Public/Private Partnerships (I.R.C. 141 and I.R.C. 145)

October 3, 2015


See ABA Section of Taxation, “Comments on Safe Harbors under Sections 141 and 145” published October 2, 2015 for a discussion of suggested safe harbors under section 141 and section 145 for public/private arrangements relating to the provision of capital improvements to be owned by qualified users.  (P3 arrangements)

Also see NABL, “REG-140379-02; REG-142599-02: Allocation of and Accounting for
Tax-Exempt Bond Proceeds for Purposes of the Private Activity Bond Restrictions” published September 17, 2014 for a discussion of partnership matters relating to allocation and accounting of bond proceeds.

Note that, on October 25, 2015, the Treasury Department published final regulations regarding allocation and accounting rules under Sections 141 and 145.  Click here to view the regulations and a discussion of any particular allocation and accounting matters.

Instrumentality (Rev. Rul. 57-128)

June 13, 2014


The status of an entity as an “instrumentality” of a state or local governmental unit is relevant for the following purposes:

  • I.R.C. 141:  Private activity bonds test (see Treas. Reg. 1.141-1(b) definition of “governmental person”);
  • I.R.C. 170:  Deductions for contributions and gifts to or for the use of a state, a possession or any political subdivision of the foregoing (see I.R.C. 170(c)(1)) or an instrumentality of a state or an instrumentality of a political subdivision of a state if the contributions are made for exclusively public purposes (see Rev. Rul. 75-359);
  • I.R.C. 3121(b)(7) and 3306(c)(7):  Federal Insurance Contribution Act (FICA) taxes on the wages paid by an employer to employees with respect to employment.

The term “instrumentality” is not defined in the Code or regulations.

Revenue Ruling 57-128 sets forth the following factors to be taken into account in determining whether an entity is an instrumentality of one or more governments:

  1. Whether the organization is used for a governmental purpose and performs a governmental function;
    •  See GCM 39683 relating to a state bar association.  An entity may still be an instrumentality even if it performed private functions in addition to governmental functions.
  2. Whether the performance of the organization’s functions is on behalf of one or more states or political subdivisions;
    • See GCM 39683.  If the activities serve governmental functions as well as private functions, it is not clear whether the performance of those functions is on behalf of the state.
  3. Whether there are private interests involved, or whether the states or political subdivisions involved have the powers and interests of an owner;
  4. Whether control or supervision of the organization is vested in public authority or authorities;
    • See GCM 39683.  Control of purse strings may be insufficient if the control exists merely to ensure that expenditures are within the purposes of the act creating the entity.  However, appointment by Texas Supreme Court of members of the state bar means power to control is vested in a public authority.
  5. Whether express or implied statutory or other authority is necessary or exists for the creation and/or use of the organization; and
    • Does the entity need statutory authority to conduct its functions?  For example, to reprimand members or bring disbarment proceedings, in the case of GCM 39683 and the state bar.
  6. The organization’s degree of financial autonomy and the source of its operating expenses.

These criteria were developed under I.R.C. 3121(b)(7) and 3306(c)(7) which exclude from the definition of “employment” services performed in the employ of a state, or any political subdivision thereof, or any instrumentality of any one or more of the foregoing which is wholly owned thereby.

The status of an entity as an instrumentality does not automatically mean that the entity is also an on-behalf-of issuer (Click link to view topic) for purposes of I.R.C. 103(c)(1).  On-behalf-of issuer status is tested based on “constituted authority” status under Rev. Rul. 57-187 or on-behalf-of status under Rev. Proc. 63-20.  There are some PLRs in which the entity at issue is both an instrumentality (usually for purposes of proving that the entity is a governmental purpose of the private activity bond test) and an on-behalf-of issuer.

Rulings and Resources:

GCM 36088 (Nov. 18, 1974):  Whether a contribution for exclusively public purposes to a wholly-owned instrumentality of a state or of a political subdivision is a contribution to rather than merely for the use of such state or political subdivision for the purposes of I.R.C. 170(c)(1) and, therefore, is subject to the 50 percent limitation on deductions for contributions by individuals under I.R.C 170(b)(1)(A).  The memorandum distinguishes between wholly owned instrumentalities and integral parts of states or political subdivisions to hold that gifts to the later are gifts “to” the state or political subdivisions.

Rev. Rul. 75-359: Deductions for contributions and gifts.  I think this is the ruling described and revised by GCM 36088.

GCM 36781 (Jul. 6, 1976):  Whether the entity is conducting a governmental function. The entity is an urban league that is organized to aid in the development of a secure and exemplary American democracy by assisting communities to ameliorate conditions and to solve problems arising out of racial inequities within the American community and to work on problems and opportunities in the fields of job development and employment, education and youth incentives, housing, and health and welfare and that is exempt from federal income taxes under the 1954 Code as a 501(c)(3).  GCM concerned the exemption from federal excise taxes on communication services. [Not particularly helpful to common 103-related instrumentality fact patters.]

GCM 39683 (Jun. 14, 1987):  Whether the bar association is performing a governmental function.  Memorandum relates to unemployment tax liability.  Under Section 3306(c)(7), employment does not include services performed in the employ of a state, a political subdivision thereof, or any instrumentality of any one or more of the foregoing which is wholly owned y one or more states or political subdivisions, and any service performed in the employ of any instrumentality of one or more states or political subdivisions to the extent that the instrumentality is, with respect to such services, immune under the Constitution of the Untied States from the tax imposed by Section 3301.  General Counsel concludes that the state bar is not a political subdivision because it does not possess any sovereign powers.   The powers to investigate and prosecute grievance actions and unauthorized practice suits are not traditional governmental powers but rather are customary powers of professional associations.  Then, General Counsel concludes that the bar is not a public corporation in the constitutional sense.  At least part of the purposes, functions and activities of the state bar are private and not governmental in nature, including encouraging cordial intercourse among its members, the protection of the professional interests of the members, etc.

PLR 200026013:  Concerns the status of the Authority as an instrumentality for purposes of I.R.C. 141 private activity bond tests, applying Rev. Rul. 57-128.  Authority is a membership corporation.  Members are all political subdivisions.  Persons serving on the board are required to be officers or employees of the members.  Each member has the power to remove (with or without cause) any of the directors that it appointed.  A removed director’s successor is appointed by the member that removed the director to serve the unexpired term.  The entity’s purpose is to coordinate the operation of electric generation resources.  The entity receives funding from its members.  The entity submits financial reports to its members.  No net earnings of the Authority may be paid or inure to the benefit of any private person.  Upon dissolution, any assets remaining after the entity satisfies its obligations are distributed ratably to its members.

PLR 200225010:  The issue addressed in this ruling is whether an Authority, which is a joint venture between tribes, is an “instrumentality” (within the meaning of Rev. Rul. 57-128) of its governmental/tribal members and therefore a “governmental person” for purposes of the private activity bond tests.

PLR 200510016: Whether (1) the Association’s income is exempt from taxation under I.R.C. 115, (2) the Association is an instrumentality for purposes of I.R.C. 3121(b)(7) and 3306(c)(7), under Rev. Rul. 57-128 and (3) the contributions made to the Association are deductible by the donors as charitable contributions under I.R.C. 170(c)(1).  Association was created by City for the purpose of carrying out the promotion of tourism for the City.  By promoting tourism in the City, the Association will contribute to the economic development of the City through increased tourism and visitation to the City and will increase the expenditure of tourist dollars at local businesses.

