Private Use Generally

A.  General Private Use Discussion:

In the case of qualified 501(c)(3) bonds, section 145 of the Code requires that 95% of the proceeds of tax-exempt bonds must be used in the exempt activities of the 501(c)(3) organization. Private use is measured over the entire term of the bond issue, rather than on an annual basis.

Frequent private use issues that arise in connection with qualified 501(c)(3) financings include: (1) unrelated trade or business; (2) leases and management contracts; (3) research agreements; (4) agents and employees; (5) short-term uses; (6) changes in use.  Certain of these matters are discussed below.

B.  Agents and Employees:

Use of a facility by an agent of the 501(c)(3) organization does not give rise to private use. The regulations are silent with respect to use by employees of the 501(c)(3) organization.  For instance, the regulations are not clear on how to evaluate employment contracts with senior management or other professional employees, which may not satisfy safe harbors.  According to texts published on this matter, IRS representatives have indicated that employees should generally be considered agents.  Employment contracts should therefore not need to satisfy the service contract provider provisions.

C.  Change in Use:

A change in use of bond financed facilities can cause private use problems endangering the exempt status of interest on bonds.  Remedies include redeeming bonds, using disposition proceeds for an alternate qualified use, using the bond financed facilities for an alternate qualified use, or paying the IRS an amount equivalent to the lost tax revenues (income or alternative minimum) under Rev. Proc. 97-15.  Financial penalties may apply under section 150(b) of the Code in the event of a change in use of bond financed facilities.

D.  Questions and Answers:

Issue: Private use when seller retains interest in property?

See IRS Private Letter Ruling 200502012.  This letter ruling addresses various types of interests purchased by a governmental entity.  One interest is a future interest in fee simple with the seller retaining a life estate.  The IRS finds that (1) the entitiy’s future interest in fee simple is the “bond-financed property” for private use purposes, (2) the entity and the seller will have distinct property interests that occur at different times and (3) the use of the property by the seller during the retained life interest will not impinge on the use by the entity during the Authority’s future interest.  Based on these findings, the IRS concludes that the seller’s use of the parcel will end at the end of the life estate, the seller will therefore not use the bond-financed property  and the Authority’s acquisition of the future interest in fee simple therefore does not give rise to a private business use of the bond proceeds.

Issue: Private corporation has a contract for broadcast, advertising and vending rights relating to bond-financed stadium. Does the contract cause private use?

See IRS Private Letter Ruling 201049003 (July 6, 2010). University will issue tax-exempt bonds to refinance improvements to its stadiums for which private corporation has a contract for broadcast, advertising, and vending rights. The agreement will not cause the private business use test of sec. 141(b)(1) to be met. “We think that the airing, distribution, and syndication of the Productions and the sale of the advertisements to be aired during the Productions are too remote to be considered use of the Bond-Financed Improvements.” And the corporation’s tangible uses of the stadiums are incidental uses within the meaning of sec. 1.141-3(d)(5).

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