) of
this section, ownership by a nongovernmental person of financed
property is private business use of that property. For this purpose,
ownership refers to ownership for federal income tax purposes.
(3) Leases. Except as provided in paragraph (d) of this section,
the lease of financed property to a nongovernmental person is private
business use of that property. For this purpose, any arrangement that
is properly characterized as a lease for federal income tax purposes is
treated as a lease. In determining whether a management contract is
properly characterized as a lease, it is necessary to consider all of
the facts and circumstances, including the following factors--
(i) The degree of control over the property that is exercised by a
nongovernmental person; and
(ii) Whether a nongovernmental person bears risk of loss of the
financed property.
(4) Management contracts--(i) Facts and circumstances test. Except
as provided in paragraph (d) of this section, a management contract
(within the meaning of paragraph (b)(4)(ii) of this section) with
respect to financed property may result in private business use of that
property, based on all of the facts and circumstances. A management
contract with respect to financed property generally results in private
business use of that property if the contract provides for compensation
for services rendered with compensation based, in whole or in part, on
a share of net profits from the operation of the facility.
(ii) Management contract defined. For purposes of this section, a
management contract is a management, service, or incentive payment
contract between a governmental person and a service provider under
which the service provider provides services involving all, a portion
of, or any function of, a facility. For example, a contract for the
provision of management services for an entire hospital, a contract for
management services for a specific department of a hospital, and an
incentive payment contract for physician services to patients of a
hospital are each treated as a management contract.
(iii) Arrangements generally not treated as management contracts.
The arrangements described in paragraphs (b)(4)(iii) (A) through (D) of
this section generally are not treated as management contracts that
give rise to private business use.
(A) Contracts for services that are solely incidental to the
primary governmental function or functions of a financed facility (for
example, contracts for janitorial, office equipment repair, hospital
billing, or similar services).
(B) The mere granting of admitting privileges by a hospital to a
doctor, even if those privileges are conditioned on the provision of de
minimis services, if those privileges are available to all
[[Page 2287]]
qualified physicians in the area, consistent with the size and nature
of its facilities.
(C) A contract to provide for the operation of a facility or system
of facilities that consists predominantly of public utility property,
if the only compensation is the reimbursement of actual and direct
expenses of the service provider and reasonable administrative overhead
expenses of the service provider.
(D) A contract to provide for services, if the only compensation is
the reimbursement of the service provider for actual and direct
expenses paid by the service provider to unrelated parties.
(iv) Management contracts that are properly treated as other types
of private business use. A management contract with respect to financed
property results in private business use of that property if the
service provider is treated as the lessee or owner of financed property
for federal income tax purposes, unless an exception under paragraph
(d) of this section applies to the arrangement.
(5) Output contracts. See Sec. 1.141-7 for special rules for
contracts for the purchase of output of output facilities.
(6) Research agreements--(i) Facts and circumstances test. Except
as provided in paragraph (d) of this section, an agreement by a
nongovernmental person to sponsor research performed by a governmental
person may result in private business use of the property used for the
research, based on all of the facts and circumstances.
(ii) Research agreements that are properly treated as other types
of private business use. A research agreement with respect to financed
property results in private business use of that property if the
sponsor is treated as the lessee or owner of financed property for
federal income tax purposes, unless an exception under paragraph (d) of
this section applies to the arrangement.
(7) Other actual or beneficial use--(i) In general. Any other
arrangement that conveys special legal entitlements for beneficial use
of bond proceeds or of financed property that are comparable to special
legal entitlements described in paragraphs (b) (2), (3), (4), (5), or
(6) of this section results in private business use. For example, an
arrangement that conveys priority rights to the use or capacity of a
facility generally results in private business use.
(ii) Special rule for facilities not used by the general public. In
the case of financed property that is not available for use by the
general public (within the meaning of paragraph (c) of this section),
private business use may be established solely on the basis of a
special economic benefit to one or more nongovernmental persons, even
if those nongovernmental persons have no special legal entitlements to
use of the property. In determining whether special economic benefit
gives rise to private business use it is necessary to consider all of
the facts and circumstances, including one or more of the following
factors--
(A) Whether the financed property is functionally related or
physically proximate to property used in the trade or business of a
nongovernmental person;
(B) Whether only a small number of nongovernmental persons receive
the special economic benefit; and
(C) Whether the cost of the financed property is treated as
depreciable by any nongovernmental person.
(c) Exception for general public use--(1) In general. Use as a
member of the general public (general public use) is not private
business use. Use of financed property by nongovernmental persons in
their trades or businesses is treated as general public use only if the
property is intended to be available and in fact is reasonably
available for use on the same basis by natural persons not engaged in a
trade or business.
(2) Use on the same basis. In general, use under an arrangement
that conveys priority rights or other preferential benefits is not use
on the same basis as the general public. Arrangements providing for use
that is available to the general public at no charge or on the basis of
rates that are generally applicable and uniformly applied do not convey
priority rights or other preferential benefits. For this purpose, rates
may be treated as generally applicable and uniformly applied even if--
(i) Different rates apply to different classes of users, such as
volume purchasers, if the differences in rates are customary and
reasonable; or
(ii) A specially negotiated rate arrangement is entered into, but
only if the user is prohibited by federal law from paying the generally
applicable rates, and the rates established are as comparable as
reasonably possible to the generally applicable rates.
(3) Long-term arrangements not treated as general public use. An
arrangement is not treated as general public use if the term of the use
under the arrangement, including all renewal options, is greater than
180 days. For this purpose, a right of first refusal to renew use under
the arrangement is not treated as a renewal option if--
(i) The compensation for the use under the arrangement is
redetermined at generally applicable, fair market value rates that are
in effect at the time of renewal; and
(ii) The use of the financed property under the same or similar
arrangements is predominantly by natural persons who are not engaged in
a trade or business.
(4) Relation to other use. Use of financed property by the general
public does not prevent the proceeds from being used for a private
business use because of other use under this section.
(d) Other exceptions--(1) Agents. Use of proceeds by
nongovernmental persons solely in their capacity as agents of a
governmental person is not private business use. For example, use by a
nongovernmental person that issues obligations on behalf of a
governmental person is not private business use to the extent the
nongovernmental person's use of proceeds is in its capacity as an agent
of the governmental person.
(2) Use incidental to financing arrangements. Use by a
nongovernmental person that is solely incidental to a financing
arrangement is not private business use. A use is solely incidental to
a financing arrangement only if the nongovernmental person has no
substantial rights to use bond proceeds or financed property other than
as an agent of the bondholders. For example, a nongovernmental person
that acts solely as an owner of title in a sale and leaseback financing
transaction with a city generally is not a private business user of the
property leased to the city, provided that the nongovernmental person
has assigned all of its rights to use the leased facility to the
trustee for the bondholders upon default by the city. Similarly, bond
trustees, servicers, and guarantors are generally not treated as
private business users.
(3) Exceptions for arrangements other than arrangements resulting
in ownership of financed property by a nongovernmental person--(i)
Arrangements not available for use on the same basis by natural persons
not engaged in a trade or business. Use by a nongovernmental person
pursuant to an arrangement, other than an arrangement resulting in
ownership of financed property by a nongovernmental person, is not
private business use if--
(A) The term of the use under the arrangement, including all
renewal options, is not longer than 90 days;
(B) The arrangement would be treated as general public use, except
that it is not available for use on the same basis by natural persons
not engaged in a trade or business because generally applicable and
uniformly applied rates
[[Page 2288]]
are not reasonably available to natural persons not engaged in a trade
or business; and
(C) The property is not financed for a principal purpose of
providing that property for use by that nongovernmental person.
(ii) Negotiated arm's-length arrangements. Use by a nongovernmental
person pursuant to an arrangement, other than an arrangement resulting
in ownership of financed property by a nongovernmental person, is not
private business use if--
(A) The term of the use under the arrangement, including all
renewal options, is not longer than 30 days;
(B) The arrangement is a negotiated arm's-length arrangement, and
compensation under the arrangement is at fair market value; and
(C) The property is not financed for a principal purpose of
providing that property for use by that nongovernmental person.
(4) Temporary use by developers. Use during an initial development
period by a developer of an improvement that carries out an essential
governmental function is not private business use if the issuer and the
developer reasonably expect on the issue date to proceed with all
reasonable speed to develop the improvement and property benefited by
that improvement and to transfer the improvement to a governmental
person, and if the improvement is in fact transferred to a governmental
person promptly after the property benefited by the improvement is
developed.
(5) Incidental use--(i) General rule. Incidental uses of a financed
facility are disregarded, to the extent that those uses do not exceed
2.5 percent of the proceeds of the issue used to finance the facility.
A use of a facility by a nongovernmental person is incidental if--
(A) Except for vending machines, pay telephones, kiosks, and
similar uses, the use does not involve the transfer to the
nongovernmental person of possession and control of space that is
separated from other areas of the facility by walls, partitions, or
other physical barriers, such as a night gate affixed to a structural
component of a building (a nonpossessory use);
(B) The nonpossessory use is not functionally related to any other
use of the facility by the same person (other than a different
nonpossessory use); and
(C) All nonpossessory uses of the facility do not, in the
aggregate, involve the use of more than 2.5 percent of the facility.
(ii) Illustrations. Incidental uses may include pay telephones,
vending machines, advertising displays, and use for television cameras,
but incidental uses may not include output purchases.
(6) Qualified improvements. Proceeds that provide a governmentally
owned improvement to a governmentally owned building (including its
structural components and land functionally related and subordinate to
the building) are not used for a private business use if--
(i) The building was placed in service more than 1 year before the
construction or acquisition of the improvement is begun;
(ii) The improvement is not an enlargement of the building or an
improvement of interior space occupied exclusively for any private
business use;
(iii) No portion of the improved building or any payments in
respect of the improved building are taken into account under section
141(b)(2)(A) (the private security test); and
(iv) No more than 15 percent of the improved building is used for a
private business use.
(e) Special rule for tax assessment bonds. In the case of a tax
assessment bond that satisfies the requirements of Sec. 1.141-5(d), the
loan (or deemed loan) of the proceeds to the borrower paying the
assessment is disregarded in determining whether the private business
use test is met. However, the use of the loan proceeds is not
disregarded in determining whether the private business use test is
met.
(f) Examples. The following examples illustrate the application of
paragraphs (a) through (e) of this section. In each example, assume
that the arrangements described are the only arrangements with
nongovernmental persons for use of the financed property.
Example 1. Nongovernmental ownership. State A issues 20-year
bonds to purchase land and equip and construct a factory. A then
enters into an arrangement with Corporation X to sell the factory to
X on an installment basis while the bonds are outstanding. The issue
meets the private business use test because a nongovernmental person
owns the financed facility. See also Sec. 1.141-2 (relating to the
private activity bond tests), and Sec. 1.141-5 (relating to the
private loan financing test).
Example 2. Lease to a nongovernmental person. (i) The facts are
the same as in Example 1, except that A enters into an arrangement
with X to lease the factory to X for 3 years rather than to sell it
to X. The lease payments will be made annually and will be based on
the tax-exempt interest rate on the bonds. The issue meets the
private business use test because a nongovernmental person leases
the financed facility. See also Sec. 1.141-14 (relating to anti-
abuse rules).
(ii) The facts are the same as in Example 2(i), except that the
annual payments made by X will equal fair rental value of the
facility and exceed the amount necessary to pay debt service on the
bonds for the 3 years of the lease. The issue meets the private
business use test because a nongovernmental person leases the
financed facility and the test does not require that the benefits of
tax-exempt financing be passed through to the nongovernmental
person.
Example 3. Management contract in substance a lease. City L
issues 30-year bonds to finance the construction of a city hospital.
L enters into a 15-year contract with M, a nongovernmental person
that operates a health maintenance organization relating to the
treatment of M's members at L's hospital. The contract provides for
reasonable fixed compensation to M for services rendered with no
compensation based, in whole or in part, on a share of net profits
from the operation of the hospital. However, the contract also
provides that 30 percent of the capacity of the hospital will be
exclusively available to M's members and M will bear the risk of
loss of that portion of the capacity of the hospital so that, under
all of the facts and circumstances, the contract is properly
characterized as a lease for federal income tax purposes. The issue
meets the private business use test because a nongovernmental person
leases the financed facility.
Example 4. Ownership of title in substance a leasehold interest.
Nonprofit corporation R issues bonds on behalf of City P to finance
the construction of a hospital. R will own legal title to the
hospital. In addition, R will operate the hospital, but R is not
treated as an agent of P in its capacity as operator of the
hospital. P has certain rights to the hospital that establish that
it is properly treated as the owner of the property for federal
income tax purposes. P does not have rights, however, to directly
control operation of the hospital while R owns legal title to it and
operates it. The issue meets the private business use test because
the arrangement provides a nongovernmental person an interest in the
financed facility that is comparable to a leasehold interest. See
paragraphs (a)(2) and (b)(7)(i) of this section.
Example 5. Rights to control use of property treated as private
business use--parking lot. Corporation C and City D enter into a
plan to finance the construction of a parking lot adjacent to C's
factory. Pursuant to the plan, C conveys the site for the parking
lot to D for a nominal amount, subject to a covenant running with
the land that the property be used only for a parking lot. In
addition, D agrees that C will have the right to approve rates
charged by D for use of the parking lot. D issues bonds to finance
construction of the parking lot on the site. The parking lot will be
available for use by the general public on the basis of rates that
are generally applicable and uniformly applied. The issue meets the
private business use test because a nongovernmental person has
special legal entitlements for beneficial use of the financed
facility that are comparable to an ownership interest. See paragraph
(b)(7)(i) of this section.
Example 6. Other actual or beneficial use--hydroelectric
enhancements. J, a political subdivision, owns and operates a
hydroelectric generation plant and related facilities. Pursuant to a
take or pay contract, J sells 15 percent of the output of the plant
[[Page 2289]]
to Corporation K, an investor-owned utility. K is treated as a
private business user of the plant. Under the license issued to J
for operation of the plant, J is required by federal regulations to
construct and operate various facilities for the preservation of
fish and for public recreation. J issues its obligations to finance
the fish preservation and public recreation facilities. K has no
special legal entitlements for beneficial use of the financed
facilities. The fish preservation facilities are functionally
related to the operation of the plant. The recreation facilities are
available to natural persons on a short-term basis according to
generally applicable and uniformly applied rates. Under paragraph
(c) of this section, the recreation facilities are treated as used
by the general public. Under paragraph (b)(7) of this section, K's
use is not treated as private business use of the recreation
facilities because K has no special legal entitlements for
beneficial use of the recreation facilities. The fish preservation
facilities are not of a type reasonably available for use on the
same basis by natural persons not engaged in a trade or business.