PLR 200524015:  That (1) Agency and Agency’s Subsidiary are instrumentalities under Rev. Rul. 57-128 for purposes of the private activity bond tests, (2) income of Agency and Agency’s Subsidiary is excludable from gross income under I.R.C. 115(l) and (3) Agency’s use of bond proceeds will not constitute use meeting either the private business tests of I.R.C. 141(b) or the private loan tests of I.R.C. 141(c).  Agency was formed by governmental entities to perform the functions of, or to carry out the purposes, of its members with a view towards maximizing the efficient acquisition, management and delivery of natural gas supplies and reducing operating costs of its members. (Keyword: Piggybacking Instrumentality.)

PLR 200718002:  A System is an instrumentality of the County under Rev. Rul. 57-128 for purposes of the private activity bond rules of I.R.C. 141 (i.e., the bond-financed facility is therefore used by a governmental person and not a private business user) as well as an on-behalf-of issuer (constituted authority under Rev. Rul. 57-187) of the County for purposes of issuing tax-exempt bonds (i.e., the System could issue tax-exempt bonds on behalf of the County).  County Board created System as a public corporation that will operate as a subsidiary of County to provide health care and related services to the general public and related education and research programs.  System is required to provide services to persons who are indigent.

PLR 200736022: [To come]

PLR 200836005:  Issues include (1) whether the entity’s income is exempt from taxation under I.R.C. 115, (2) whether the entity qualifies as an instrumentality for purposes of making charitable contributions to the entity under I.R.C. 170(c)(1) and (3) whether interest on bonds issued by the entity are excludible from gross income because the entity is a constituted authority under Rev. Rul. 57-187.

PLR 201220005, February 3, 2012:  Public corporation established to support state’s schools for the vision and hearing impaired qualifies as an “instrumentality of the state” contributions to which are deductible under I.R.C. 170(c)(1).

PLR 201308010 (Nov. 20, 2012):  The Internal Revenue Service applies the six factors in Rev. Rul. 57-128 to economic development corporations created by City.  Ruling relates to determining whether services provided to the corporations are “employment” under FICA.

PLR 201411018 (Aug. 9, 2013):  The Internal Revenue Service applies the six factors in Rev. Rul. 57-128 to a state university or community college and concludes that the university/college is an instrumentality of the state for purposes of I.R.C. 141 private activity bond tests and is eligible to receive charitable contributions under I.R.C. 170(c)(1) (“A state, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia, but only if the contribution or gift is made for exclusively public purposes”).


Output Facilities (I.R.C. 141)

October 18, 2012

General Background

Special rules apply to the application of the private business tests to output facilities that do not apply to other facilities.

“Output facilities” include electric and gas generation, transmission, distribution and related facilities, and water collection, storage and distribution facilities.  A reservoir, for instance, is an output facility.  However, a pipeline to transport wastewater for disposal is not an output facility.  See PLR 200026020 (and City of Santa Rosa, California v. C.I.R., 120 T.C. 339, Tax Ct. Rep. (CCH) 55145).

The 1997 final private activity bond regulations reserve Section 1.141-7 of the Regulations because “regulatory changes are dramatically affecting the electric power industry” but state that the final 1997 regulations otherwise apply to bonds issued to finance output facilities.

Application of Private Business Tests

The following comes from White, “Private Activity Bond Tests,” 2012 Edition, West.  “The purchase pursuant to a contract by a nongovernmental person of available output from an output facility financed with bond proceeds is taken into account under the private business tests if the purchase satisfies the ‘burdens and benefits test’ discussed below.  In the case of other arrangements for use of an output facility, as well as in the case of an output contract that is properly characterized as a lease for federal income tax purposes, the general rules relating to private business tests apply.”

“For purposes of the above rules, a tenant in common interest in a generating facility is a separate property interest treated as a separate facility, and therefore if the tenant-in-common interest is owned by a governmental unit and financed with bonds, the ownership interest of the other tenants in common in the output facility are not treated as private business use.”  See, e.g., example 1 in Treas. Reg. 1.141-7(i).

See also PLR 200501003 applying the example to a pool of generator equipment owned jointly by various governmental issuers.

PLR 201727003:  Concerns allocation of output, multipurpose allocations and other output contract related private business use matters.

Questions, Answers, References

  1. A reservoir is owned by a farmers corporation.  Shares are owned by a local city and by other private parties.  The city is required to finance its allocable portion of the reservoir improvements.  Can the improvements be financed with tax-exempt bonds?
  2. PLR 201507002 (October 28, 2014):  Private business use of proceeds to be used for 1st water supply improvements, services allocable to improvements, and equipment allocable to 1st water supply doesn’t exceed 10 percent; and 2nd water supply improvements, including services allocable to improvements, and equipment allocable to 2nd water supply constitute facilities for furnishing of water under Code Sec. 142(a)(4) and 142(e).
  3. PLR 9142012 (Jul. 17, 1991) (aka “Alabama” ruling): A prepayment for electric power capacity is not a private loan or arrangement that gives rise to private business use.


Guarantees and Payment of Debt Service

July 30, 2012

Aggregation of Instruments

Context: Is the guarantee a separate instrument from the bond, such that payments under the guarantee are not eligible for exemption to the recipient thereof?

Basic tax law concepts state that, even though a guarantee always represents a claim against a different party from the issuer of the underlying security, payments under the guarantee are treated as if they are payments under the guaranteed obligation.  See James M. Peaslee and David Z. Nirenberg, “Aggregation or Bifurcation of Property Interests, Tax Notes (December 12, 2011).  In other words, the basic tax rules state that the guarantee payment takes on the character of the actual debt service payment from the issuer (steps in the shoes concept).  See, e.g., Rev. Rul. 72-134, amplified by Rev. Rul. 72-575 and Rev. Rul. 76-78.

However, Rev. Rul. 94-42 describes a situation in which the IRS determined that the guarantee was separate from the bonds and, unlike in Rev. Rul. 72-134, as amplified, guarantee payments did not qualify for tax-exemption with respect to the interest components thereof.  The IRS in this ruling held that “amounts paid or accrued under an agreement for defaulted interest are not excludable from gross income under Section 103 if the agreement is not incidental or is in substance a separate debt instrument or similar investment when purchased.”

Guarantees and Private Activity Tests

Context:  What is the effect of a guarantee of debt service on the private activity tests?  See, e.g., PLR 8945032 (August 15, 1989).

Allocation and Accounting Regulations (Treas. Reg. 1.141-6)

March 24, 2012

General Overview

On October 25, 2015, the Treasury Department released finalized regulations in T.D. 9741 to address allocation and accounting rules, including rules relating to undivided portion allocation, treatment of partnerships and certain remedial action matters, including anticipatory remedial actions. Click the following link (2015-27328 Allocation and Accounting Rules) to download the final regulations.


PLR 200441025 (Jun. 14, 2004): Parking ramp example with adjacent retail structure and a roof deck for future private business use.  Facilities are split into discrete portions.  For purposes of the roof deck, the discrete portion includes the additional costs needed for supporting future private business use construction.  Allocation of proceeds and equity using these discrete portions. Discussion of simultaneous governmental and private business use of parking deck and allocation of proceeds based on percentage of parking spaces used for private business use leases. Allocation of private payments to sources in the same percentage as parking spaces used for the good and bad purposes.  Allocation of private payments “to the extent that those expenses are directly attributable to the operation and maintenance of the parking ramp related to the use under the parking agreements.”

Private Activity Bonds (I.R.C. 141)

February 21, 2012

General Overview

Interest on bonds issued by state and local governments (and on-behalf-of issuers) is exempt from federal income tax if the bonds are not “private activity bonds,” although certain exceptions for qualified private activity bonds are permitted under the federal tax laws.  See I.R.C. § 141(e).  A bond is a private activity bond if either the private business test or the private loan test is met.

The private business test is met if both of the following are true:

  1. More than 10% of the proceeds of the bonds is to be used for private business use; and
  2. More than 10% of the debt service on the bonds is to be derived directly or indirectly from payments for private business property or secured by private business property.