Under all of the facts and circumstances (including the functional
relationship of the fish preservation facilities to property used in
K's trade or business) under paragraph (b)(7)(ii) of this section, K
derives a special economic benefit from the fish preservation
facilities. Therefore, K's private business use may be established
solely on the basis of that special economic benefit, and K's use of
the fish preservation facilities is treated as private business use.
Example 7. Other actual or beneficial use--pollution control
facilities. City B issues obligations to finance construction of a
specialized pollution control facility on land that it owns adjacent
to a factory owned by Corporation N. B will own and operate the
pollution control facility, and N will have no special legal
entitlements to use the facility. B, however, reasonably expects
that N will be the only user of the facility. The facility will not
be reasonably available for use on the same basis by natural persons
not engaged in a trade or business. Under paragraph (b)(7)(ii) of
this section, because under all of the facts and circumstances the
facility is functionally related and is physically proximate to
property used in N's trade or business, N derives a special economic
benefit from the facility. Therefore, N's private business use may
be established solely on the basis of that special economic benefit,
and N's use is treated as private business use of the facility. See
paragraph (b)(7)(ii) of this section.
Example 8. General public use--airport runway. (i) City I issues
bonds and uses all of the proceeds to finance construction of a
runway at a new city-owned airport. The runway will be available for
take-off and landing by any operator of an aircraft desiring to use
the airport, including general aviation operators who are natural
persons not engaged in a trade or business. It is reasonably
expected that most of the actual use of the runway will be by
private air carriers (both charter airlines and commercial airlines)
in connection with their use of the airport terminals leased by
those carriers. These leases for the use of terminal space provide
no priority rights or other preferential benefits to the air
carriers for use of the runway. Moreover, under the leases the lease
payments are determined without taking into account the revenues
generated by runway landing fees (that is, the lease payments are
not determined on a ``residual'' basis). Although the lessee air
carriers receive a special economic benefit from the use of the
runway, this economic benefit is not sufficient to cause the air
carriers to be private business users, because the runway is
available for general public use. The issue does not meet the
private business use test. See paragraphs (b)(7)(ii) and (c) of this
section.
(ii) The facts are the same as in Example 8(i), except that the
runway will be available for use only by private air carriers. The
use by these private air carriers is not for general public use,
because the runway is not reasonably available for use on the same
basis by natural persons not engaged in a trade or business.
Depending on all of the facts and circumstances, including whether
there are only a small number of lessee private air carriers, the
issue may meet the private business use test solely because the
private air carriers receive a special economic benefit from the
runway. See paragraph (b)(7)(ii) of this section.
(iii) The facts are the same as in Example 8(i), except that the
lease payments under the leases with the private air carriers are
determined on a residual basis by taking into account the net
revenues generated by runway landing fees. These leases cause the
private business use test to be met with respect to the runway
because they are arrangements that convey special legal entitlements
to the financed facility to nongovernmental persons. See paragraph
(b)(7)(i) of this section.
Example 9. General public use--airport parking garage. City S
issues bonds and uses all of the proceeds to finance construction of
a city-owned parking garage at the city-owned airport. S reasonably
expects that more than 10 percent of the actual use of the parking
garage will be by employees of private air carriers (both charter
airlines and commercial airlines) in connection with their use of
the airport terminals leased by those carriers. The air carriers'
use of the parking garage, however, will be on the same basis as
passengers and other members of the general public using the
airport. The leases for the use of the terminal space provide no
priority rights to the air carriers for use of the parking garage,
and the lease payments are determined without taking into account
the revenues generated by the parking garage. Although the lessee
air carriers receive a special economic benefit from the use of the
parking garage, this economic benefit is not sufficient to cause the
air carriers to be private business users, because the parking
garage is available for general public use. The issue does not meet
the private business use test. See paragraphs (b)(7)(ii) and (c) of
this section.
Example 10. Long-term arrangements not treated as general public
use--insurance fund. Authority T deposits all of the proceeds of its
bonds in its insurance fund and invests all of those proceeds in
tax-exempt bonds. The insurance fund provides insurance to a large
number of businesses and natural persons not engaged in a trade or
business. Each participant receives insurance for a term of 1 year.
The use by the participants, other than participants that are
natural persons not engaged in a trade or business, is treated as
private business use of the proceeds of the bonds because the
participants have special legal entitlements to the use of bond
proceeds, even though the contractual rights are not necessarily
properly characterized as ownership, leasehold, or similar interests
listed in paragraph (b) of this section. Use of the bond proceeds is
not treated as general public use because the term of the insurance
is greater than 180 days. See paragraphs (b)(7)(i) and (c)(3) of
this section.
Example 11. General public use--port road. Highway Authority W
uses all of the proceeds of its bonds to construct a 25-mile road to
connect an industrial port owned by Corporation Y with existing
roads owned and operated by W. Other than the port, the nearest
residential or commercial development to the new road is 12 miles
away. There is no reasonable expectation that development will occur
in the area surrounding the new road. W and Y enter into no
arrangement (either by contract or ordinance) that conveys special
legal entitlements to Y for the use of the road. Use of the road
will be available without restriction to all users, including
natural persons who are not engaged in a trade or business. The
issue does not meet the private business use test because the road
is treated as used only by the general public.
Example 12. General public use of governmentally owned hotel.
State Q issues bonds to purchase land and construct a hotel for use
by the general public (that is, tourists, visitors, and business
travelers). The bond documents provide that Q will own and operate
the project for the term of the bonds. Q will not enter into a lease
or license with any user for use of rooms for a period longer than
180 days (although users may actually use rooms for consecutive
periods in excess of 180 days). Use of the hotel by hotel guests who
are travelling in connection with trades or businesses of
nongovernmental persons is not a private business use of the hotel
by these persons because the hotel is intended to be available and
in fact is reasonably available for use on the same basis by natural
persons not engaged in a trade or business. See paragraph (c)(1) of
this section.
Example 13. General public use with rights of first refusal.
Authority V uses all of the proceeds of its bonds to construct a
parking garage. At least 90 percent of the spaces in the garage will
be available to the general public on a monthly first-come, first-
served basis. V reasonably expects that the spaces will be
predominantly leased to natural persons not engaged in a trade or
business who have priority rights to renew their spaces at then
current fair market value rates. More than 10 percent of the spaces
will be leased to nongovernmental persons acting in a trade or
business. These leases are not treated as arrangements with a term
of use
[[Page 2290]]
greater than 180 days. The rights to renew are not treated as
renewal options because the compensation for the spaces is
redetermined at generally applicable, fair market value rates that
will be in effect at the time of renewal and the use of the spaces
under similar arrangements is predominantly by natural persons who
are not engaged in a trade or business. The issue does not meet the
private business use test because at least 90 percent of the use of
the parking garage is general public use. See paragraph (c)(3) of
this section.
Example 14. General public use with a specially negotiated rate
agreement with agency of United States. G, a sewage collection and
treatment district, operates facilities that were financed with its
bonds. F, an agency of the United States, has a base located within
G. Approximately 20 percent of G's facilities are used to treat
sewage produced by F under a specially negotiated rate agreement.
Under the specially negotiated rate agreement, G uses its best
efforts to charge F as closely as possible the same amount for its
use of G's services as its other customers pay for the same amount
of services, although those other customers pay for services based
on standard district charges and tax levies. F is prohibited by
federal law from paying for the services based on those standard
district charges and tax levies. The use of G's facilities by F is
on the same basis as the general public. See paragraph (c)(2)(ii) of
this section.
Example 15. Arrangements not available for use by natural
persons not engaged in a trade or business--federal use of prisons.
Authority E uses all of the proceeds of its bonds to construct a
prison. E contracts with federal agency F to house federal prisoners
on a space-available, first-come, first-served basis, pursuant to
which F will be charged approximately the same amount for each
prisoner as other persons that enter into similar transfer
agreements. It is reasonably expected that other persons will enter
into similar agreements. The term of the use under the contract is
not longer than 90 days, and F has no right to renew, although E
reasonably expects to renew the contract indefinitely. The prison is
not financed for a principal purpose of providing the prison for use
by F. It is reasonably expected that during the term of the bonds,
more than 10 percent of the prisoners at the prison will be federal
prisoners. F's use of the facility is not general public use because
this type of use (leasing space for prisoners) is not available for
use on the same basis by natural persons not engaged in a trade or
business. The issue does not meet the private business use test,
however, because the leases satisfy the exception of paragraph
(d)(3)(i) of this section.
Example 16. Negotiated arm's-length arrangements--auditorium
reserved in advance. (i) City Z issues obligations to finance the
construction of a municipal auditorium that it will own and operate.
The use of the auditorium will be open to anyone who wishes to use
it for a short period of time on a rate-scale basis. Z reasonably
expects that the auditorium will be used by schools, church groups,
sororities, and numerous commercial organizations. Corporation H, a
nongovernmental person, enters into an arm's-length arrangement with
Z to use the auditorium for 1 week for each year for a 10-year
period (a total of 70 days), pursuant to which H will be charged a
specific price reflecting fair market value. On the date the
contract is entered into, Z has not established generally applicable
rates for future years. Even though the auditorium is not financed
for a principal purpose of providing use of the auditorium to H, H
is not treated as using the auditorium as a member of the general
public because its use is not on the same basis as the general
public. Because the term of H's use of the auditorium is longer than
30 days, the arrangement does not meet the exception under paragraph
(d)(3)(ii) of this section.
(ii) The facts are the same as in Example 16(i), except that H
will enter into an arm's-length arrangement with Z to use the
auditorium for 1 week for each year for a 4-year period (a total of
28 days), pursuant to which H will be charged a specific price
reflecting fair market value. H is not treated as a private business
user of the auditorium because its contract satisfies the exception
of paragraph (d)(3)(ii) of this section for negotiated arm's-length
arrangements.
(g) Measurement of private business use--(1) In general. In
general, the private business use of proceeds is allocated to property
under Sec. 1.141-6. The amount of private business use of that property
is determined according to the average percentage of private business
use of that property during the measurement period.
(2) Measurement period--(i) General rule. Except as provided in
this paragraph (g)(2), the measurement period of property financed by
an issue begins on the later of the issue date of that issue or the
date the property is placed in service and ends on the earlier of the
last date of the reasonably expected economic life of the property or
the latest maturity date of any bond of the issue financing the
property (determined without regard to any optional redemption dates).
In general, the period of reasonably expected economic life of the
property for this purpose is based on reasonable expectations as of the
issue date.
(ii) Special rule for refundings of short-term obligations. For an
issue of short-term obligations that the issuer reasonably expects to
refund with a long-term financing (such as bond anticipation notes),
the measurement period is based on the latest maturity date of any bond
of the last refunding issue with respect to the financed property
(determined without regard to any optional redemption dates).
(iii) Special rule for reasonably expected mandatory redemptions.
If an issuer reasonably expects on the issue date that an action will
occur during the term of the bonds to cause either the private business
tests or the private loan financing test to be met and is required to
redeem bonds to meet the reasonable expectations test of Sec. 1.141-
2(d)(2), the measurement period ends on the reasonably expected
redemption date.
(iv) Special rule for ownership by a nongovernmental person. The
amount of private business use resulting from ownership by a
nongovernmental person is the greatest percentage of private business
use in any 1-year period.
(v) Anti-abuse rule. If an issuer establishes the term of an issue
for a period that is longer than is reasonably necessary for the
governmental purposes of the issue for a principal purpose of
increasing the permitted amount of private business use, the
Commissioner may determine the amount of private business use according
to the greatest percentage of private business use in any 1-year
period.
(3) Determining average percentage of private business use. The
average percentage of private business use is the average of the
percentages of private business use during the 1-year periods within
the measurement period. Appropriate adjustments must be made for
beginning and ending periods of less than 1 year.
(4) Determining the average amount of private business use for a 1-
year period--(i) In general. The percentage of private business use of
property for any 1-year period is the average private business use
during that year. This average is determined by comparing the amount of
private business use during the year to the total amount of private
business use and use that is not private business use (government use)
during that year. Paragraphs (g)(4) (ii) through (v) of this section
apply to determine the average amount of private business use for a 1-
year period.
(ii) Uses at different times. For a facility in which actual
government use and private business use occur at different times (for
example, different days), the average amount of private business use
generally is based on the amount of time that the facility is used for
private business use as a percentage of the total time for all actual
use. In determining the total amount of actual use, periods during
which the facility is not in use are disregarded.
(iii) Simultaneous use. In general, for a facility in which
government use and private business use occur simultaneously, the
entire facility is treated as having private business use. For example,
a governmentally owned facility that is leased or managed by a
nongovernmental person in a manner
[[Page 2291]]
that results in private business use is treated as entirely used for a
private business use. If, however, there is also private business use
and actual government use on the same basis, the average amount of
private business use may be determined on a reasonable basis that
properly reflects the proportionate benefit to be derived by the
various users of the facility (for example, reasonably expected fair
market value of use). For example, the average amount of private
business use of a garage with unassigned spaces that is used for
government use and private business use is generally based on the
number of spaces used for private business use as a percentage of the
total number of spaces.
(iv) Discrete portion. For purposes of this paragraph (g),
measurement of the use of proceeds allocated to a discrete portion of a
facility is determined by treating that discrete portion as a separate
facility.
(v) Relationship to fair market value. For purposes of paragraphs
(g)(4) (ii) through (iv) of this section, if private business use is
reasonably expected as of the issue date to have a significantly
greater fair market value than government use, the average amount of
private business use must be determined according to the relative
reasonably expected fair market values of use rather than another
measure, such as average time of use. This determination of relative
fair market value may be made as of the date the property is acquired
or placed in service if making this determination as of the issue date
is not reasonably possible (for example, if the financed property is
not identified on the issue date). In general, the relative reasonably
expected fair market value for a period must be determined by taking
into account the amount of reasonably expected payments for private
business use for the period in a manner that properly reflects the
proportionate benefit to be derived from the private business use.
(5) Common areas. The amount of private business use of common
areas within a facility is based on a reasonable method that properly
reflects the proportionate benefit to be derived by the users of the
facility. For example, in general, a method that is based on the
average amount of private business use of the remainder of the entire
facility reflects proportionate benefit.
(6) Allocation of neutral costs. Proceeds that are used to pay
costs of issuance, invested in a reserve or replacement fund, or paid
as fees for a qualified guarantee or a qualified hedge must be
allocated ratably among the other purposes for which the proceeds are
used.
(7) Commencement of measurement of private business use. Generally,
private business use commences on the first date on which there is a
right to actual use by the nongovernmental person. However, if an
issuer enters into an arrangement for private business use a
substantial period before the right to actual private business use
commences and the arrangement transfers ownership or is an arrangement
for other long-term use (such as a lease for a significant portion of
the remaining economic life of financed property), private business use
commences on the date the arrangement is entered into, even if the
right to actual use commences after the measurement period. For this
purpose, 10 percent of the measurement period is generally treated as a
substantial period.
(8) Examples. The following examples illustrate the application of
this paragraph (g):
Example 1. Research facility. University U, a state owned and
operated university, owns and operates a research facility. U
proposes to finance general improvements to the facility with the
proceeds of an issue of bonds. U enters into sponsored research
agreements with nongovernmental persons that result in private
business use because the sponsors will own title to any patents
resulting from the research. The governmental research conducted by
U and the research U conducts for the sponsors take place
simultaneously in all laboratories within the research facility. All
laboratory equipment is available continuously for use by workers
who perform both types of research. Because it is not possible to
predict which research projects will be successful, it is not
reasonably practicable to estimate the relative revenues expected to
result from the governmental and nongovernmental research. U
contributed 90 percent of the cost of the facility and the
nongovernmental persons contributed 10 percent of the cost. Under
this section, the nongovernmental persons are using the facility for
a private business use on the same basis as the government use of
the facility. The portions of the costs contributed by the various
users of the facility provide a reasonable basis that properly
reflects the proportionate benefit to be derived by the users of the
facility. The nongovernmental persons are treated as using 10
percent of the proceeds of the issue.
Example 2. Stadium. (i) City L issues bonds and uses all of the
proceeds to construct a stadium. L enters into a long-term contract
with a professional sports team T under which T will use the stadium
20 times during each year. These uses will occur on nights and
weekends. L reasonably expects that the stadium will be used more
than 180 other times each year, none of which will give rise to
private business use. This expectation is based on a feasibility
study and historical use of the old stadium that is being replaced
by the new stadium. There is no significant difference in the value
of T's uses when compared to the other uses of the stadium, taking
into account the payments that T is reasonably expected to make for
its use. Assuming no other private business use, the issue does not
meet the private business use test because not more than 10 percent
of the use of the facility is for a private business use.
(ii) The facts are the same as in Example 2(i), except that L
reasonably expects that the stadium will be used not more than 60
other times each year, none of which will give rise to private
business use. The issue meets the private business use test because
25 percent of the proceeds are used for a private business use.
Example 3. Airport terminal areas treated as common areas. City
N issues bonds to finance the construction of an airport terminal.
Eighty percent of the leasable space of the terminal will be leased
to private air carriers. The remaining 20 percent of the leasable
space will be used for the term of the bonds by N for its
administrative purposes. The common areas of the terminal, including
waiting areas, lobbies, and hallways are treated as 80 percent used
by the air carriers for purposes of the private business use test.
Sec. 1.141-4 Private security or payment test.
(a) General rule--(1) Private security or payment. The private
security or payment test relates to the nature of the security for, and
the source of, the payment of debt service on an issue. The private
payment portion of the test takes into account the payment of the debt
service on the issue that is directly or indirectly to be derived from
payments (whether or not to the issuer or any related party) in respect
of property, or borrowed money, used or to be used for a private
business use. The private security portion of the test takes into
account the payment of the debt service on the issue that is directly
or indirectly secured by any interest in property used or to be used
for a private business use or payments in respect of property used or
to be used for a private business use. For additional rules for output
facilities, see Sec. 1.141-7.
(2) Aggregation of private payments and security. For purposes of
the private security or payment test, payments taken into account as
private payments and payments or property taken into account as private
security are aggregated. However, the same payments are not taken into
account as both private security and private payments.
(3) Underlying arrangement. The security for, and payment of debt
service on, an issue is determined from both the terms of the bond
documents and on the basis of any underlying arrangement. An underlying
arrangement may result from separate agreements between the parties or
may
[[Page 2292]]
be determined on the basis of all of the facts and circumstances
surrounding the issuance of the bonds. For example, if the payment of
debt service on an issue is secured by both a pledge of the full faith
and credit of a state or local governmental unit and any interest in
property used or to be used in a private business use, the issue meets
the private security or payment test.
(b) Measurement of private payments and security--(1) Scope. This
paragraph (b) contains rules that apply to both private security and
private payments.
(2) Present value measurement--(i) Use of present value. In
determining whether an issue meets the private security or payment
test, the present value of the payments or property taken into account
is compared to the present value of the debt service to be paid over
the term of the issue.
(ii) Debt service--(A) Debt service paid from proceeds. Debt
service does not include any amount paid or to be paid from sale
proceeds or investment proceeds. For example, debt service does not
include payments of capitalized interest funded with proceeds.
(B) Adjustments to debt service. Debt service is adjusted to take
into account payments and receipts that adjust the yield on an issue
for purposes of section 148(f). For example, debt service includes fees
paid for qualified guarantees under Sec. 1.148-4(f) and is adjusted to
take into account payments and receipts on qualified hedges under
Sec. 1.148-4(h).
(iii) Computation of present value--(A) In general. Present values
are determined by using the yield on the issue as the discount rate and
by discounting all amounts to the issue date. See, however, Sec. 1.141-
13 for special rules for refunding bonds.
(B) Fixed yield issues. For a fixed yield issue, yield is
determined on the issue date and is not adjusted to take into account
subsequent events.
(C) Variable yield issues. The yield on a variable yield issue is
determined over the term of the issue. To determine the reasonably
expected yield as of any date, the issuer may assume that the future
interest rate on a variable yield bond will be the then-current
interest rate on the bonds determined under the formula prescribed in
the bond documents. A deliberate action requires a recomputation of the
yield on the variable yield issue to determine the present value of
payments under that arrangement. In that case, the issuer must use the
yield determined as of the date of the deliberate action for purposes
of determining the present value of payments under the arrangement
causing the deliberate action. See paragraph (g) of this section,
Example 3.
(iv) Application to private security. For purposes of determining
the present value of debt service that is secured by property, the
property is valued at fair market value as of the first date on which
the property secures bonds of the issue.
(c) Private payments--(1) In general. This paragraph (c) contains
rules that apply to private payments.
(2) Payments taken into account--(i) Payments for use--(A) In
general. Both direct and indirect payments made by any nongovernmental
person that is treated as using proceeds of the issue are taken into
account as private payments to the extent allocable to the proceeds
used by that person. Payments are taken into account as private
payments only to the extent that they are made for the period of time
that proceeds are used for a private business use. Payments for a use
of proceeds include payments (whether or not to the issuer) in respect
of property financed (directly or indirectly) with those proceeds, even
if not made by a private business user. Payments are not made in
respect of financed property if those payments are directly allocable
to other property being directly used by the person making the payment
and those payments represent fair market value compensation for that
other use. See paragraph (g) of this section, Example 4 and Example 5.
See also paragraph (c)(3) of this section for rules relating to
allocation of payments to the source or sources of funding of property.
(B) Payments not to exceed use. Payments with respect to proceeds
that are used for a private business use are not taken into account to
the extent that the present value of those payments exceeds the present
value of debt service on those proceeds. Payments need not be directly
derived from a private business user, however, to be taken into
account. Thus, if 7 percent of the proceeds of an issue is used by a
person over the measurement period, payments with respect to the
property financed with those proceeds are taken into account as private
payments only to the extent that the present value of those payments
does not exceed the present value of 7 percent of the debt service on
the issue.
(C) Payments for operating expenses. Payments by a person for a use
of proceeds do not include the portion of any payment that is properly
allocable to the payment of ordinary and necessary expenses (as defined
under section 162) directly attributable to the operation and
maintenance of the financed property used by that person. For this
purpose, general overhead and administrative expenses are not directly
attributable to those operations and maintenance. For example, if an
issuer receives $5,000 rent during the year for use of space in a
financed facility and during the year pays $500 for ordinary and
necessary expenses properly allocable to the operation and maintenance
of that space and $400 for general overhead and general administrative
expenses properly allocable to that space, $500 of the $5,000 received
would not be considered a payment for the use of the proceeds allocable
to that space (regardless of the manner in which that $500 is actually
used).
(ii) Refinanced debt service. Payments of debt service on an issue
to be made from proceeds of a refunding issue are taken into account as
private payments in the same proportion that the present value of the
payments taken into account as private payments for the refunding issue
bears to the present value of the debt service to be paid on the
refunding issue. For example, if all the debt service on a note is paid
with proceeds of a refunding issue, the note meets the private security
or payment test if (and to the same extent that) the refunding issue
meets the private security or payment test. This paragraph (c)(2)(ii)
does not apply to payments that arise from deliberate actions that
occur more than 3 years after the retirement of the prior issue that
are not reasonably expected on the issue date of the refunding issue.
For purposes of this paragraph (c)(2)(ii), whether an issue is a
refunding issue is determined without regard to Sec. 1.150-1(d)(2)(i)
(relating to certain payments of interest).
(3) Allocation of payments--(i) In general. Private payments for
the use of property are allocated to the source or different sources of
funding of property. The allocation to the source or different sources
of funding is based on all of the facts and circumstances, including
whether an allocation is consistent with the purposes of section 141.
In general, a private payment for the use of property is allocated to a
source of funding based upon the nexus between the payment and both the
financed property and the source of funding. For this purpose,
different sources of funding may include different tax-exempt issues,
taxable issues, and amounts that are not derived from a borrowing, such
as revenues of an issuer (equity).
(ii) Payments for use of discrete property. Payments for the use of
a discrete facility (or a discrete portion of a facility) are allocated
to the source or
[[Page 2293]]
different sources of funding of that discrete property.
(iii) Allocations among two or more sources of funding. In general,
except as provided in paragraphs (c)(3)(iv) and (v) of this section, if
a payment is made for the use of property financed with two or more
sources of funding (for example, equity and a tax-exempt issue), that
payment must be allocated to those sources of funding in a manner that
reasonably corresponds to the relative amounts of those sources of
funding that are expended on that property. If an issuer has not
retained records of amounts expended on the property (for example,
records of costs of a building that was built 30 years before the
allocation), an issuer may use reasonable estimates of those
expenditures. For this purpose, costs of issuance and other similar
neutral costs are allocated ratably among expenditures in the same
manner as in Sec. 1.141-3(g)(6). A payment for the use of property may
be allocated to two or more issues that finance property according to
the relative amounts of debt service (both paid and accrued) on the
issues during the annual period for which the payment is made, if that
allocation reasonably reflects the economic substance of the
arrangement. In general, allocations of payments according to relative
debt service reasonably reflect the economic substance of the
arrangement if the maturity of the bonds reasonably corresponds to the
reasonably expected economic life of the property and debt service
payments on the bonds are approximately level from year to year.
(iv) Payments made under an arrangement entered into in connection
with issuance of bonds. A private payment for the use of property made
under an arrangement that is entered into in connection with the
issuance of the issue that finances that property generally is
allocated to that issue. Whether an arrangement is entered into in
connection with the issuance of an issue is determined on the basis of
all of the facts and circumstances. An arrangement is ordinarily
treated as entered into in connection with the issuance of an issue
if--
(A) The issuer enters into the arrangement during the 3-year period
beginning 18 months before the issue date; and
(B) The amount of payments reflects all or a portion of debt
service on the issue.
(v) Allocations to equity. A private payment for the use of
property may be allocated to equity before payments are allocated to an
issue only if--
(A) Not later than 60 days after the date of the expenditure of
those amounts, the issuer adopts an official intent (in a manner
comparable to Sec. 1.150-2(e)) indicating that the issuer reasonably
expects to be repaid for the expenditure from a specific arrangement;
and
(B) The private payment is made not later than 18 months after the
later of the date the expenditure is made or the date the project is
placed in service.
(d) Private security--(1) In general. This paragraph (d) contains
rules that relate to private security.
(2) Security taken into account. The property that is the security
for, or the source of, the payment of debt service on an issue need not
be property financed with proceeds. For example, unimproved land or
investment securities used, directly or indirectly, in a private
business use that secures an issue provides private security. Private
security (other than financed property and private payments) for an
issue is taken into account under section 141(b), however, only to the
extent it is provided, directly or indirectly, by a user of proceeds of
the issue.
(3) Pledge of unexpended proceeds. Proceeds qualifying for an
initial temporary period under Sec. 1.148-2(e)(2) or (3) or deposited
in a reasonably required reserve or replacement fund (as defined in
Sec. 1.148-2(f)(2)(i)) are not taken into account under this paragraph
(d) before the date on which those amounts are either expended or
loaned by the issuer to an unrelated party.
(4) Secured by any interest in property or payments. Property used
or to be used for a private business use and payments in respect of
that property are treated as private security if any interest in that
property or payments secures the payment of debt service on the bonds.
For this purpose, the phrase any interest in is to be interpreted
broadly and includes, for example, any right, claim, title, or legal
share in property or payments.
(5) Payments in respect of property. The payments taken into
account as private security are payments in respect of property used or
to be used for a private business use. Except as otherwise provided in
this paragraph (d)(5) and paragraph (d)(6) of this section, the rules
in paragraphs (c)(2)(i)(A) and (B) and (c)(2)(ii) of this section apply
to determine the amount of payments treated as payments in respect of
property used or to be used for a private business use. Thus, payments
made by members of the general public for use of a facility used for a
private business use (for example, a facility that is the subject of a
management contract that results in private business use) are taken
into account as private security to the extent that they are made for
the period of time that property is used by a private business user.
(6) Allocation of security among issues. In general, property or
payments from the disposition of that property that are taken into
account as private security are allocated to each issue secured by the
property or payments on a reasonable basis that takes into account
bondholders' rights to the payments or property upon default.
(e) Generally applicable taxes--(1) General rule. For purposes of
the private security or payment test, generally applicable taxes are
not taken into account (that is, are not payments from a
nongovernmental person and are not payments in respect of property used
for a private business use).
(2) Definition of generally applicable taxes. A generally
applicable tax is an enforced contribution exacted pursuant to
legislative authority in the exercise of the taxing power that is
imposed and collected for the purpose of raising revenue to be used for
governmental purposes. A generally applicable tax must have a uniform
tax rate that is applied to all persons of the same classification in
the appropriate jurisdiction and a generally applicable manner of
determination and collection.
(3) Special charges. A payment for a special privilege granted or
service rendered is not a generally applicable tax. Special assessments
paid by property owners benefiting from financed improvements are not
generally applicable taxes. For example, a tax or a payment in lieu of
tax that is limited to the property or persons benefited by an
improvement is not a generally applicable tax.