The private loan test is met if either the lesser of $5,000,000 or 5% of the proceeds is to be used to make or finance loans to persons other than governmental units.  (The threshold from 5% to $5 million is $100 million.)

If neither the private business test nor the private loan test is met, the bonds will not be private activity bonds and will be considered “governmental bonds.”

Recent history of regulations and guidance relating to the private business use test, the private security or payment test and the private loan test:

  1. 1994: Proposed regulations (59 FR 67658, Dec. 30, 1994) under I.R.C. 141.
  2. 1997: Final regulations (Basic Regulations) (T.D. 8712, 1997-12 I.R.B. 35, Jan. 10, 1997) under I.R.C. 141 were published on January 16, 1997 to provide comprehensive guidance on most aspects of the private activity bond restrictions.  The 1997 Final Regulations, however, reserved most of the general allocation and accounting rules for purposes of I.R.C. 141.
  3. 2002: Final regulations and guidance (Output Facilities) was published on September 23, 2002 (REG-142599-02, published in the I.R.B. as Announcement 2002-91, 2002-2 C.B. 685) (67 FR 59767)) regarding allocation and accounting rules for tax-exempt bond proceeds used to finance mixed-use output facilities.  Includes a statement that a “facility” includes an undivided ownership interest in a facility.  Also T.D. 9016, 67 FR 59756, Sept. 23, 2002, corrected by Announcement 2002-112.
  4. 2003: Proposed regulations (Refunding Rules) (68 FR 25845, May 14, 2003) under I.R.C. 141 issued as the first comprehensive attempt to deal with the private activity bond tests since the 1986 Tax Reform Act.  Most of the sections of the 1994 Proposed Regulations were finalized in the 1997 Final Regulations, although portions dealing with refundings, allocation rules and output facilities were not included in these 1997 regulations.  The output regulations were finalized in 2002.
  5. 2005: Final regulations (Refunding Rules) (T.D. 9234, IRB 2006-4) issued under I.R.C. 141 address the private activity bond restrictions with respect to refunding issues and are a finalization of the proposed regulations issued 2003.
  6. 2006: Proposed regulations (private payments and PILOTs) (REG-136806-06) were issued to attempt to revise and provide guidance (and limitations) regarding the existing PILOT regulation in Treas. Reg. 1.141-4(e)(5), including what it means to have a payment that is “commensurate with” and “not greater than” amounts imposed by a statute for a tax of general application.
  7. 2006: Proposed regulations (Allocation Matters) (REG-140379-02, I.R.B. 2006-44) were issued on October 30, 2006, proposing rules for (a) the allocation of, and accounting for, tax-exempt bond proceeds, (b) allocating proceeds used to finance mixed-use facilities, (c) treatment of partnerships as owners or users of facilities for purposes of I.R.C. 141, and (d) amendments to the regulations for I.R.C. 145 regarding related matters that apply to qualified 501(c)(3) bonds.  The 2002 guidance remains applicable.

See the NABL comments to the 1997 Final Regulations for a helpful discussion of the regulations and examples; and Linda B. Schakel, “Private Activity Bond Refunding Regulations,” Municipal Finance Journal, Volume No. 24, Number 2 (Summer 2003).

General Overview: Private Business Tests

General limitations:

  • Under the private business tests, a bond is a private activity bond if it is part of an issue in which:
    1. More than 10% of the proceeds of the issue are to be used in the trade or business of any person other than a governmental unit (the “private business use test”); and
    2. More than 10% of the payment of principal of or interest on the issue is, directly or indirectly, secured by property used in a trade or business, or derived from payments related to property used in a trade or business (the “private security or payment test”).
  • If both tests are met, the bond is a private activity bond.  If the private business use test is not met, there is no need to test the private security or payment test – the bond will not constitute a private activity bond.

Lower limit for certain output facilities:

  • It’s a private activity bond if (1) more than 5% of the proceeds are used for an output facility (other than water furnishing facility) and (2) more than $15 million of the issue is used to finance a portion of an output facility that is subject to a private business use or secured by private payments.
  • See Treas. Reg. 1.141-7 and -8 for more information concerning this limit.
  • Example:
    • Power Authority K, a political subdivision, intends to issue a single issue of tax-exempt bonds at par with a stated principal amount and sale proceeds of $500 million to finance the acquisition of an electric generating facility.
    • No portion of the facility will be used for a private business use, except that L, an investor-owned utility, will purchase 10% of the output of the facility under a take contract and will pay 10% of the debt service on the bonds.
    • The nonqualified amount (see Section 141(b)(8) for the definition) with respect to the bonds is thus $50 million. (I.e., there are payments with respect to 10% of the total issue)
    • Therefore, the maximum amount of tax-exempt bonds that may actually be issued for the acquisition of the facility is $465 million. (I.e., $450 million for the 90% of the facility that is governmentally owned and used, plus a nonqualified amount of $15 million)

Private Business Use Test

General rule:

  • For qualified 501(c)(3) bonds:
    • References in the private business use test 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); and
    • References to 10% and “proceeds” in the context of the private business use test and the private security or payment test mean 5% and “net proceeds.
    • Costs of issuance are treated as proceeds used in a private business use and take away from the 5% amount.
  • 1994 Proposed Regulations Preamble:  The proposed regulations provide that a bond-financed facility is indirectly used by a nongovernmental person if the provision of that facility discharges a primary and unconditional obligation of the nongovernmental person.
  • Tax Reform Act of 1986 (H.R. Rep. No. 426, 99th Cong. 1st Sess. 522-23 (1985), 1986-3 (Vol. 2) C.B. 522-23 (House of Representatives Report):  The determination of who used bond proceeds or bond-financed property generally is made by reference to the ultimate user of the proceeds or property.  As under present law, however, the proceeds of an issue generally are not treated as used in any trade or business of a nongovernmental person when the proceeds are used to pay for services rendered to the government or to defray other liabilities of a governmental unit arising from general government operations.  For example, bond proceeds used to purchase a computer to be owned and used by the purchasing governmental unit are not treated as used in the computer company’s business. Likewise, bond proceeds used to satisfy contractual obligations undertaken in connection with general governmental operations, such as payment of government employees’ salaries, or to pay legal judgment against a governmental unit, are not treated as used in the business of the payee. This is to be contrasted with the indirect nongovernmental use of bond proceeds that occurs […] when […] a […] government […] contracts […] with […] a nongovernmental person to supply that person’s business with a service (e.g., electric energy) on a basis different from that on which the service is provided to the public generally or to finance property used in that person’s business (e.g., a manufacturing plant).  In both of these instances a nongovernmental person is considered to use the bond proceeds other than as a member of the general public.
    • See PLR 201043001 (October 29, 2010): Bonds are issued to finance payments to policyholders for losses under policies issued by an instrumentality of the issuer.  For PBU purposes, use of proceeds by the ultimate policyholders must be tracked.  PBU existed because use was not tracked.  However, there was no private payment or security with respect to the bonds.
  • There are nine exceptions to private business use: (1) Use as a member of the general public; (2) Short-term use; (3) Use as an agent; (4) Use incidental to a financing arrangement; (5) Temporary use as a developer; (6) Incidental use; (7) Qualified improvements [this is a limited one and there are no helpful interpretations in letter rulings or elsewhere]; (8) Tax assessment bonds; and (9) Qualified management contracts and qualified research contracts. (MIAMI SAID)

Exception for use as a member of the general public (“general public use”):