(4) Manner of determination and collection--(i) In general. A tax
does not have a generally applicable manner of determination and
collection to the extent that one or more taxpayers make any
impermissible agreements relating to payment of those taxes. An
impermissible agreement relating to the payment of a tax is taken into
account whether or not it is reasonably expected to result in any
payments that would not otherwise have been made. For example, if an
issuer uses proceeds to make a grant to a taxpayer to improve property,
agreements that impose reasonable conditions on the use of the grant do
not cause a tax on that property to fail to be a generally applicable
tax. If an agreement by a taxpayer causes the tax imposed on that
taxpayer not to be treated as a generally applicable tax, the
[[Page 2294]]
entire tax paid by that taxpayer is treated as a special charge, unless
the agreement is limited to a specific portion of the tax.
(ii) Impermissible agreements. The following are examples of
agreements that cause a tax to fail to have a generally applicable
manner of determination and collection: an agreement to be personally
liable on a tax that does not generally impose personal liability, to
provide additional credit support such as a third party guarantee, or
to pay unanticipated shortfalls; an agreement regarding the minimum
market value of property subject to property tax; and an agreement not
to challenge or seek deferral of the tax.
(iii) Permissible agreements. The following are examples of
agreements that do not cause a tax to fail to have a generally
applicable manner of determination and collection: an agreement to use
a grant for specified purposes (whether or not that agreement is
secured); a representation regarding the expected value of the property
following the improvement; an agreement to insure the property and, if
damaged, to restore the property; a right of a grantor to rescind the
grant if property taxes are not paid; and an agreement to reduce or
limit the amount of taxes collected to further a bona fide governmental
purpose. For example, an agreement to abate taxes to encourage a
property owner to rehabilitate property in a distressed area is a
permissible agreement.
(5) Payments in lieu of taxes. A tax equivalency payment and any
other payment in lieu of a tax is treated as a generally applicable tax
if--
(i) The payment is commensurate with and not greater than the
amounts imposed by a statute for a tax of general application; and
(ii) The payment is designated for a public purpose and is not a
special charge (as described in paragraph (e)(3) of this section). For
example, a payment in lieu of taxes made in consideration for the use
of property financed with tax-exempt bonds is treated as a special
charge.
(f) Certain waste remediation bonds--(1) Scope. This paragraph (f)
applies to bonds issued to finance hazardous waste clean-up activities
on privately owned land (hazardous waste remediation bonds).
(2) Persons that are not private users. Payments from
nongovernmental persons who are not (other than coincidentally) either
users of the site being remediated or persons potentially responsible
for disposing of hazardous waste on that site are not taken into
account as private security. This paragraph (f)(2) applies to payments
that secure (directly or indirectly) the payment of principal of, or
interest on, the bonds under the terms of the bonds. This paragraph
(f)(2) applies only if the payments are made pursuant to either a
generally applicable state or local taxing statute or a state or local
statute that regulates or restrains activities on an industry-wide
basis of persons who are engaged in generating or handling hazardous
waste, or in refining, producing, or transporting petroleum, provided
that those payments do not represent, in substance, payment for the use
of proceeds. For this purpose, a state or local statute that imposes
payments that have substantially the same character as those described
in Chapter 38 of the Code are treated as generally applicable taxes.
(3) Persons that are private users. If payments from
nongovernmental persons who are either users of the site being
remediated or persons potentially responsible for disposing of
hazardous waste on that site do not secure (directly or indirectly) the
payment of principal of, or interest on, the bonds under the terms of
the bonds, the payments are not taken into account as private payments.
This paragraph (f)(3) applies only if at the time the bonds are issued
the payments from those nongovernmental persons are not material to the
security for the bonds. For this purpose, payments are not material to
the security for the bonds if--
(i) The payments are not required for the payment of debt service
on the bonds;
(ii) The amount and timing of the payments are not structured or
designed to reflect the payment of debt service on the bonds;
(iii) The receipt or the amount of the payment is uncertain (for
example, as of the issue date, no final judgment has been entered into
against the nongovernmental person);
(iv) The payments from those nongovernmental persons, when and if
received, are used either to redeem bonds of the issuer or to pay for
costs of any hazardous waste remediation project; and
(v) In the case when a judgment (but not a final judgment) has been
entered by the issue date against a nongovernmental person, there are,
as of the issue date, costs of hazardous waste remediation other than
those financed with the bonds that may be financed with the payments.
(g) Examples. The following examples illustrate the application of
this section:
Example 1. Aggregation of payments. State B issues bonds with
proceeds of $10 million. B uses $9.7 million of the proceeds to
construct a 10-story office building. B uses the remaining $300,000
of proceeds to make a loan to Corporation Y. In addition,
Corporation X leases 1 floor of the building for the term of the
bonds. Under all of the facts and circumstances, it is reasonable to
allocate 10 percent of the proceeds to that 1 floor. As a percentage
of the present value of the debt service on the bonds, the present
value of Y's loan repayments is 3 percent and the present value of
X's lease payments is 8 percent. The bonds meet the private security
or payment test because the private payments taken into account are
more than 10 percent of the present value of the debt service on the
bonds.
Example 2. Indirect private payments. J, a political subdivision
of a state, will issue several series of bonds from time to time and
will use the proceeds to rehabilitate urban areas. Under all of the
facts and circumstances, the private business use test will be met
with respect to each issue that will be used for the rehabilitation
and construction of buildings that will be leased or sold to
nongovernmental persons for use in their trades or businesses.
Nongovernmental persons will make payments for these sales and
leases. There is no limitation either on the number of issues or the
aggregate amount of bonds that may be outstanding. No group of
bondholders has any legal claim prior to any other bondholders or
creditors with respect to specific revenues of J, and there is no
arrangement whereby revenues from a particular project are paid into
a trust or constructive trust, or sinking fund, or are otherwise
segregated or restricted for the benefit of any group of
bondholders. There is, however, an unconditional obligation by J to
pay the principal of, and the interest on, each issue. Although not
directly pledged under the terms of the bond documents, the leases
and sales are underlying arrangements. The payments relating to
these leases and sales are taken into account as private payments to
determine whether each issue of bonds meets the private security or
payment test.
Example 3. Computation of payment in variable yield issues. (i)
City M issues general obligation bonds with proceeds of $10 million
to finance a 5-story office building. The bonds bear interest at a
variable rate that is recomputed monthly according to an index that
reflects current market yields. The yield that the interest index
would produce on the issue date is 6 percent. M leases 1 floor of
the office building to Corporation T, a nongovernmental person, for
the term of the bonds. Under all of the facts and circumstances, T
is treated as using more than 10 percent of the proceeds. Using the
6 percent yield as the discount rate, M reasonably expects on the
issue date that the present value of lease payments to be made by T
will be 8 percent of the present value of the total debt service on
the bonds. After the issue date of the bonds, interest rates decline
significantly, so that the yield on the bonds over their entire term
is 4 percent. Using this actual 4 percent yield as the discount
rate, the present value of lease payments made by T is 12 percent of
the present value of the actual total debt service
[[Page 2295]]
on the bonds. The bonds are not private activity bonds because M
reasonably expected on the issue date that the bonds would not meet
the private security or payment test and because M did not take any
subsequent deliberate action to meet the private security or payment
test.
(ii) The facts are the same as Example 3(i), except that 5 years
after the issue date M leases a second floor to Corporation S, a
nongovernmental person, under a long-term lease. Because M has taken
a deliberate action, the present value of the lease payments must be
computed. On the date this lease is entered into, M reasonably
expects that the yield on the bonds over their entire term will be
5.5 percent, based on actual interest rates to date and the then-
current rate on the variable yield bonds. M uses this 5.5 percent
yield as the discount rate. Using this 5.5 percent yield as the
discount rate, as a percentage of the present value of the debt
service on the bonds, the present value of the lease payments made
by S is 3 percent. The bonds are private activity bonds because the
present value of the aggregate private payments is greater than 10
percent of the present value of debt service.
Example 4. Payments not in respect of financed property. In
order to further public safety, City Y issues tax assessment bonds
the proceeds of which are used to move existing electric utility
lines underground. Although the utility lines are owned by a
nongovernmental utility company, that company is under no obligation
to move the lines. The debt service on the bonds will be paid using
assessments levied by City Y on the customers of the utility.
Although the utility lines are privately owned and the utility
customers make payments to the utility company for the use of those
lines, the assessments are payments in respect of the cost of
relocating the utility line. Thus, the assessment payments are not
made in respect of property used for a private business use. Any
direct or indirect payments to Y by the utility company for the
undergrounding are, however, taken into account as private payments.
Example 5. Payments from users of proceeds that are not private
business users taken into account. City P issues general obligation
bonds to finance the renovation of a hospital that it owns. The
hospital is operated for P by D, a nongovernmental person, under a
management contract that results in private business use under
Sec. 1.141-3. P will use the revenues from the hospital (after the
required payments to D and the payment of operation and maintenance
expenses) to pay the debt service on the bonds. The bonds meet the
private security or payment test because the revenues from the
hospital are payments in respect of property used for a private
business use.
Example 6. Limitation of amount of payments to amount of private
business use not determined annually. City Q issues bonds with a
term of 15 years and uses the proceeds to construct an office
building. The debt service on the bonds is level throughout the 15-
year term. Q enters into a 5-year lease with Corporation R under
which R is treated as a user of 11 percent of the proceeds. R will
make lease payments equal to 20 percent of the annual debt service
on the bonds for each year of the lease. The present value of R's
lease payments is equal to 12 percent of the present value of the
debt service over the entire 15-year term of the bonds. If, however,
the lease payments taken into account as private payments were
limited to 11 percent of debt service paid in each year of the
lease, the present value of these payments would be only 8 percent
of the debt service on the bonds over the entire term of the bonds.
The bonds meet the private security or payment test, because R's
lease payments are taken into account as private payments in an
amount not to exceed 11 percent of the debt service of the bonds.
Example 7. Allocation of payments to funds not derived from a
borrowing. City Z purchases property for $1,250,000 using $1,000,000
of proceeds of its tax increment bonds and $250,000 of other
revenues that are in its redevelopment fund. Within 60 days of the
date of purchase, Z declared its intent to sell the property
pursuant to a redevelopment plan and to use that amount to reimburse
its redevelopment fund. The bonds are secured only by the
incremental property taxes attributable to the increase in value of
the property from the planned redevelopment of the property. Within
18 months after the issue date, Z sells the financed property to
Developer M for $250,000, which Z uses to reimburse the
redevelopment fund. The property that M uses is financed both with
the proceeds of the bonds and Z's redevelopment fund. The payments
by M are properly allocable to the costs of property financed with
the amounts in Z's redevelopment fund. See paragraphs (c)(3) (i) and
(v) of this section.
Example 8. Allocation of payments to different sources of
funding--improvements. In 1997, City L issues bonds with proceeds of
$8 million to finance the acquisition of a building. In 2002, L
spends $2 million of its general revenues to improve the heating
system and roof of the building. At that time, L enters into a 10-
year lease with Corporation M for the building providing for annual
payments of $1 million to L. The lease payments are at fair market
value, and the lease payments do not otherwise have a significant
nexus to either the issue or to the expenditure of general revenues.
Eighty percent of each lease payment is allocated to the issue and
is taken into account under the private payment test because each
lease payment is properly allocated to the sources of funding in a
manner that reasonably corresponds to the relative amounts of the
sources of funding that are expended on the building.
Example 9. Security not provided by users of proceeds not taken
into account. County W issues certificates of participation in a
lease of a building that W owns and covenants to appropriate annual
payments for the lease. A portion of each payment is specified as
interest. More than 10 percent of the building is used for private
business use. None of the proceeds of the obligations are used with
respect to the building. W uses the proceeds of the obligations to
make a grant to Corporation Y for the construction of a factory that
Y will own. Y makes no payments to W, directly or indirectly, for
its use of proceeds, and Y has no relationship to the users of the
leased building. If W defaults under the lease, the trustee for the
holders of the certificates of participation has a limited right of
repossession under which the trustee may not foreclose but may lease
the property to a new tenant at fair market value. The obligations
are secured by an interest in property used for a private business
use. However, because the property is not provided by a private
business user and is not financed property, the obligations do not
meet the private security or payment test.
Example 10. Allocation of payments among issues. University L, a
political subdivision, issued three separate series of revenue bonds
during 1989, 1991, and 1993 under the same bond resolution. L used
the proceeds to construct facilities exclusively for its own use.
Bonds issued under the resolution are equally and ratably secured
and payable solely from the income derived by L from rates, fees,
and charges imposed by L for the use of the facilities. The bonds
issued in 1989, 1991, and 1993 are not private activity bonds. In
1997, L issues another series of bonds under the resolution to
finance additional facilities. L leases 20 percent of the new
facilities for the term of the 1997 bonds to nongovernmental persons
who will use the facilities in their trades or businesses. The
present value of the lease payments from the nongovernmental users
will equal 15 percent of the present value of the debt service on
the 1997 bonds. L will commingle all of the revenues from all its
bond-financed facilities in its revenue fund. The present value of
the portion of the lease payments from nongovernmental lessees of
the new facilities allocable to the 1997 bonds under paragraph (d)
of this section is less than 10 percent of the present value of the
debt service on the 1997 bonds because the bond documents provide
that the bonds are equally and ratably secured. Accordingly, the
1997 bonds do not meet the private security test. The 1997 bonds
meet the private payment test, however, because the private lease
payments for the new facility are properly allocated to those bonds
(that is, because none of the proceeds of the prior issues were used
for the new facilities). See paragraph (c) of this section.
Example 11. Generally applicable tax. (i) Authority N issues
bonds to finance the construction of a stadium. Under a long-term
lease, Corporation X, a professional sports team, will use more than
10 percent of the stadium. X will not, however, make any payments
for this private business use. The security for the bonds will be a
ticket tax imposed on each person purchasing a ticket for an event
at the stadium. The portion of the ticket tax attributable to
tickets purchased by persons attending X's events will, on a present
value basis, exceed 10 percent of the present value of the debt
service on N's bonds. The bonds meet the private security or payment
test. The ticket tax is not a generally applicable tax and, to the
extent that the tax receipts relate to X's events, the taxes are
payments in respect of property used for a private business use.
(ii) The facts are the same as Example 11(i), except that the
ticket tax is imposed by N on
[[Page 2296]]
tickets purchased for events at a number of large entertainment
facilities within the N's jurisdiction (for example, other stadiums,
arenas, and concert halls), some of which were not financed with
tax-exempt bonds. The ticket tax is a generally applicable tax and
therefore the revenues from this tax are not payments in respect of
property used for a private business use. The receipt of the ticket
tax does not cause the bonds to meet the private security or payment
test.
Sec. 1.141-5 Private loan financing test.
(a) In general. Bonds of an issue are private activity bonds if
more than the lesser of 5 percent or $5 million of the proceeds of the
issue is to be used (directly or indirectly) to make or finance loans
to persons other than governmental persons. Section 1.141-2(d) applies
in determining whether the private loan financing test is met. In
determining whether the proceeds of an issue are used to make or
finance loans, indirect, as well as direct, use of the proceeds is
taken into account.
(b) Measurement of test. In determining whether the private loan
financing test is met, the amount actually loaned to a nongovernmental
person is not discounted to reflect the present value of the loan
repayments.
(c) Definition of private loan--(1) In general. Any transaction
that is generally characterized as a loan for federal income tax
purposes is a loan for purposes of this section. In addition, a loan
may arise from the direct lending of bond proceeds or may arise from
transactions in which indirect benefits that are the economic
equivalent of a loan are conveyed. Thus, the determination of whether a
loan is made depends on the substance of a transaction rather than its
form. For example, a lease or other contractual arrangement (for
example, a management contract or an output contract) may in substance
constitute a loan if the arrangement transfers tax ownership of the
facility to a nongovernmental person. Similarly, an output contract or
a management contract with respect to a financed facility generally is
not treated as a loan of proceeds unless the agreement in substance
shifts significant burdens and benefits of ownership to the
nongovernmental purchaser or manager of the facility.
(2) Application only to purpose investments--(i) In general. A loan
may be either a purpose investment or a nonpurpose investment. A loan
that is a nonpurpose investment does not cause the private loan
financing test to be met. For example, proceeds invested in loans, such
as obligations of the United States, during a temporary period, as part
of a reasonably required reserve or replacement fund, as part of a
refunding escrow, or as part of a minor portion (as each of those terms
are defined in Sec. 1.148-1 or Sec. 1.148-2) are generally not treated
as loans under the private loan financing test.
(ii) Certain prepayments treated as loans. Except as otherwise
provided, a prepayment for property or services is treated as a loan
for purposes of the private loan financing test if a principal purpose
for prepaying is to provide a benefit of tax-exempt financing to the
seller. A prepayment is not treated as a loan for purposes of the
private loan financing test if--
(A) The prepayment is made for a substantial business purpose other
than providing a benefit of tax-exempt financing to the seller and the
issuer has no commercially reasonable alternative to the prepayment; or
(B) Prepayments on substantially the same terms are made by a
substantial percentage of persons who are similarly situated to the
issuer but who are not beneficiaries of tax-exempt financing.
(3) Grants--(i) In general. A grant of proceeds is not a loan.
Whether a transaction may be treated as a grant or a loan depends on
all of the facts and circumstances.
(ii) Tax increment financing--(A) In general. Generally, a grant
using proceeds of an issue that is secured by generally applicable
taxes attributable to the improvements to be made with the grant is not
treated as a loan, unless the grantee makes any impermissible
agreements relating to the payment that results in the taxes imposed on
that taxpayer not to be treated as generally applicable taxes under
Sec. 1.141-4(e).
(B) Amount of loan. If a grant is treated as a loan under this
paragraph (c)(3), the entire grant is treated as a loan unless the
impermissible agreement is limited to a specific portion of the tax.
For this purpose, an arrangement with each unrelated grantee is treated
as a separate grant.
(4) Hazardous waste remediation bonds. In the case of an issue of
hazardous waste remediation bonds, payments from nongovernmental
persons that are either users of the site being remediated or persons
potentially responsible for disposing of hazardous waste on that site
do not establish that the transaction is a loan for purposes of this
section. This paragraph (c)(4) applies only if those payments do not
secure the payment of principal of, or interest on, the bonds (directly
or indirectly), under the terms of the bonds and those payments are not
taken into account under the private payment test pursuant to
Sec. 1.141-4(f)(3).
(d) Tax assessment loan exception--(1) General rule. For purposes
of this section, a tax assessment loan that satisfies the requirements
of this paragraph (d) is not a loan for purposes of the private loan
financing test.
(2) Tax assessment loan defined. A tax assessment loan is a loan
that arises when a governmental person permits or requires property
owners to finance any governmental tax or assessment of general
application for an essential governmental function that satisfies each
of the requirements of paragraphs (d) (3) through (5) of this section.
(3) Mandatory tax or other assessment. The tax or assessment must
be an enforced contribution that is imposed and collected for the
purpose of raising revenue to be used for a specific purpose (that is,
to defray the capital cost of an improvement). Taxes and assessments do
not include fees for services. The tax or assessment must be imposed
pursuant to a state law of general application that can be applied
equally to natural persons not acting in a trade or business and
persons acting in a trade or business. For this purpose, taxes and
assessments that are imposed subject to protest procedures are treated
as enforced contributions.
(4) Specific essential governmental function--(i) In general. A
mandatory tax or assessment that gives rise to a tax assessment loan
must be imposed for one or more specific, essential governmental
functions.
(ii) Essential governmental functions. For purposes of paragraph
(d) of this section, improvements to utilities and systems that are
owned by a governmental person and that are available for use by the
general public (such as sidewalks, streets and street-lights; electric,
telephone, and cable television systems; sewage treatment and disposal
systems; and municipal water facilities) serve essential governmental
functions. For other types of facilities, the extent to which the
service provided by the facility is customarily performed (and financed
with governmental bonds) by governments with general taxing powers is a
primary factor in determining whether the facility serves an essential
governmental function. For example, parks that are owned by a
governmental person and that are available for use by the general
public serve an essential governmental function. Except as otherwise
provided in this paragraph (d)(4)(ii), commercial or industrial
facilities and improvements to property owned by a nongovernmental
person do not serve an essential governmental
[[Page 2297]]
function. Permitting installment payments of property taxes or other
taxes is not an essential governmental function.
(5) Equal basis requirement--(i) In general. Owners of both
business and nonbusiness property benefiting from the financed
improvements must be eligible, or required, to make deferred payments
of the tax or assessment giving rise to a tax assessment loan on an
equal basis (the equal basis requirement). A tax or assessment does not
satisfy the equal basis requirement if the terms for payment of the tax
or assessment are not the same for all taxed or assessed persons. For
example, the equal basis requirement is not met if certain property
owners are permitted to pay the tax or assessment over a period of
years while others must pay the entire tax or assessment immediately or
if only certain property owners are required to prepay the tax or
assessment when the property is sold.
(ii) General rule for guarantees. A guarantee of debt service on
bonds, or of taxes or assessments, by a person that is treated as a
borrower of bond proceeds violates the equal basis requirement if it is
reasonable to expect on the date the guarantee is entered into that
payments will be made under the guarantee.
(6) Coordination with private business tests. See Secs. 1.141-3 and
1.141-4 for rules for determining whether tax assessment loans cause
the bonds financing those loans to be private activity bonds under the
private business use and the private security or payment tests.
(e) Examples. The following examples illustrate the application of
this section:
Example 1. Turnkey contract not treated as a loan. State agency
Z and federal agency H will each contribute to rehabilitate a
project owned by Z. H can only provide its funds through a
contribution to Z to be used to acquire the rehabilitated project on
a turnkey basis from an approved developer. Under H's turnkey
program, the developer must own the project while it is
rehabilitated. Z issues its notes to provide funds for construction.
A portion of the notes will be retired using the H contribution, and
the balance of the notes will be retired through the issuance by Z
of long-term bonds. Z lends the proceeds of its notes to Developer B
as construction financing and transfers title to B for a nominal
amount. The conveyance is made on condition that B rehabilitate the
property and reconvey it upon completion, with Z retaining the right
to force reconveyance if these conditions are not satisfied. B must
name Z as an additional insured on all insurance. Upon completion, B
must transfer title to the project back to Z at a set price, which
price reflects B's costs and profit, not fair market value. Further,
this price is adjusted downward to reflect any cost-underruns. For
purposes of section 141(c), this transaction does not involve a
private loan.
Example 2. Essential government function requirement not met.
City D creates a special taxing district consisting of property
owned by nongovernmental persons that requires environmental clean-
up. D imposes a special tax on each parcel within the district in an
amount that is related to the expected environmental clean-up costs
of that parcel. The payment of the tax over a 20-year period is
treated as a loan by the property owners for purposes of the private
loan financing test. The special district issues bonds, acting on
behalf of D, that are payable from the special tax levied within the
district, and uses the proceeds to pay for the costs of
environmental clean-up on the property within the district. The
bonds meet the private loan financing test because more than 5
percent of the proceeds of the issue are loaned to nongovernmental
persons. The issue does not meet the tax assessment loan exception
because the improvements to property owned by a nongovernmental
person are not an essential governmental function under section
141(c)(2). The issue also meets the private business tests of
section 141(b).
Sec. 1.141-6 Allocation and accounting rules.
(a) Allocation of proceeds to expenditures. For purposes of
Secs. 1.141-1 through 1.141-15, the provisions of Sec. 1.148-6(d) apply
for purposes of allocating proceeds to expenditures. Thus, allocations
generally may be made using any reasonable, consistently applied
accounting method, and allocations under section 141 and section 148
must be consistent with each other.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds. [Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
Sec. 1.141-7 Special rules for output contracts. [Reserved]
Sec. 1.141-8 $15 million limitation for output facilities. [Reserved]
Sec. 1.141-9 Unrelated or disproportionate use test.
(a) General rules--(1) Description of test. Under section 141(b)(3)
(the unrelated or disproportionate use test), an issue meets the
private business tests if the amount of private business use and
private security or payments attributable to unrelated or
disproportionate private business use exceeds 5 percent of the proceeds
of the issue. For this purpose, the private business use test is
applied by taking into account only use that is not related to any
government use of proceeds of the issue (unrelated use) and use that is
related but disproportionate to any government use of those proceeds
(disproportionate use).
(2) Application of unrelated or disproportionate use test--(i)
Order of application. The unrelated or disproportionate use test is
applied by first determining whether a private business use is related
to a government use. Next, private business use that relates to a
government use is examined to determine whether it is disproportionate
to that government use.
(ii) Aggregation of unrelated and disproportionate use. All the
unrelated use and disproportionate use financed with the proceeds of an
issue are aggregated to determine compliance with the unrelated or
disproportionate use test. The amount of permissible unrelated and
disproportionate private business use is not reduced by the amount of
private business use financed with the proceeds of an issue that is
neither unrelated use nor disproportionate use.
(iii) Deliberate actions. A deliberate action that occurs after the
issue date does not result in unrelated or disproportionate use if the
issue meets the conditions of Sec. 1.141-12(a).
(b) Unrelated use--(1) In general. Whether a private business use
is related to a government use financed with the proceeds of an issue
is determined on a case-by-case basis, emphasizing the operational
relationship between the government use and the private business use.
In general, a facility that is used for a related private business use
must be located within, or adjacent to, the governmentally used
facility.
(2) Use for the same purpose as government use. Use of a facility
by a nongovernmental person for the same purpose as use by a
governmental person is not treated as unrelated use if the government
use is not insignificant. Similarly, a use of a facility in the same
manner both for private business use that is related use and private
business use that is unrelated use does not result in unrelated use if
the related use is not insignificant. For example, a privately owned
pharmacy in a governmentally owned hospital does not ordinarily result
in unrelated use solely because the pharmacy also serves individuals
not using the hospital. In addition, use of parking spaces in a garage
by a nongovernmental person is not treated as unrelated use if more
than an insignificant portion of the parking
[[Page 2298]]
spaces are used for a government use (or a private business use that is
related to a government use), even though the use by the
nongovernmental person is not directly related to that other use.
(c) Disproportionate use--(1) Definition of disproportionate use. A
private business use is disproportionate to a related government use
only to the extent that the amount of proceeds used for that private
business use exceeds the amount of proceeds used for the related
government use. For example, a private use of $100 of proceeds that is
related to a government use of $70 of proceeds results in $30 of
disproportionate use.
(2) Aggregation of related uses. If two or more private business
uses of the proceeds of an issue relate to a single government use of
those proceeds, those private business uses are aggregated to apply the
disproportionate use test.
(3) Allocation rule. If a private business use relates to more than
a single use of the proceeds of the issue (for example, two or more
government uses of the proceeds of the issue or a government use and a
private use), the amount of any disproportionate use may be determined
by--
(i) Reasonably allocating the proceeds used for the private
business use among the related uses;
(ii) Aggregating government uses that are directly related to each
other; or
(iii) Allocating the private business use to the government use to
which it is primarily related.
(d) Maximum use taken into account. The determination of the amount
of unrelated use or disproportionate use of a facility is based on the
maximum amount of reasonably expected government use of a facility
during the measurement period. Thus, no unrelated use or
disproportionate use arises solely because a facility initially has
excess capacity that is to be used by a nongovernmental person if the
facility will be completely used by the issuer during the term of the
issue for more than an insignificant period.
(e) Examples. The following examples illustrate the application of
this section:
Example 1. School and remote cafeteria. County X issues bonds
with proceeds of $20 million and uses $18.1 million of the proceeds
for construction of a new school building and $1.9 million of the
proceeds for construction of a privately operated cafeteria in its
administrative office building, which is located at a remote site.
The bonds are secured, in part, by the cafeteria. The $1.9 million
of proceeds is unrelated to the government use (that is, school
construction) financed with the bonds and exceeds 5 percent of $20
million. Thus, the issue meets the private business tests.
Example 2. Public safety building and courthouse. City Y issues
bonds with proceeds of $50 million for construction of a new public
safety building ($32 million) and for improvements to an existing
courthouse ($15 million). Y uses $3 million of the bond proceeds for
renovations to an existing privately operated cafeteria located in
the courthouse. The bonds are secured, in part, by the cafeteria.
Y's use of the $3 million for the privately operated cafeteria does
not meet the unrelated or disproportionate use test because these
expenditures are neither unrelated use nor disproportionate use.
Example 3. Unrelated garage. City Y issues bonds with proceeds
of $50 million for construction of a new public safety building
($30.5 million) and for improvements to an existing courthouse ($15
million). Y uses $3 million of the bond proceeds for renovations to
an existing privately operated cafeteria located in the courthouse.
The bonds are secured, in part, by the cafeteria. Y also uses $1.5
million of the proceeds to construct a privately operated parking
garage adjacent to a private office building. The private business
use of the parking garage is unrelated to any government use of
proceeds of the issue. Since the proceeds used for unrelated uses
and disproportionate uses do not exceed 5 percent of the proceeds,
the unrelated or disproportionate use test is not met.