  • Use of bond-financed property “as a member of the general public” is not private business use, unless the use is in the form of ownership.  The property must be publicly available.  Use must be on the same basis as use by other members of the general public.
  • The public use exception only applies if the property is publicly available.  It is publicly available only if the property is (1) intended to be available for use by natural persons not engaged in a trade or business on the same basis and (2) in fact is reasonably available for that use.
  • Use under a long-term arrangement is not use as a member of the general public.  A long-term arrangement is an arrangement having a term of use of more than 200 days (used to be 180 days, but revised because many contracts have a term of 6 months, which is more than 180 days).  In determining whether the term of use of an arrangement is longer than 200 days, renewal options are included.  The term of use relates to the number of days of use, not to the term of the contract.  For instance, a one-year contract permitting 100 days of use would not be prohibited as use by a member of the general public because the term of use is less than 200 days. There are special rules concerning the definition of “renewal options.”
  • Use under an arrangement that conveys priority rights or other preferential benefits is not use on the same basis as the general public.  Furthermore, if use is on the same basis as the general public (including use as an industrial customer), then the exception for use as a member of the general public applies and the use is disregarded in determining whether the 10% limit of the private business use test is met (1986 Conference Report, H.R. Conf. Rep. No. 99-841, at page II-688 (Sept. 18, 1986)).  If rates for use are imposed, the rates must be generally applicable and uniformly applied – otherwise the arrangement will not satisfy the general public use requirement.  Rates are uniformly and generally applicable even if different rates apply to different classes of users (such as volume purchasers) if the differences in rates are customary and reasonable.  A specifically negotiated rate arrangement is permissible only if the user is prohibited by federal law from paying generally applicable rates and the rates are established as comparable as reasonably possible to generally applicable rates.
  • Examples for use as a member of the general public:
    • Airport runway:  Use of a bond-financed airport runway by aircraft operators is disregarded under the facts described in Treas. Reg. 1.141-3(f), Ex. 8(i).
    • Parking garage: Use of bond-financed, city-owned parking garage at a city-owned airport by employees of private air carriers in connection with their use of leased space in airport terminals is disregarded under the facts described in Treas. Reg. 1.141-3(f), Ex. 9.
    • Port road:  Use by a corporation of bond-financed road connecting the corporation’s port with existing authority roads is disregarded under the facts described in Treas. Reg. 1.141-3(f), Ex. 11.  (But see PLR 8618008, in which the IRS concluded that nonexempt commercial users had virtually exclusive use of the road such that there could not be deemed to be general public use.)
    • State-owned hotel:  Use by business travelers of a bond-financed state-owned hotel is disregarded under the facts described in Treas. Reg. 1.141-3(f), Ex. 12
    • Parking garage:  Use of a bond-financed parking garage by business vehicles is disregarded under the facts described in Treas. Reg. 1.141-3(f), Ex. 13, where more than 10% of the spaces will be leased to persons engaged in a ToB because at least 90% of the spaces will be available to the general public on a month-to-mont first come, first served basis, because the issuer reasonably expects that spaces will be predominantly leased to natural persons who are not engaged in a ToB and who will have priority rights to renew at then current fair market value, and because the rights to renew are not required to be treated as renewal options since the compensation for spaces is redetermined at generally applicable fair market value rates.
    • Sewage treatment facilities:  Use by a federal agency of bond-financed, district-owned sewage treatment facilities is disregarded for purposes of the private business use test by reason of the exception for use as a member of the general public where the district enters into a specially negotiated rate agreement with the federal government where the district uses its best efforts to charge the federal agency as closely as possible the same amount as other customers and where the federal agency is prohibited from paying in accordance with standard district charges and tax levies. 1.141-3(f), Ex. 14.
    • Tribal casino:  Drainage and highway improvements that initially serve a tribal casino will not result in private business use when the improvements will eventually be used for a variety of public uses that are neither commercial nor industrial and where the tribal government and the general public will have the same access to the improvements as patrons of the casino.  PLR 200648024. (But, if there is no expectation of public use, this PLR may not be helpful.)
    • Water treatment plant:  A water treatment plan did not satisfy the public use requirement (for exempt facility IDBs) where one company, under a water treatment contract, initially would use 30% of the water treated by the water treatment plan per day and, within seven years, would use 70% of the water treated by the water treatment plan per day, and where only a few other industrial corporations were possible users of treated water not needed by the company.  PLR 7818032
    • Auditorium:  An arrangement by a city with a corporation for use of a bond-financed city auditorium is a special legal entitlement constituting private business use, where the arrangement provides for use by the corporation for one week each year for 10 years (70 days) at the then fair market value price, and where the city has not established generally applicable rates for future years.  Treas. Reg. 1.141-3(f), Ex. 16(i).
    • Water and Wastewater System:  A district financed a water and wastewater system.  The developer is a user of the system.  Is the user a member of the general public?  What does it mean to be a member of the general public? FSA 002142 (Jul. 21, 1997).
  • Though guidance in this area is sparse, the Service has previously ruled that, when publicly owned facilities which are intended for general public use, are constructed with the proceeds of a bond issue, and are used by nonexempt persons in their trade or businesses on the same basis as other members of the public, such use is not a trade or business of a nonexempt person for the purpose of the trade or business test. For example, see, PLR 9625042 and PLR 9107022:
    • In PLR 9625042, the bond financed waste water treatment and disposal system was used by 2 municipal entities and 45 industrial customers. The issuer had entered into contracts for use of the system with the municipal entities and 3 of the industrial customers. Approximately 91 percent of the influent treated by the system was derived from noncontracting industrial customers and less than 3% of the influent treated was derived from the contracting industrial customers. None of the 45 industrial customers would own or lease the system or the system upgrades financed with the proceeds of the bonds, and none of the 42 noncontracting industrial customers had the contractual right to use the system, or had any obligation to the issuer with regard to either the use of the system or any payment with regard to the system. The Service ruled that because none of the noncontracting customers had any special legal entitlement to use the system, these customers did not have any arrangement with respect to the system that would cause them to be private users of the bond proceeds for purposes of section 141(b)(1).
    • PLR 9107022 dealt with a parking garage and bulk purchases of parking permits for employees. Providing parking is generally not considered an essential governmental function. A city had issued bonds to finance a parking garage that was available to the general public on a first-come, first-served basis. However, some of the spaces were leased to a bank for its private usè. To encourage additional use of the parking garage, the city desired to sell parking spaces in bulk to private entities, at a reduced rate. The purchasers of bulk rate spaces would be subject to the same terms and conditions as the members of the general public and would not have reserved parking spaces. The city requested a ruling that sale of such spaces would not cause the bonds to become private activity bonds. The Service ruled that although more than 10 percent of the parking spaces in the garage would be leased to employees of a private entity in its trade or business, the private use test was nevertheless not met. This was because the parking spaces were available for use by all members of the general public on an equal basis.
  • If one is able to conclude that the facility in question is publicly available and that the particular user has no arrangement for use amounting to a preference or priority or other special legal entitlement for use of the facility, the use by that person will be excluded under the general affirmative conclusion that it represents use as a member of the general public under the exception.
  • A road within a gated community may give rise to private business use.  Street lights within a gated community, however, certainly do not give rise to private business use, assuming the community consists of what might be thought of as a “general public.”  The distinction between roads and lights isn’t necessarily clear, but one might think of lights as more of a governmental purpose similar to water and sewer facilities than private roads.
  • See Form 5701-TEB dated December 17, 2014 (Click here to open), for arguments by the Internal Revenue Service regarding general public use in connection with The Villages.
    • The Sales Agreements gave the Developer special legal entitlements to the bond-financed Amenity Facilities because the Developer continued to use those facilities in its development business by virtue of its right to sell residential lots that provided right of access to all the Amenity Facilities, including those that the Issuer purchased.
    • The Developer used the bond-financed Amenity Facilities to meet its own obligations to the purchasers of those lots.
    • The Developer, through control over the Issuer, retained control over the bond-financed Amenity Facilities, which also gave rise to special legal entitlements.  The Developer, through control of the board, hired the Center District’s manager and continued to determine the day-to-day operations of the Center District, including how the Amenity Facilities were operated.
    • The Developer has legal entitlements to certain revenues arising from residents’ use of the bond-financed Amenity Facilities.
    • The Amenity Facilities were not available to the general public and, as such, private use also arose because the Developer received special economic benefits from the bond-financed Amenity Facilities.  The value of the land developed and sold by the Developer reflected the purchasers’ rights to use the bond-financed Amenity Facilities.
    • The Developer also retained certain Amenity Fees paid by certain residents for the use of the bond-financed Amenity Facilities.
    • Through the Developer’s control over the Issuer, the Developer also was able to enter into transactions and arrangements with the Issuer that may not have reflected terms that would have been made in arm’s-length transactions.