Example 4. Disproportionate use of garage. County Z issues bonds
with proceeds of $20 million for construction of a hospital with no
private business use ($17 million); renovation of an office building
with no private business use ($1 million); and construction of a
garage that is entirely used for a private business use ($2
million). The use of the garage is related to the use of the office
building but not to the use of the hospital. The private business
use of the garage results in $1 million of disproportionate use
because the proceeds used for the garage ($2 million) exceed the
proceeds used for the related government use ($1 million). The bonds
are not private activity bonds, however, because the
disproportionate use does not exceed 5 percent of the proceeds of
the issue.
Example 5. Bonds for multiple projects. (i) County W issues
bonds with proceeds of $80 million for the following purposes: (1)
$72 million to construct a County-owned and operated waste
incinerator; (2) $1 million for a County-owned and operated facility
for the temporary storage of hazardous waste prior to final
disposal; (3) $1 million to construct a privately owned recycling
facility located at a remote site; and (4) $6 million to build a
garage adjacent to the County-owned incinerator that will be leased
to Company T to store and repair trucks that it owns and uses to
haul County W refuse. Company T uses 75 percent of its trucks to
haul materials to the incinerator and the remaining 25 percent of
its trucks to haul materials to the temporary storage facility.
(ii) The $1 million of proceeds used for the recycling facility
is used for an unrelated use. The garage is related use. In
addition, 75 percent of the use of the $6 million of proceeds used
for the garage is allocable to the government use of proceeds at the
incinerator. The remaining 25 percent of the proceeds used for the
garage ($1.5 million) relates to the government use of proceeds at
the temporary storage facility. Thus, this portion of the proceeds
used for the garage exceeds the proceeds used for the temporary
storage facility by $0.5 million and this excess is disproportionate
use (but not unrelated use). Thus, the aggregate amount of unrelated
use and disproportionate use financed with the proceeds of the issue
is $1.5 million. Alternatively, under paragraph (c)(3)(iii) of this
section, the entire garage may be treated as related to the
government use of the incinerator and, under that allocation, the
garage is not disproportionate use. In either event, section
141(b)(3) limits the aggregate unrelated use and disproportionate
use to $4 million. Therefore, the bonds are not private activity
bonds under this section.
Sec. 1.141-10 Coordination with volume cap. [Reserved]
Sec. 1.141-11 Acquisition of nongovernmental output property.
[Reserved]
Sec. 1.141-12 Remedial actions.
(a) Conditions to taking remedial action. An action that causes an
issue to meet the private business tests or the private loan financing
test is not treated as a deliberate action if the issuer takes a
remedial action described in paragraph (d), (e), or (f) of this section
with respect to the nonqualified bonds and if all of the requirements
in paragraphs (a) (1) through (5) of this section are met.
(1) Reasonable expectations test met. The issuer reasonably
expected on the issue date that the issue would meet neither the
private business tests nor the private loan financing test for the
entire term of the bonds. For this purpose, if the issuer reasonably
expected on the issue date to take a deliberate action prior to the
final maturity date of the issue that would cause either the private
business tests or the private loan financing test to be met, the term
of the bonds for this purpose may be determined by taking into account
a redemption provision if the provisions of Sec. 1.141-2(d)(2)(ii) (A)
through (C) are met.
(2) Maturity not unreasonably long. The term of the issue must not
be longer than is reasonably necessary for the governmental purposes of
the issue (within the meaning of Sec. 1.148-1(c)(4)). Thus, this
requirement is met if the weighted average maturity of the bonds of the
issue is not greater than 120 percent of the average reasonably
expected economic life of the property financed with the proceeds of
the issue as of the issue date.
(3) Fair market value consideration. Except as provided in
paragraph (f) of this section, the terms of any arrangement that
results in satisfaction
[[Page 2299]]
of either the private business tests or the private loan financing test
are bona fide and arm's-length, and the new user pays fair market value
for the use of the financed property. Thus, for example, fair market
value may be determined in a manner that takes into account
restrictions on the use of the financed property that serve a bona fide
governmental purpose.
(4) Disposition proceeds treated as gross proceeds for arbitrage
purposes. The issuer must treat any disposition proceeds as gross
proceeds for purposes of section 148. For purposes of eligibility for
temporary periods under section 148(c) and exemptions from the
requirement of section 148(f) the issuer may treat the date of receipt
of the disposition proceeds as the issue date of the bonds and
disregard the receipt of disposition proceeds for exemptions based on
expenditure of proceeds under Sec. 1.148-7 that were met before the
receipt of the disposition proceeds.
(5) Proceeds expended on a governmental purpose. Except for a
remedial action under paragraph (d) of this section, the proceeds of
the issue that are affected by the deliberate action must have been
expended on a governmental purpose before the date of the deliberate
action.
(b) Effect of a remedial action--(1) In general. The effect of a
remedial action is to cure use of proceeds that causes the private
business use test or the private loan financing test to be met. A
remedial action does not affect application of the private security or
payment test.
(2) Effect on bonds that have been advance refunded. If proceeds of
an issue were used to advance refund another bond, a remedial action
taken with respect to the refunding bond proportionately reduces the
amount of proceeds of the advance refunded bond that is taken into
account under the private business use test or the private loan
financing test.
(c) Disposition proceeds--(1) Definition. Disposition proceeds are
any amounts (including property, such as an agreement to provide
services) derived from the sale, exchange, or other disposition
(disposition) of property (other than investments) financed with the
proceeds of an issue.
(2) Allocating disposition proceeds to an issue. In general, if the
requirements of paragraph (a) of this section are met, after the date
of the disposition, the proceeds of the issue allocable to the
transferred property are treated as financing the disposition proceeds
rather than the transferred property. If a disposition is made pursuant
to an installment sale, the proceeds of the issue continue to be
allocated to the transferred property. If an issue does not meet the
requirements for remedial action in paragraph (a) of this section or
the issuer does not take an appropriate remedial action, the proceeds
of the issue are allocable to either the transferred property or the
disposition proceeds, whichever allocation produces the greater amount
of private business use and private security or payments.
(3) Allocating disposition proceeds to different sources of
funding. If property has been financed by different sources of funding,
for purposes of this section, the disposition proceeds from that
property are first allocated to the outstanding bonds that financed
that property in proportion to the principal amounts of those
outstanding bonds. In no event may disposition proceeds be allocated to
bonds that are no longer outstanding or to a source of funding not
derived from a borrowing (such as revenues of the issuer) if the
disposition proceeds are not greater than the total principal amounts
of the outstanding bonds that are allocable to that property. For
purposes of this paragraph (c)(3), principal amount has the same
meaning as in Sec. 1.148-9(b)(2) and outstanding bonds do not include
advance refunded bonds.
(d) Redemption or defeasance of nonqualified bonds--(1) In general.
The requirements of this paragraph (d) are met if all of the
nonqualified bonds of the issue are redeemed. Proceeds of tax-exempt
bonds must not be used for this purpose, unless the tax-exempt bonds
are qualified bonds, taking into account the purchaser's use of the
facility. If the bonds are not redeemed within 90 days of the date of
the deliberate action, a defeasance escrow must be established for
those bonds within 90 days of the deliberate action.
(2) Special rule for dispositions for cash. If the consideration
for the disposition of financed property is exclusively cash, the
requirements of this paragraph (d) are met if the disposition proceeds
are used to redeem a pro rata portion of the nonqualified bonds at the
earliest call date after the deliberate action. If the bonds are not
redeemed within 90 days of the date of the deliberate action, the
disposition proceeds must be used to establish a defeasance escrow for
those bonds within 90 days of the deliberate action.
(3) Notice of defeasance. The issuer must provide written notice to
the Commissioner of the establishment of the defeasance escrow within
90 days of the date the defeasance escrow is established.
(4) Special limitation. The establishment of a defeasance escrow
does not satisfy the requirements of this paragraph (d) if the period
between the issue date and the first call date of the bonds is more
than 10 1/2 years.
(5) Defeasance escrow defined. A defeasance escrow is an
irrevocable escrow established to redeem bonds on their earliest call
date in an amount that, together with investment earnings, is
sufficient to pay all the principal of, and interest and call premium
on, bonds from the date the escrow is established to the earliest call
date. The escrow may not be invested in higher yielding investments or
in any investment under which the obligor is a user of the proceeds of
the bonds.
(e) Alternative use of disposition proceeds--(1) In general. The
requirements of this paragraph (e) are met if--
(i) The deliberate action is a disposition for which the
consideration is exclusively cash;
(ii) The issuer reasonably expects to expend the disposition
proceeds within two years of the date of the deliberate action;
(iii) The disposition proceeds are treated as proceeds for purposes
of section 141 and are used in a manner that does not cause the issue
to meet either the private business tests or the private loan financing
test, and the issuer does not take any action subsequent to the date of
the deliberate action to cause either of these tests to be met; and
(iv) If the issuer does not use all of the disposition proceeds for
an alternative use described in paragraph (e)(1)(iii) of this section,
the issuer uses those remaining disposition proceeds for a remedial
action that meets paragraph (d) of this section.
(2) Special rule for use by 501(c)(3) organizations. If the
disposition proceeds are to be used by a 501(c)(3) organization, the
nonqualified bonds must in addition be treated as reissued for purposes
of sections 141, 145, 147, 149, and 150 and, under this treatment,
satisfy all of the applicable requirements for qualified 501(c)(3)
bonds. Thus, beginning on the date of the deliberate action,
nonqualified bonds that satisfy these requirements must be treated as
qualified 501(c)(3) bonds for all purposes, including sections 145(b)
and 150(b).
(f) Alternative use of facility. The requirements of this paragraph
(f) are met if--
(1) The facility with respect to which the deliberate action occurs
is used in an alternative manner (for example, used for a qualifying
purpose by a nongovernmental person or used by a
[[Page 2300]]
501(c)(3) organization rather than a governmental person);
(2) The nonqualified bonds are treated as reissued, as of the date
of the deliberate action, for purposes of sections 55 through 59 and
141, 142, 144, 145, 146, 147, 149 and 150, and under this treatment,
the nonqualified bonds satisfy all the applicable requirements for
qualified bonds throughout the remaining term of the nonqualified
bonds;
(3) The deliberate action does not involve a disposition to a
purchaser that finances the acquisition with proceeds of another issue
of tax-exempt bonds; and
(4) Any disposition proceeds other than those arising from an
agreement to provide services (including disposition proceeds from an
installment sale) resulting from the deliberate action are used to pay
the debt service on the bonds on the next available payment date or,
within 90 days of receipt, are deposited into an escrow that is
restricted to the yield on the bonds to pay the debt service on the
bonds on the next available payment date.
(g) Rules for deemed reissuance. For purposes of determining
whether bonds that are treated as reissued under paragraphs (e) and (f)
of this section are qualified bonds--
(1) The provisions of the Code and regulations thereunder in effect
as of the date of the deliberate action apply; and
(2) For purposes of paragraph (f) of this section, section 147(d)
(relating to the acquisition of existing property) does not apply.
(h) Authority of Commissioner to provide for additional remedial
actions. The Commissioner may, by publication in the Federal Register
or the Internal Revenue Bulletin, provide additional remedial actions,
including making a remedial payment to the United States, under which a
subsequent action will not be treated as a deliberate action for
purposes of Sec. 1.141-2.
(i) Effect of remedial action on continuing compliance. Solely for
purposes of determining whether deliberate actions that are taken after
a remedial action cause an issue to meet the private business tests or
the private loan financing test--
(1) If a remedial action is taken under paragraph (d), (e), or (f)
of this section, the private business use or private loans resulting
from the deliberate action are not taken into account for purposes of
determining whether the bonds are private activity bonds; and
(2) After a remedial action is taken, the amount of disposition
proceeds is treated as equal to the proceeds of the issue that had been
allocable to the transferred property immediately prior to the
disposition. See paragraph (k) of this section, Example 5.
(j) Nonqualified bonds--(1) Amount of nonqualified bonds. The
percentage of outstanding bonds that are nonqualified bonds equals the
highest percentage of private business use in any 1-year period
commencing with the deliberate action.
(2) Allocation of nonqualified bonds. Allocations to nonqualified
bonds must be made on a pro rata basis, except that, for purposes of
paragraph (d) of this section (relating to redemption or defeasance),
an issuer may treat bonds with longer maturities (determined on a bond-
by-bond basis) as the nonqualified bonds.
(k) Examples. The following examples illustrate the application of
this section:
Example 1. Disposition proceeds less than outstanding bonds used
to retire bonds. On June 1, 1997, City C issues 30-year bonds with
an issue price of $10 million to finance the construction of a
hospital building. The bonds have a weighted average maturity that
does not exceed 120 percent of the reasonably expected economic life
of the building. On the issue date, C reasonably expects that it
will be the only user of the building for the entire term of the
bonds. Six years after the issue date, C sells the building to
Corporation P for $5 million. The sale price is the fair market
value of the building, as verified by an independent appraiser. C
uses all of the $5 million disposition proceeds to immediately
retire a pro rata portion of the bonds. The sale does not cause the
bonds to be private activity bonds because C has taken a remedial
action described in paragraph (d) of this section so that P is not
treated as a private business user of bond proceeds.
Example 2. Lease to nongovernmental person. The facts are the
same as in Example 1, except that instead of selling the building,
C, 6 years after the issue date, leases the building to P for 7
years and uses other funds to redeem all of the $10 million
outstanding bonds within 90 days of the deliberate act. The bonds
are not treated as private activity bonds because C has taken the
remedial action described in paragraph (d) of this section.
Example 3. Sale for less than fair market value. The facts are
the same as in Example 1, except that the fair market value of the
building at the time of the sale to P is $6 million. Because the
transfer was for less than fair market value, the bonds are
ineligible for the remedial actions under this section. The bonds
are private activity bonds because P is treated as a user of all of
the proceeds and P makes a payment ($6 million) for this use that is
greater than 10 percent of the debt service on the bonds, on a
present value basis.
Example 4. Fair market value determined taking into account
governmental restrictions. The facts are the same as in Example 1,
except that the building was used by C only for hospital purposes
and C determines to sell the building subject to a restriction that
it be used only for hospital purposes. After conducting a public
bidding procedure as required by state law, the best price that C is
able to obtain for the building subject to this restriction is $4.5
million from P. C uses all of the $4.5 million disposition proceeds
to immediately retire a pro rata portion of the bonds. The sale does
not cause the bonds to be private activity bonds because C has taken
a remedial action described in paragraph (d) of this section so that
P is not treated as a private business user of bond proceeds.
Example 5. Alternative use of disposition proceeds. The facts
are the same as in Example 1, except that C reasonably expects on
the date of the deliberate action to use the $5 million disposition
proceeds for another governmental purpose (construction of
governmentally owned roads) within two years of receipt, rather than
using the $5 million to redeem outstanding bonds. C treats these
disposition proceeds as gross proceeds for purposes of section 148.