Exception for short-term use

  • Performing arts facility:  Where an authority obtained a loan to finance a performing arts facility, the use of the facility by local performing arts groups was not private business use by such groups because, under the regulations, the rights of such users are only those of transient occupants rather than the full legal possessory interests of a lessee.  PLR 8232044 (May 12, 1982).

Exception for use as an agent

Exception for use incidental to a financing arrangement

Exception for temporary use as a developer

Exception for incidental uses

Exception for qualified improvements

Special rule for tax assessment bonds:

  • If the bonds are tax assessment bonds that satisfy the requirements of Treas. Reg. 1.141-5(d), the 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.  See Treas. Reg. 1.141-3(e).

Qualified management contracts:

  • PLR 201726007:  Governmental hospital enters into arrangement with nonprofit school to permit school’s pharmacy students to participate in hospital’s training programs for nursing students.  Ruling looks to Revenue Procedure 2017-13 to conclude that the arrangement does not give rise to private business use, even though arrangement does not meet all of the safe harbor conditions of the procedure.  (Not sure which element is missing – perhaps the requirement that the exempt user control rates, etc.)

Qualified research contracts

Private Security or Payment Test

General discussion

  • The private security or payment test is met if the payment of principal or interest on more than 10% of the proceeds of an issue is directly or indirectly (a) secured by (i) any interest in property used or to be used for a private business use or (ii) payments in respect of such property, or (b) to be derived from payments in respect of property or borrowed money used or to be used for a private business use.  The private security or payment test is therefore comprised of two parts: (1) the security portion of the test, which takes into account the direct or indirect security for the bonds, and (2) the payment portion of the test, which takes into account the direct or indirect source of payment for the bonds. The private security or payment test is met if the present value of private payments (excluding payments for maintenance and operation and payments in excess of use) is more than 10% of the present value of adjusted debt service (i.e., debt service excluding amounts paid from proceeds or allocable to credit enhancement).
  • Note that private payments are considered in this test only if they are made by private persons who are treated as using the bond proceeds, regardless of whether they are formally pledged as security or directly used to pay debt service on the bonds.  Payments from persons who are not users of bond proceeds are not counted unless the payments are pledged to pay debt service or otherwise satisfy the 1954 Code security interest test.  See 1986 Act Bluebook at 1161.  Assume the federal government makes a grant to the debt service fund of a bond-financed project but is not otherwise considered a user of the bond-financed property.  Is this considered a private payment?  Notiz 20120321.  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 the fair market value compensation for that other use.  Treas. Reg. 1.141-4(c)(2)(i)(A).
  • Private payments for the use of property are allocated to the source or different source of funding of property.  The allocation to the source or different sources of funding is based on all facts and circumstances, including whether the allocation is consistent with the purposes of I.R.C. 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).  Treas. Reg. 1.141-4(c)(3)(i).  See also PLR 200747009.
  • PLR 9928036 (Apr. 14, 1999):  Concerns a bond-financed stadium used by a professional team and by state universities.  State proposes to issue bonds and grant the proceeds to a city to build a stadium leased to a partnership.  The stadium is also used by state universities.  During the university use, the partnership will operate the stadium, but will not receive all of the revenues.  The issue is whether revenues retained by the universities will count against the private payment test.  The ruling holds that they will – those revenues, though not paid to the partnership, arise “in respect of” property used for a private business use.  By reason of the lease, the partnership has a special legal entitlement to use the stadium 365 days a year, and under Treas. Reg. 1.141-3(g)(4)(iii), if governmental use and private business use occur simultaneously, the entire facility is treated as having private business use.  Although the revenues do not originate from the partnership, “this is not relevant…”  Also, the universities are related to the state and, therefore, payments received by the universities are treated as received by the state, and the indirect payment test is met.  There is no requirement for tracing the payments directly to the payment of debt service in order for the payments to be private payments.
  • PLR 201043001 (Oct. 29, 2010):  Section 1.141-4(d)(5) provides that payments taken into account as private security are payments in respect of property used or to be used for a private business use.  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 gives rise to 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.  In the PLR, there was PBU because use of proceeds bu ultimate recipient was not tracked.  Assessments against insurers and policy premiums were not considered private payment and security.
  • Under Treas. Reg. 1.141-4(c)(2)(i)(C), payments by a person for the use of proceeds do not include the portion of any payment that is properly allocable to the payment of ordinary and necessary expenses 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.  Some bond counsel require that operating expenses to be offset occur within the same accounting periods as the revenues that are to be offset – it is unlikely that revenues in one period may be offset by expenses occurring many periods later unless there are facts that clearly suggest that the payments are “properly allocable” to those expenses.  Though not addressing the question of what period the revenues and expenses may happen, the following PLRs reference this section of the regulations: PLR 9647019 (Arena and parking lot); PLR 200441025 (Parking ramp and roof deck ruling); PLR 200640001 and 2006410002; PLR 200747009; PLR 201346002.
  • Treas. Reg. § 1.141-4(g), Example 2:  Indicates that lease and sale payments by private business users for property financed with redevelopment bonds otherwise payable solely from tax increment funds arising from generally applicable taxes count against the private security or payment test even though the lease and sale payments are not pledged under the terms of the bonds documents.
  • PLR 201519015 (Directly or indirectly related):  Bus fares on private business use managed lanes.
  • PLR 9813003 (Dec. 5, 1997):  Corridor Project with multiple sources of financing.  PLR addresses private business use allocations, but is also helpful to identify private payment matters.  Applies the anti-abuse rules of 1.141-14.
  • PLR 201346002 (Aug. 14, 2013):  Assume agency A operates a facility.  The facility is managed under a bad management contract that causes private business use.  The facility is financed by annually appropriate lease financing by agency A.  Payments under the lease are made by agency B.  The facility itself does not give rise to revenues, and the facility is not security for the lease financing.  Do the payments from agency B constitute “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”?  Note that section 1.141-4(c) refers to payments made by any nongovernmental persons.

Exception: Generally applicable taxes

  • Basic discussion:  Generally applicable taxes (but not charges, assessments, fees or special taxes) are excluded as private payments unless paid pursuant to an impermissible agreement.  Thus, generally applicable taxes are not deemed to be payments by a nongovernmental person, even though the property subject to the taxes is used for a private business use.  See Treas. Reg. 1.141-4(e)(1) and TAM 9250005.  Query, therefore, whether payment of district bonds from ad valorem property taxes causes private security or payment problems, if the ad valorem property taxes are considered 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 or public 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.  Treas. Reg. 1.141-4(e)(2).  Examples where the exception for generally applicable taxes from the private security or payment test was considered:
    • Ticket taxes:  Treas. Reg. 1.141-4(g), Ex. 11(i)
    • Ticket taxes:  Treas. Reg. 1.141-4(g), Ex. 11(ii)
    • Tax increment revenues:
      • Rev. Rul. 73-481, 1973-2 C.B. 23: The original precedent for tax exemption of tax increment financing may be found in this Revenue Ruling.  The ruling concludes that the interest on bonds issued by a redevelopment agency to be repaid from revenue collected on the increase in the assessed value of certain property is excludable from the gross income of the recipients.  The only constraint noted in the ruling is that none of the property acquired or land sale proceeds to be received by the agency would be used to pay or secure the bonds.  The Revenue Ruling appears never to have been amended or revoked by the Internal Revenue Service.
      • PLR 8105079:  Tax increment bonds were ruled not to be industrial development bonds under the 1954 Code where the bonds were secured by the full faith and credit of the city together with a pledge of tax revenues consisting of property taxes collected each year on the increased assessed value of property within a central business district of 45 square blocks and where funds derived from the sale or lease of property within the city’s central business district were not security for debt service on the bonds.
      • G.C.M. 37972 (June 4, 1979):  Reflecting the withdrawal of a proposed Revenue Ruling, which would have revoked Rev. Rul. 73-481, and holding that tax increment bonds do not satisfy the security interest test.
      • PLR 200022028:
      • 1986 Conference Report, H. Conf. Rep. No. 99-841, 99th Cong., 2nd Sess., September 18, 1986, at page 11-688:  The exclusion of generally applicable taxes does not encompass other payments made by business users of bond-financed property. For example where bonds are used to acquire land for redevelopment purposes and the land is sold to businesses, amounts paid by the businesses for the land are payments for purposes of the private security or payment test even though tax increment revenues relating to generally applicable taxes are the stated security for the bonds.
    • Regulatory and registration fees:  PLR 9534014 and PLR 9243051
    • Emergency assessments:  PLR 9827007
    • Insurance premium surcharges and assessments:  PLR 201043001
  • Exclusion of special charges, assessments and special taxes, and examples:
    • The Blue Book (the report dated May 4, 1987, by the Staff of the Joint Committee on Taxation) states on page 1161 that: “Revenues from generally applicable taxes are not treated as payments for purposes of the security interest test.  Congress intended, however, that special charges imposed on persons satisfying the private business use test (but not the members of the public generally) would be taken into account if the charges are in substance amounts paid for the use of the bond proceeds.”
    • TAM 9250005 (Aug. 28, 1992):  The first indication of what types of arrangements the Internal Revenue Service thought might cause otherwise generally applicable taxes to be treated as private payments may be found in this TAM.  In the situation described by the TAM, the taxpayer agreed to construct enough property so that the assessed valuation would provide sufficient tax revenue to repay the bonds.  The taxpayer also agreed to the assessed value of its property.  The TAM concludes that special contractual arrangements established a nexus between the tax increment and the private business use, causing the tax increment payments to be payments in respect of property used for a private business use.
  • [Exclusion of taxes arising from impermissible agreements]
  • Tretment of payments in lieu of taxes (PILOTs):  PILOTs are considered generally applicable taxes and are therefore excluded from the private security or payment test if certain requirements are satisfied.  See Treas. Reg. 1.141-4(e)(5). See also Maria Di Miceli, “Drive Your Own PILOT: Federal and State Constitutional Challenges to the Imposition of Payments in Lieu of Taxes on Tax-Exempt Entities,” The Tax Lawyer, Vol. 66, No. 4, Summer 2013 for a discussion of the uses and concerns with PILOTS.
    • The requirements for PILOTS are:
      • The PILOT must not be greater than the amount imposed by statute for a generally applicable tax in each year;
      • The PILOT must be commensurate with the amount imposed by a statute for a generally applicable tax in each year (a PILOT is commensurate only if it is equal to a fixed percentage of the generally applicable tax that would otherwise apply in each year or it reflects a fixed adjustment to the generally applicable tax that would otherwise apply in each year;  a PILOT based on a property tax does not fail to be commensurate with the property tax as a result of changes in the level of the percentage of or adjustment to that property tax for a reasonable phase-in period ending when the subject property is placed in service; a PILOT based on a property tax must take into account the current assessed value of the property for property tax purposes for each year in which the PILOT is paid and that assessed value must be determined in the same manner and with the same frequency as property subject to the property tax; a PILOT is not commensurate, however, if the PILOT is set at a fixed dollar amount (for example, fixed debt service on a bond issue) that cannot vary with changes in the level of the generally applicable tax on which it is based);
      • The PILOT must be used for governmental or public purposes for which the generally applicable tax on which it is based may be used; and
      • The PILOT must not be a “special charge” under Treas. Reg. 1.141-4(e)(3).
    • For example, a PILOT made in consideration for the use of property financed with tax-exempt bonds will not be considered a generally applicble tax because it will not satisfy the third and fourth conditions.  In contrast, an otherwise qualified or eligible PILOT that is based on a generally applicable tax is not treated as a special charge merely because the PILOTs received are used for governmental or public purposes in a manner that benefits particular property owners.  See PLR 200640001 and PLR 200641002.
    • Examples of PILOT agreements considered generally applicable taxes and excluded from the private security or payment test:
      • Stadium:  PLR 200640001; PLR 200641002
      • Parking facilities agreement:  PLR 200641002
    • See the June 28, 2007 publication by NABL addressing proposed regulations of 2006 which attempt to provide more limitations on the application of the PILOT regulation in Treas. Reg. 1.141-4(e)(5).

Private Loan Financing Test

General discussion

  • As summarized by Sharon White in “Private Activity Bond Tests,” 2012 Edition:
    • If more than 5% (or $5,000,000, if less) of bond proceeds is used to make a loan, whether or not the loan is for private business use, the private loan financing test is met and the bonds are private activity bonds.
    • Prepayments may be loans, subject to specific exceptions.
    • Transfers in the form of grants are not loans, but only if the transfer does not impose conditions on the grantee (except as necessary to fulfill the purpose of the grant).
    • Tax assessments are not loans, but only if there is compliance with three requirements: (1) the mandatory assessment or tax requirement; (2) the essential governmental function requirement; and (3) the equal basis requirement.
  • Treas. Reg. § 1.141-5(b) provides that, 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.
  • Treas. Reg. § 1.141-5(c)(1) provides that any transaction that is generally characterized as a loan for federal income tax purposes is a loan for purposes of Treas. Reg. § 1.141-5.
  • See Priv. Ltr. Rul. 201246032:  Whether lease revenue bonds satisfy the private loan financing test of I.R.C. § 141(c).  The ruling analyzes a complex set of facts to come to a conclusion that the use of bond proceeds does not constitute a private loan.
  • Assume a district issues bonds and uses the bond proceeds to finance public improvements.  Assume also that the residents in the district are required to pay ad valorem property taxes to the district such that the district may repay the bonds.  Why isn’t this arrangement a private loan, since the district could be viewed as loaning the proceeds to the residents, and the residents financing the bond-financed improvements by paying property taxes?  See TAM 9250005 for a discussion of generally applicable taxes.