The bonds are not private activity bonds because C has taken a
remedial action described in paragraph (e) of this section. After
the date of the deliberate action, the proceeds of all of the
outstanding bonds are treated as used for the construction of the
roads, even though only $5 million of disposition proceeds was
actually used for the roads.
Example 6. Alternative use of financed property. The facts are
the same as in Example 1, except that C determines to lease the
hospital building to Q, an organization described in section
501(c)(3), for a term of 10 years rather than to sell the building
to P. In order to induce Q to provide hospital services, C agrees to
lease payments that are less than fair market value. Before entering
into the lease, an applicable elected representative of C approves
the lease after a noticed public hearing. As of the date of the
deliberate action, the issue meets all the requirements for
qualified 501(c)(3) bonds, treating the bonds as reissued on that
date. For example, the issue meets the two percent restriction on
use of proceeds of finance issuance costs of section 147(g) because
the issue pays no costs of issuance from disposition proceeds in
connection with the deemed reissuance. C and Q treat the bonds as
qualified 501(c)(3) bonds for all purposes commencing with the date
of the deliberate action. The bonds are treated as qualified
501(c)(3) bonds commencing with the date of the deliberate action.
Example 7. Deliberate action before proceeds are expended on a
governmental purpose. County J issues bonds with proceeds of $10
million that can be used only to finance a correctional facility. On
the issue date of the bonds, J reasonably expects that it will be
the sole user of the bonds for the useful life of the facility. The
bonds have a weighted average maturity that does not exceed 120
percent of the reasonably expected economic life of the facility.
After the issue date of the bonds, but before the facility is placed
in service, J enters into a contract with the federal government
pursuant to which the federal government will make a fair market
value, lump sum payment equal to 25 percent of the cost of the
[[Page 2301]]
facility. In exchange for this payment, J provides the federal
government with priority rights to use of 25 percent of the
facility. J uses the payment received from the federal government to
defease the nonqualified bonds. The agreement does not cause the
bonds to be private activity bonds because J has taken a remedial
action described in paragraph (d) of this section. See paragraph
(a)(5) of this section.
Example 8. Compliance after remedial action. In 1997, City G
issues bonds with proceeds of $10 million to finance a courthouse.
The bonds have a weighted average maturity that does not exceed 120
percent of the reasonably expected economic life of the courthouse.
G uses $1 million of the proceeds for a private business use and
more than 10 percent of the debt service on the issue is secured by
private security or payments. G later sells one-half of the
courthouse property to a nongovernmental person for cash. G
immediately redeems 60 percent of the outstanding bonds. This
percentage of outstanding bonds is based on the highest private
business use of the courthouse in any 1-year period commencing with
the deliberate action. For purposes of subsequently applying section
141 to the issue, G may continue to use all of the proceeds of the
outstanding bonds in the same manner (that is, for both the
courthouse and the existing private business use) without causing
the issue to meet the private business use test. The issue, however,
continues to meet the private security or payment test. The result
would be the same if D, instead of redeeming the bonds, established
a defeasance escrow for those bonds, provided that the requirement
of paragraph (d)(4) of this section was met.
Sec. 1.141-13 Refunding issues. [Reserved]
Sec. 1.141-14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of transactions.
If an issuer enters into a transaction or series of transactions with
respect to one or more issues with a principal purpose of transferring
to nongovernmental persons (other than as members of the general
public) significant benefits of tax-exempt financing in a manner that
is inconsistent with the purposes of section 141, the Commissioner may
take any action to reflect the substance of the transaction or series
of transactions, including--
(1) Treating separate issues as a single issue for purposes of the
private activity bond tests;
(2) Reallocating proceeds to expenditures, property, use, or bonds;
(3) Reallocating payments to use or proceeds;
(4) Measuring private business use on a basis that reasonably
reflects the economic benefit in a manner different than as provided in
Sec. 1.141-3(g); and
(5) Measuring private payments or security on a basis that
reasonably reflects the economic substance in a manner different than
as provided in Sec. 1.141-4.
(b) Examples. The following examples illustrate the application of
this section:
Example 1. Reallocating proceeds to indirect use. City C issues
bonds with proceeds of $20 million for the stated purpose of
financing improvements to roads that it owns. As a part of the same
plan of financing, however, C also agrees to make a loan of $7
million to Corporation M from its general revenues that it otherwise
would have used for the road improvements. The interest rate of the
loan corresponds to the interest rate on a portion of the issue. A
principal purpose of the financing arrangement is to transfer to M
significant benefits of the tax-exempt financing. Although C
actually allocates all of the proceeds of the bonds to the road
improvements, the Commissioner may reallocate a portion of the
proceeds of the bonds to the loan to M because a principal purpose
of the financing arrangement is to transfer to M significant
benefits of tax-exempt financing in a manner that is inconsistent
with the purposes of section 141. The bonds are private activity
bonds because the issue meets the private loan financing test. The
bonds also meet the private business tests. See also Secs. 1.141-
3(a)(2), 1.141-4(a)(1), and 1.141-5(a), under which indirect use of
proceeds and payments are taken into account.
Example 2. Taking into account use of amounts derived from
proceeds that would be otherwise disregarded. County B issues bonds
with proceeds of $10 million to finance the purchase of land. On the
issue date, B reasonably expects that it will be the sole user of
the land. Subsequently, the federal government acquires the land for
$3 million in a condemnation action. B uses this amount to make a
loan to Corporation M. In addition, the interest rate on the loan
reflects the tax-exempt interest rate on the bonds and thus is
substantially less than a current market rate. A principal purpose
of the arrangement is to transfer to M significant benefits of the
tax-exempt financing. Although the condemnation action is not a
deliberate action, the Commissioner may treat the condemnation
proceeds as proceeds of the issue because a principal purpose of the
arrangement is to transfer to M significant benefits of tax-exempt
financing in a manner inconsistent with the purposes of section 141.
The bonds are private activity bonds.
Example 3. Measuring private business use on an alternative
basis. City F issues bonds with a 30-year term to finance the
acquisition of an industrial building having a remaining reasonably
expected useful economic life of more than 30 years. On the issue
date, F leases the building to Corporation G for 3 years. F
reasonably expects that it will be the sole user of the building for
the remaining term of the bonds. Because of the local market
conditions, it is reasonably expected that the fair rental value of
the industrial building will be significantly greater during the
early years of the term of the bonds than in the later years. The
annual rental payments are significantly less than fair market
value, reflecting the interest rate on the bonds. The present value
of these rental payments (net of operation and maintenance expenses)
as of the issue date, however, is approximately 25 percent of the
present value of debt service on the issue. Under Sec. 1.141-3, the
issue does not meet the private business tests, because only 10
percent of the proceeds are used in a trade or business by a
nongovernmental person. A principal purpose of the issue is to
transfer to G significant benefits of tax-exempt financing in a
manner inconsistent with the purposes of section 141. The method of
measuring private business use over the reasonably expected useful
economic life of financed property is for the administrative
convenience of issuers of state and local bonds. In cases where this
method is used in a manner inconsistent with the purposes of section
141, the Commissioner may measure private business use on another
basis that reasonably reflects economic benefit, such as in this
case on an annual basis. If the Commissioner measures private
business use on an annual basis, the bonds are private activity
bonds because the private payment test is met and more than 10
percent of the proceeds are used in a trade or business by a
nongovernmental person.
Example 4. Treating separate issues as a single issue. City D
enters into a development agreement with Corporation T to induce T
to locate its headquarters within D's city limits. Pursuant to the
development agreement, in 1997 D will issue $20 million of its
general obligation bonds (the 1997 bonds) to purchase land that it
will grant to T. The development agreement also provides that, in
1998, D will issue $20 million of its tax increment bonds (the 1998
bonds), secured solely by the increase in property taxes in a
special taxing district. Substantially all of the property within
the special taxing district is owned by T or D. T will separately
enter into an agreement to guarantee the payment of tax increment to
D in an amount sufficient to retire the 1998 bonds. The proceeds of
the 1998 bonds will be used to finance improvements owned and
operated by D that will not give rise to private business use.
Treated separately, the 1997 issue meets the private business use
test, but not the private security or payment test; the 1998 issue
meets the private security or payment test, but not the private
business use test. A principal purpose of the financing plan
including the two issues is to transfer significant benefits of tax-
exempt financing to T for its headquarters. Thus, the 1997 issue and
the 1998 issue may be treated by the Commissioner as a single issue
for purposes of applying the private activity bond tests.
Accordingly, the bonds of both the 1997 issue and the 1998 issue may
be treated as private activity bonds.
Example 5. Reallocating proceeds. City E acquires an electric
generating facility with a useful economic life of more than 40
years and enters into a 30-year take or pay contract to sell 30
percent of the available output to investor-owned utility M. E plans
to use the remaining 70 percent of available output for its own
governmental purposes. To finance the entire cost of the facility, E
issues $30 million of its series A taxable bonds at taxable interest
rates and $70 million series
[[Page 2302]]
B bonds, which purport to be tax-exempt bonds, at tax-exempt
interest rates. E allocates all of M's private business use to the
proceeds of the series A bonds and all of its own government use to
the proceeds of the series B bonds. The series A bonds have a
weighted average maturity of 15 years, while the series B bonds have
a weighted average maturity of 26 years. M's payments under the take
or pay contract are expressly determined by reference to 30 percent
of M's total costs (that is, the sum of the debt service required to
be paid on both the series A and the series B bonds and all other
operating costs). The allocation of all of M's private business use
to the series A bonds does not reflect economic substance because
the series of transactions transfers to M significant benefits of
the tax-exempt interest rates paid on the series B bonds. A
principal purpose of the financing arrangement is to transfer to M
significant benefits of the tax-exempt financing. Accordingly, the
Commissioner may allocate M's private business use on a pro rata
basis to both the series B bonds as well as the series A bonds, in
which case the series B bonds are private activity bonds.
Example 6. Allocations respected. The facts are the same as in
Example 5, except that the debt service component of M's payments
under the take or pay contract is based exclusively on the amounts
necessary to pay the debt service on the taxable series A bonds. E's
allocation of all of M's private business use to the series A bonds
is respected because the series of transactions does not actually
transfer benefits of tax-exempt interest rates to M. Accordingly,
the series B bonds are not private activity bonds. The result would
be the same if M's payments under the take or pay contract were
based exclusively on fair market value pricing, rather than the tax-
exempt interest rates on E's bonds. The result also would be the
same if the series A bonds and the series B bonds had substantially
equivalent weighted average maturities and E and M had entered into
a customary contract providing for payments based on a ratable share
of total debt service. E would not be treated by the Commissioner in
any of these cases as entering into the contract with a principal
purpose of transferring the benefits of tax-exempt financing to M in
a manner inconsistent with the purposes of section 141.
Sec. 1.141-15 Effective dates.
(a) Scope. The effective dates in this section apply for purposes
of Secs. 1.141-0 through 1.141-14, and 1.145-0 through 1.145-2 (the
private activity bond regulations), and Sec. 1.150-1(a)(3) and the
definition of bond documents contained in Sec. 1.150-1(b).
(b) Effective dates. Except as otherwise provided in this section,
the private activity bond regulations, Sec. 1.150-1(a)(3), and the
definition of bond documents contained in Sec. 1.150-1(b) apply to
bonds issued on or after May 16, 1977 (the effective date) that are
subject to section 1301 of the Tax Reform Act of 1986.
(c) Refunding bonds. The private activity bond regulations,
Sec. 1.150-1(a)(3), and the definition of bond documents contained in
Sec. 1.150-1(b) do not apply to bonds issued on or after the effective
date to refund a bond to which the private activity bond regulations do
not apply unless--
(1) The weighted average maturity of the refunding bonds is longer
than--
(i) The weighted average maturity of the refunded bonds; or
(ii) In the case of a short-term obligation that the issuer
reasonably expects to refund with a long-term financing (such as a bond
anticipation note), 120 percent of the weighted average reasonably
expected economic life of the facilities financed; or
(2) A principal purpose for the issuance of the refunding bonds is
to make one or more new conduit loans.
(d) Permissive application of regulations. Except as provided in
paragraph (e) of this section, the private activity bond regulations,
Sec. 1.150-1(a)(3), and the definition of bond documents contained in
Sec. 1.150-1(b) may be applied in whole, but not in part, to--
(1) Bonds that are outstanding on the effective date and subject to
section 141; or
(2) Refunding bonds issued on or after the effective date.
(e) Permissive retroactive application of certain sections. The
following sections may each be applied to any bonds issued before the
effective date:
(1) Section 1.141-3(b)(4);
(2) Section 1.141-3(b)(6); and
(3) Section 1.141-12.
Sec. 1.141-16 Effective dates for qualified private activity bond
provisions.
(a) Scope. The effective dates of this section apply for purposes
of Secs. 1.142-0 through 1.142-2, 1.144-0 through 1.144-2, 1.147-0
through 1.147-2, and 1.150-4.
(b) Effective dates. Except as otherwise provided in this section,
the regulations designated in paragraph (a) of this section apply to
bonds issued on or after May 16, 1997 (the effective date).
(c) Permissive application. The regulations designated in paragraph
(a) of this section may be applied in whole, but not in part, to bonds
outstanding on the effective date.
Par. 7. Sections 1.142-0 and 1.142-3 are added and Secs. 1.142-1
and 1.142-2 are revised to read as follows:
Sec. 1.142-0 Table of Contents.
This section lists the captioned paragraphs contained in
Secs. 1.142-1 through 1.142-3.
Sec. 1.142-1 Exempt facility bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.142-2 Remedial actions.
(a) General rule.
(b) Reasonable expectations requirement.
(c) Redemption or defeasance.
(1) In general.
(2) Notice of defeasance.
(3) Special limitation.
(4) Special rule for dispositions of personal property.
(5) Definitions.
(d) When a failure to properly use proceeds occurs.
(1) Proceeds not spent.
(2) Proceeds spent.
(e) Nonqualified bonds.
Sec. 1.142-3 Refunding issues.
[Reserved]
Sec. 1.142-1 Exempt facility bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(A), an exempt facility bond issued under
section 142 may be a qualified bond.
Under section 142(a), an exempt facility bond is any bond issued as
a part of an issue using 95 percent or more of the proceeds for certain
exempt facilities.
(b) Scope. Sections 1.142-0 through 1.142-3 apply for purposes of
the rules for exempt facility bonds under section 142, except that,
with respect to net proceeds that have been spent, Sec. 1.142-2 does
not apply to bonds issued under section 142(d) (relating to bonds
issued to provide qualified residential rental projects) and section
142(f) (2) and (4) (relating to bonds issued to provide local
furnishing of electric energy or gas).
(c) Effective dates. For effective dates of Secs. 1.142-0 through
1.142-2, see Sec. 1.141-16.
Sec. 1.142-2 Remedial actions.
(a) General rule. If less than 95 percent of the net proceeds of an
exempt facility bond are actually used to provide an exempt facility,
and for no other purpose, the issue will be treated as meeting the use
of proceeds requirement of section 142(a) if the issue meets the
condition of paragraph (b) of this section and the issuer takes the
remedial action described in paragraph (c) of this section.
(b) Reasonable expectations requirement. The issuer must have
reasonably expected on the issue date that 95 percent of the net
proceeds of the issue would be used to provide an exempt facility and
for no other purpose for the entire term of the bonds (disregarding any
redemption
[[Page 2303]]
provisions). To meet this condition the amount of the issue must have
been based on reasonable estimates about the cost of the facility.
(c) Redemption or defeasance--(1) In general. The requirements of
this paragraph (c) are met if all of the nonqualified bonds of the
issue are redeemed on the earliest call date after the date on which
the failure to properly use the proceeds occurs under paragraph (d) of
this section. Proceeds of tax-exempt bonds (other than those described
in paragraph (d)(1) of this section) must not be used for this purpose.
If the bonds are not redeemed within 90 days of the date on which the
failure to properly use proceeds occurs, a defeasance escrow must be
established for those bonds within 90 days of that date.
(2) Notice of defeasance. The issuer must provide written notice to
the Commissioner of the establishment of the defeasance escrow within
90 days of the date the escrow is established.
(3) Special limitation. The establishment of a defeasance escrow
does not satisfy the requirements of this paragraph (c) if the period
between the issue date and the first call date is more than 10\1/2\
years.
(4) Special rule for dispositions of personal property. For
dispositions of personal property exclusively for cash, the
requirements of this paragraph (c) are met if the issuer expends the
disposition proceeds within 6 months of the date of the disposition to
acquire replacement property for the same qualifying purpose of the
issue under section 142.
(5) Definitions. For purposes of paragraph (c)(4) of this section,
disposition proceeds means disposition proceeds as defined in
Sec. 1.141-12(c).
(d) When a failure to properly use proceeds occurs--(1) Proceeds
not spent. For net proceeds that are not spent, a failure to properly
use proceeds occurs on the earlier of the date on which the issuer
reasonably determines that the financed facility will not be completed
or the date on which the financed facility is placed in service.
(2) Proceeds spent. For net proceeds that are spent, a failure to
properly use proceeds occurs on the date on which an action is taken
that causes the bonds not to be used for the qualifying purpose for
which the bonds were issued.
(e) Nonqualified bonds. For purposes of this section, the
nonqualified bonds are a portion of the outstanding bonds in an amount
that, if the remaining bonds were issued on the date on which the
failure to properly use the proceeds occurs, at least 95 percent of the
net proceeds of the remaining bonds would be used to provide an exempt
facility. If no proceeds have been spent to provide an exempt facility,
all of the outstanding bonds are nonqualified bonds. The nonqualified
bonds must be determined on a pro rata allocation basis, except that an
issuer may treat bonds with longer maturities (determined on a bond-by-
bond basis) as the nonqualified bonds.
Sec. 1.142-3 Refunding issues.
[Reserved]
Par. 8. Section 1.144-0 is added and Secs. 1.144-1 and 1.144-2 are
revised to read as follows:
Sec. 1.144-0 Table of Contents.
This section lists the captioned paragraphs contained in
Secs. 1.144-1 and 1.144-2.
Sec. 1.144-1 Qualified small issue bonds, qualified student
loan bonds, and qualified redevelopment bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.144-2 Remedial actions.
Sec. 1.144-1 Qualified small issue bonds, qualified student loan
bonds, and qualified redevelopment bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(D), a qualified small issue bond issued
under section 144(a) may be a qualified bond. Under section 144(a), any
qualified small issue bond is any bond issued as a part of an issue 95
percent or more of the proceeds of which are to be used to provide
certain manufacturing facilities or certain depreciable farm property
and which meets other requirements. Under section 141(e)(1)(F) a
qualified redevelopment bond issued under section 144(c) is a qualified
bond. Under section 144(c), a qualified redevelopment bond is any bond
issued as a part of an issue 95 percent or more of the net proceeds of
which are to be used for one or more redevelopment purposes and which
meets certain other requirements.
(b) Scope. Sections 1.144-0 through 1.144-2 apply for purposes of
the rules for small issue bonds under section 144(a) and qualified
redevelopment bonds under section 144(c), except that Sec. 1.144-2 does
not apply to the requirements for qualified small issue bonds under
section 144(a)(4) (relating to the limitation on capital expenditures)
or under section 144(a)(10) (relating to the aggregate limit of tax-
exempt bonds per taxpayer).
(c) Effective dates. For effective dates of Secs. 1.144-0 through
1.144-2, see Sec. 1.141-16.
Sec. 1.144-2 Remedial actions.
The remedial action rules of Sec. 1.142-2 apply to qualified small
issue bonds issued under section 144(a) and to qualified redevelopment
bonds issued under section 144(c), for this purpose treating those
bonds as exempt facility bonds and the qualifying purposes for those
bonds as exempt facilities.
Par. 9. Sections 1.145-0 through 1.145-2 are added to read as
follows:
Sec. 1.145-0 Table of Contents.
This section lists the captioned paragraphs contained in
Secs. 1.145-1 and 1.145-2.
Sec. 1.145-1 Qualified 501(c)(3) bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.145-2 Application of private activity bond regulations.
(a) In general.
(b) Modification of private business tests.
(c) Exceptions.
(1) Certain provisions relating to governmental programs.
(2) Costs of issuance.
Sec. 1.145-1 Qualified 501(c)(3) bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 141(e)(1)(G), a qualified 501(c)(3) bond issued
under section 145 is a qualified bond. Under section 145, a qualified
501(c)(3) bond is any bond issued as a part of an issue that satisfies
the requirements of sections 145(a) through (d).
(b) Scope. Sections 1.145-0 through 1.145-2 apply for purposes of
section 145(a).
(c) Effective dates. For effective dates of Secs. 1.145-0 through
1.145-2, see Sec. 1.141-15.
Sec. 1.145-2 Application of private activity bond regulations.
(a) In general. Except as provided in this section, Secs. 1.141-0
through 1.141-15 apply to section 145(a). For example, under this
section, Sec. 1.141-1, and Sec. 1.141-2, an issue ceases to be an issue
of qualified 501(c)(3) bonds if the issuer or a conduit borrower
501(c)(3) organization takes a deliberate action, subsequent to the
issue date, that causes the issue to fail to comply with the
requirements of sections 141(e) and 145 (such as an action that results
in revocation of exempt status of the 501(c)(3) organization).
(b) Modification of private business tests. In applying
Secs. 1.141-0 through 1.141-15 to section 145(a)--
[[Page 2304]]
(1) References to governmental persons include 501(c)(3)
organizations with respect to their activities that do not constitute
unrelated trades or businesses under section 513(a);
(2) References to ``10 percent'' and ``proceeds'' in the context of
the private business use test and the private security or payment test
mean ``5 percent'' and ``net proceeds''; and
(3) References to the private business use test in Secs. 1.141-2
and 1.141-12 include the ownership test of section 145(a)(1).
(c) Exceptions--(1) Certain provisions relating to governmental
programs. The following provisions do not apply to section 145:
Sec. 1.141-2(d)(4) (relating to the special rule for dispositions of
personal property in the ordinary course of an established governmental
program) and Sec. 1.141-2(d)(5) (relating to the special rule for
general obligation bond programs that finance a large number of
separate purposes).
(2) Costs of issuance. Section 1.141-3(g)(6) does not apply to
section 145(a)(2) to the extent that it provides that costs of issuance
are allocated ratably among the other purposes for which the proceeds
are used. For purposes of section 145(a)(2), costs of issuance are
treated as private business use.
Par. 10. Sections 1.147-0 through 1.147-2 are added to read as
follows:
Sec. 1.147-0 Table of Contents.
This section lists the captioned paragraphs contained in
Secs. 1.147-1 and 1.147-2.
Sec. 1.147-1 Other requirements applicable to certain private
activity bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
Sec. 1.147-2 Remedial actions.
Sec. 1.147-1 Other requirements applicable to certain private activity
bonds.
(a) Overview. Interest on a private activity bond is not excludable
from gross income under section 103(a) unless the bond is a qualified
bond. Under section 147, certain requirements must be met for a private
activity bond to qualify as a qualified bond.
(b) Scope. Sections 1.147-0 through 1.147-2 apply for purposes of
the rules in section 147 for qualified private activity bonds that
permit use of proceeds to acquire land for environmental purposes
(section 147(c)(3)), permit use of proceeds for certain rehabilitations
(section 147(d) (2) and (3)), prohibit use of proceeds to finance
skyboxes, airplanes, gambling establishments and similar facilities
(section 147(e)), and require public approval (section 147(f)), but not
for the rules limiting use of proceeds to acquire land or existing
property under sections 147(c) (1) and (2), and (d)(1).
(c) Effective dates. For effective dates of Secs. 1.147-0 through
1.147-2, see Sec. 1.141-16.
Sec. 1.147-2 Remedial actions.
The remedial action rules of Sec. 1.142-2 apply to the rules in
section 147 for qualified private activity bonds that permit use of
proceeds to acquire land for environmental purposes (section
147(c)(3)), permit use of proceeds for certain rehabilitations (section
147(d) (2) and (3)), prohibit use of proceeds to finance skyboxes,
airplanes, gambling establishments and similar facilities (section
147(e)), and require public approval (section 147(f)), for this purpose
treating those private activity bonds subject to the rules under
section 147 as exempt facility bonds and the qualifying purposes for
those bonds as exempt facilities.
Par. 11. Section 1.148-6 is amended by adding new paragraphs (a)(3)
and (d)(1)(iii) to read as follows:
Sec. 1.148-6 General allocation and accounting rules.
(a) * * *
(3) Absence of allocation and accounting methods. If an issuer
fails to maintain books and records sufficient to establish the
accounting method for an issue and the allocation of the proceeds of
that issue, the rules of this section are applied using the specific
tracing method. This paragraph (a)(3) applies to bonds issued on or
after May 16, 1997.
* * * * *
(d) * * *
(1) * * *
(iii) Timing. An issuer must account for the allocation of proceeds
to expenditures not later than 18 months after the later of the date
the expenditure is paid or the date the project, if any, that is
financed by the issue is placed in service. This allocation must be
made in any event by the date 60 days after the fifth anniversary of
the issue date or the date 60 days after the retirement of the issue,
if earlier. This paragraph (d)(1)(iii) applies to bonds issued on or
after May 16, 1997.
* * * * *
Par. 12. Section 1.150-1 is amended as follows:
1. Paragraph (a)(3) is added.
2. Paragraph (b) is amended by adding a new definition in
alphabetical order.
The additions read as follows:
Sec. 1.150-1 Definitions.
(a) * * *
(3) Exception to general effective date. See Sec. 1.141-15 for the
effective date of the definition of bond documents contained in
paragraph (b) of this section.
* * * * *
(b) * * *
Bond documents means the bond indenture or resolution, transcript
of proceedings, and any related documents.* * *
* * * * *
Par. 13. Section 1.150-4 is added to read as follows:
Sec. 1.150-4 Change in use of facilities financed with tax-exempt
private activity bonds.
(a) Scope. This section applies for purposes of the rules for
change of use of facilities financed with private activity bonds under
sections 150(b)(3) (relating to qualified 501(c)(3) bonds), 150(b)(4)
(relating to certain exempt facility bonds and small issue bonds),
150(b)(5) (relating to facilities required to be owned by governmental
units or 501(c)(3) organizations), and 150(c).
(b) Effect of remedial actions--(1) In general. Except as provided
in this section, the change of use provisions of sections 150(b) (3)
through (5), and 150(c) apply even if the issuer takes a remedial
action described in Secs. 1.142-2, 1.144-2, or 1.145-2.
(2) Exceptions--(i) Redemption. If nonqualified bonds are redeemed
within 90 days of a deliberate action under Sec. 1.145-2(a) or within
90 days of the date on which a failure to properly use proceeds occurs
under Sec. 1.142-2 or Sec. 1.144-2, sections 150(b) (3) through (5) do
not apply during the period between that date and the date on which the
nonqualified bonds are redeemed.
(ii) Alternative qualifying use of facility. If a bond-financed
facility is used for an alternative qualifying use under Secs. 1.145-2
and 1.141-12(f), sections 150(b) (3) and (5) do not apply because of
the alternative use.
(iii) Alternative use of disposition proceeds. If disposition
proceeds are used for a qualifying purpose under Secs. 1.145-2 and
1.141-12(e), 1.142-2(c)(4), or 1.144-2, sections 150(b) (3) through (5)
do not apply because of the deliberate action that gave rise to the
disposition proceeds after the date on which all of the disposition
proceeds have been expended on the qualifying purpose. If all of the
disposition proceeds are so expended within 90 days of the date of the
deliberate action, however, sections 150(b) (3) through (5) do not
apply because of the deliberate action.
(c) Allocation rules--(1) In general. If a change in use of a
portion of the property financed with an issue of qualified private
activity bonds causes
[[Page 2305]]
section 150 (b)(3), (b)(4), or (b)(5) to apply to an issue, the bonds
of the issue allocable to that portion under section 150(c)(3) are the
same as the nonqualified bonds determined for purposes of Secs. 1.142-
1, 1.144-1, and 1.145-1, except that bonds allocable to all common
areas are also allocated to that portion.
(2) Special rule when remedial action is taken. If an issuer takes
a remedial action with respect to an issue of private activity bonds
under Secs. 1.142-2, 1.144-2, or 1.145-2, the bonds of the issue
allocable to a portion of property are the same as the nonqualified
bonds determined for purposes of those sections.
(d) Effective dates. For effective dates of this section, see
Sec. 1.141-16.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 14. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 15. In Sec. 602.101, paragraph (c) is amended by adding
entries in numerical order to the table to read as follows:
Sec. 602.101 OMB Control numbers.
* * * * *
(c) * * *
------------------------------------------------------------------------
Current OMB
CFR part or section where identified and described control No.
------------------------------------------------------------------------
* * * * *
1.141-1................................................. 1545-1451
1.141-12................................................ 1545-1451
1.142-2................................................. 1545-1451
* * * * *
1.148-6................................................. 1545-1451
* * * * *
------------------------------------------------------------------------
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: December 30, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the Treasury.
[FR Doc. 97-710 Filed 1-10-97; 8:45 am]
BILLING CODE 4830-01-U