Definition of “loan”

  • Colloquially, a loan is a debt evidenced by a note which specifies, among other things, the principal amount, the interest rate and the date of repayment.  A loan entails the reallocation of the subject asset for a period of time between the lender and the borrower.
  • A loan also exists in a transaction in which indirect benefits that are the economic equivalent of a loan are conveyed.  Thus, a contractual arrangement with respect to a facility (such as a lease, management contract or output contract) may be a loan if it transfers tax ownership of the facility or shifts significant burdens and benefits of ownership to a nongovernmental person, or otherwise permits a nongovernmental person to defer payments either directly or indirectly (tax assessment loans).
  • Query whether the following gives rise to a private loan: A developer controlled district issued bonds and uses the proceeds to finance a road in the developer’s shopping mall.  The bonds are repaid from ad valorem property taxes on the developer’s property.  The argument might be that the district is transferring an economic benefit to the developer in the form of use of the road and that the developer is repaying the benefit by virtue of being the only taxpayer in the district.  To counter this argument, one would either need to prove that no economic benefit is being transferred (some kind of general public use argument) or that the bonds are paid from more than just the developer’s payments (perhaps repaid from sales taxes).
  • Company guarantee of debt service:  See PLR 8945032.  Make sure the guarantee is not reasonably expected to be needed to pay debt service.
  • From the regulations and legislative history, it appears there are three requirements to find a private loan:
    1. There must be an arrangement that permits the payor (e.g., developer) to defer payments.
    2. There must be a promise to pay.
    3. The payor must either receive the proceeds of the obligation, the obligation-financed facilities or the benefits that are the equivalent of a loan.

Exception: Regulatory prepayment exceptions

Exception: Statutory prepayment exceptions

Exception: Grants

  • Example language one might use to identify a grant for purposes of allocation of proceeds to expenditures under I.R.C. 148:  “Expenditure for Grants.  The City expects to accomplish the Transfer on or about June 1, 2010, and the City does not expect the Grantee to repay any portion of the Transfer to the City.  The Transfer constitutes a transfer from the City to the Grantee for a governmental purpose; the Grantee is not a Related Person to or an agent of the City; and the transfer does not impose any obligation or condition to directly or indirectly repay any amount of the Transfer to the City, all within the meaning of Treas. Reg. § 1.148-6(d)(4)(iii).

Exception: Tax assessment loans

  • Section 141(c) provides that certain tax assessment loans are not treated as loans in applying the private loan financing test.  A tax assessment loan is a loan that arises from the imposition of a tax or assessment of general application for specific, essential governmental functions.  Essential governmental function has the same meaning as under section 7871.  See also I.R.C. 115.
  • To qualify for this special exception, owners of business and nonbusiness property must be eligible to make assessment payments on an equal basis.
  • Guidance is provided in the 1997 Final Regulations on the types of special arrangements regarding payment of an assessment that cause the assessment to fail the equal basis requirement (for example, due-on-sale clauses).
  • The regulations clarify that loans qualifying under the tax assessment loan exception may still result in private payments.
  • Taxes and assessments for purposes of the exception do not include fees for services.  See Treas. Reg. 1.141-5(d)(3).  The requirement should permit variations among jurisdictions within a state.  As stated in the House Report to the 1986 Tax Reform Act (H. Rep. No. 99-426, at page 525): “The committee understands that the method of assessing residents for these improvements varies from State to State.  Taxes or other mandatory assessments with respect to the improvements serving an essential governmental function may be levied on a property frontage basis or may be levied on an ad valorem basis.  The committee intends that deemed loans for these purposes be disregarded in determining the tax status of bonds whether the taxes or other assessments are based on a property frontage basis, an ad valorem basis, or any comparable method that results in equivalent mandatory assessments to all residents benefiting from the improvements.”  Does the state law need to identify any manner of imposition, or perhaps that manner of imposing assessments can be determined by the issuer in the assessment resolution?  There should probably be reports to identify the equitable allocation of assessments.

Private Business Tests and Partnerships

Prop. Treas. Reg. 1.141-6 provides proposed guidance regarding treatment of partnerships as owners or users of facilities for purposes of the private business tests.  The proposed regulations confirm that, by default, a partnership should be treated as a separate entity and not as an aggregate of its partners.  I.e., a partnership is a new entity that is neither a govermental entity nor a 501(c)(3) organization (unless in a rare circumstance the partnership itself has a 501(c)(3) determination).

A limited exception for purposes of I.R.C. 141 disregards the partnership as a separate entity if all partners of the partnership are governmental entities.  Such an entity is treated as an aggregate of each of its partners.

For purposes of the private business use rule of I.R.C. 141, the proposed regulations suggest similar treatment where the partners of a partnership include 501(c)(3) organizations and governmental entities.  (This aggregate treatment is not intended to apply for purposes of the ownership rule of I.R.C. 145(a)(1), however, which requires actual ownership of the bond-financed facility by the 501(c)(3) organization.)

The Treasury Department states that the reason for the default rule (treating partnerships as separate entities) is that it would be administratively difficult in a partnership between a governmental (or 501(c)(3)) entity and a private business to determine how to treat shared profits, savings and allocation of partnership items.

The Treasury Department does note that it may be willing to permit partnerships between such exempt persons and a private business (i.e., thereby disregarding eligible partnerships as separate private business entities), but only if (1) each partner receives the same distributive share of each partnership item for federal tax purposes (including income, gain, deduction, loss, credit and basis) as such partner’s respective interest in the partnership (i.e., “straight-up allocations”), and (2) this share remains the same for the entire measurement period for the bonds or the entire period that the person is a partner.  In the proposed regulations, the Treasury Department solicited public comments regarding whether it would be useful to treat such a partnership as an aggregate in this limited circumstance involving “straight-up allocations” of all partnership items in accordance with constant percentage interests in the partnership.

Assuming a public-private partnership is permitted to be treated as an aggregate of its partners, how would private business use be measured?

As described in Treas. Reg. 1.103-7(c), Example 13, public-private partnerships are expressly permitted in connection with output facilities:

In order to construct an electric generating facility of a size sufficient to take advantage of the economies of scale: (1) City H will issue $50 million of its 25-year bonds and Z (a privately owned electric utility) will use $100 million of its funds for construction of a facility they will jointly own as tenants in common. (2) Each of the participants will share in the ownership, output, and operating expenses of the facility in proportion to its contribution to the cost of the facility, that is, one-third by H and two-thirds by Z. (3) H’s bonds will be secured by H’s ownership in the facility and by revenues to be derived from the sale of H’s share of the annual output of the facility. (4) Because H will need only 50 percent of its share of the annual output of the facility, it agrees to sell to Z 25 percent of its share of such annual output for a period of 20 years pursuant to a contract under which Z agrees to take or pay for such power in all events. The facility will begin operation, and Z will begin to receive power, 4 years after the City H obligations are issued. The contract term of the issue will, therefore, be 21 years. (5) H also agrees to sell the remaining 25 percent of its share of the annual output to numerous other private utilities under a prevailing rate schedule including demand charges. (6) No contracts will be executed obligating any person other than Z to purchase any specified amount of the power for any specified period of time and no one such person (other than Z) will pay a demand charge or other minimum payment under conditions which, under paragraph (b)(5) of this section, result in a transfer of the benefits of ownership and the burdens of paying the debt service on obligations used directly or indirectly to provide such facilities. The bonds are not industrial development bonds because H’s one-third interest in the facility (financed with bond proceeds) shall be treated as a separate property interest and, although 25 percent of H’s interest in the annual output of the facility will be used directly or indirectly in the trade or business of Z, a nonexempt person, under the rule of paragraph (b)(5) of this section, such portion constitutes less than a major portion of the subparagraph (5) output of the facility. If more than 25 percent of the subparagraph (5) output of the facility were to be sold to Z pursuant to the take or pay contract, the bonds would be industrial development bonds since they would be secured by H’s ownership in the facility and revenues therefrom, and under the rules of paragraph (b)(5) of this section a major portion of the proceeds of the bond issue would be used in the trade or business of Z, a nonexempt person.

For output facilities, the governmental partner’s interest in the facilities (1/3 in the example) is treated as a separate property interest and not as a shared interest with the other private partner.

Mixed-Use Projects

See this posting regarding mixed-use projects.

Private Business Tests and Refundings

General discussion:

  • See “IRS Issues Final Regulations Regarding Application of Private Activity Bonds Restrictions to Refunding Issues” by Perkins Coie.  See also “Private Activity Bond Refunding Regulations” by Linda Schakel referred to above.
  • On December 19, 2005, the IRS issued final regulations (the “Refunding Regulations”) that provide guidance for applying the private activity bond tests to refunding issues (T.D. 9234).
  • There is a special one-year rule for when an arrangement is not entered into in contemplation of a refunding issue.  See Treas. Reg. 1.141-13(c)(3).
  • The Refunding Regulations state that, for purposes of determining the amount of private business use of a refunding bond, proceeds of the prior bond used to pay costs of issuance are treated as exempt purpose use.  This means that an issuer can use of to 2% of the proceeds of any refunding issue to pay costs of issuance without having those amounts accumulate to cause the bonds to exceed the 5% bad cost limitation.  Treas. Reg. 1.145-2(d).

Private business use test:

  • The Refunding Regulations provide that the proceeds of a refunding issue are allocated to the same expenditures and purpose investments as the proceeds of the prior issue.  Treas. Reg. 1.141-13(b).
  • General Rule:  The general rule is that a refunding issue and a prior issue are tested separately under section 141.  Thus, the determination of whether a refunding issue consists of private activity bonds generally does not depend on whether the prior issue consists of private activity bonds.
  • IRS Concerns with the General Rule:  There is a special rule that applies to refundings of governmental bonds.  Here is brief background regarding the history of the special rule, taken from Linda Shakel’s article referred to at the top of this posting:
    • The 1994 Proposed Regulations had taken the view that if more than 10% of the proceeds of a bond issue were used for private business use in any one-year period, the 10% private business use test was exceeded.  However, the 10% private payment or security test was measured by present-valuing the private business use payments over the term of the bonds, with specific provisions for refunding bonds.
    • The 1997 Final Regulations reversed the approach of the 1994 regulations by permitting private business use to be measured over a specified “measurement period.”  The measurement period begins when the financed project 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 the bonds.  Issuers welcomed this more liberal approach to measurement.  The measurement over time would permit financing a building with a holdover tenant or temporary leasing of space at a later date if the space needs of the issuer had changed.
    • However, the Internal Revenue Service was concerned that an issuer could front-load private business use, then issue refunding bonds to obtain a fresh start on a 10% private business use limitation.  The 2003 Proposed Regulations and the Refunding Regulations provide the special rule as a method for accommodating the IRS concerns.
  • Special Rule:  In applying the private business test to a refunding issue that refunds a prior issue of governmental bonds or qualified 501(c)(3) bonds, the amount of private business use of the refunding issue is the amount of private business under either of the following two methods:
    1. General rule: Amount of private business use is the amount of private business use during the “combined measurement period”; or
    2. Special rule: Amount of private business use is the amount of private business use during the measurement period of the refunding issue only (but only if the prior issue does not satisfy the private business use test based on a measurement period that begins on the first day of the combined measurement period and ends on the issue date of the refunding issue).
    3. Note: In applying these rules in a refunding of qualified 501(c)(3) bonds with governmental bonds, any use of the refinanced property before the issue date of the refunding issue by a 501(c)(3) organization with respect to activities that do not constitute an unrelated trade or business under I.R.C. 513(a) is treated as government use.
  • See the regulatory example in Treas. Reg. 1.141-13(g), Ex. 1 and Ex. 4
  • These Refunding Regulations may result in increased recordkeeping by issuers regarding the level of private business use of an issue so that issuers and bond counsel have the maximum flexibility in deciding whether or not to combine or separate measurement periods for testing private business use of refunding issues.

Private security or payment test:

  • If the amount of private business use is determined based on the separate measurement rule (the general rule), then the amount of private security and payments allocable to the refunding issue is determined by treating the refunding issue as a separate issue.
  • If the amount of private business use is determined based on the combined measurement period, then the amount of private security and payments allocable to the refunding issue is determined by treating the refunding issue and all earlier issues that are taken into account in determining the combined measurement period as a combined issue.

Measuring Private Business Use

A.  Naming Rights Ruling

Ltr. Rul. 200323006 is the “naming rights” ruling.  Certain determinations in the ruling are listed below:

  • Under Treas. Reg. 1.141-3(d)(5), certain incidental uses of a financed facility are disregarded to the extent that those uses do not exceed 2.5% of the proceeds of the issue used to finance the facility.  The IRS agrees that the type of use under the naming rights contract is similar to the types of incidental uses described in the regulations.  The naming rights contract does not involve the transfer to the nongovermental person of possession of space that is separated from other areas of the facility by walls, partitions or other physical barriers.  In addition, the naming party’s use is not functionally related to any other use of the facility by the naming party.
  • Special legal entitlement may arise when a private user has control over the facility.  See Treas. Reg. 1.141-3(f), Ex. 5, relating to the corporation’s ability to approve rates charged by the city for use of the parking lot.  A nongovernmental person need not have physical possession of the property in order to be a private business user.  The power to control how the facility is used is sufficient to give rise to private business use of the facility.
  • In determining private business use based on comparable fair market values of use, 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.
  • The issuer argues that a naming rights agreement cannot give rise to private business use because there are no bond proceeds that can be traced to the creation of the naming rights.  The IRS does not find this argument compelling and points to the parking facility example referenced above.  In that example, there were no bond proceeds that could be traced to the creation of the right to control parking rates.  However, the IRS determines that certain rights are inherent in an asset.  In the case of the naming rights facility, it is the right to the name of the facility and control over its use.  The IRS, therefore, concludes that there is private business use – there is use of the bond-financed assets through control.
  • With regard to the measurement of private business use, the issuer argues that private business use should be based on the amount of physical space in the facility used pursuant to the contract.  The IRS does not agree and believes this approach does not properly reflect the value of the contract to the naming party.  The naming party receives benefits under the contract beyond any benefit from the physical uses of the fcility, such as all references to the facility including a reference to the naming party and all items produced with respect to the facility referring to the naming party.  These benefits are not adequately represented by measuring physical space used by the naming party at the facility.
  • Usually, where there is simultaneous use by the private entity and the governmental user, there will be private business use of the entire facility.  In the naming rights case, however, the IRS believes this is not the correct way to measure private business use because the use is not as pervasive a use of the facility as with the management contract described in the regulations (1.141-3(g)(4)(iii)).  Rather, the use is similar to nonpossessory use to which the incidental use rule of 1.141-3(d)(5) applies.  Therefore, it is more appropriate to measure the private business use on a reasonable basis that properly reflects the proportionate benefit to be derived from the various users of the facility.
  • To measure the proportionate benefit to be derived by the naming party under the contract, the IRS looks to the fair market value of the contract compared to the fair market value of the facility. (FMV of contract / FMV of facility * Bond-financed percentage)
  • With respect to the naming rights contract, the FMV of the private business use for each year is equal to the payments to be made to the issuer each year under the contract.
  • The cost to construct the facility is a reasonable proxy for the FMV of the facility.

(An important factor to consider in determining whether a naming right gives rise to private business use is whether the naming right agreement provides the non-exempt user legally enforceable rights with respect to how the facility is to be referred to and rights to control how the facility is used.)

B.  Measuring Private Business Use for Solar Panel Installations

Steps: (1) Determine the arbitrage yield of the bonds; (2) Prepare a schedule showing, for each period, energy production, utility rate and total charge based on production, power purchase agreement (PPA) rate and total charge based on production, savings/imputed rent of utility total charges versus PPA total charges, present value of the savings using the arbitrage yield of the bonds.  The sum of the present value of the savings is a good proxy for the FMV of the PPA contract.  Divide this FMV by the FMV of the facility to identify the private business use percentage.  The FMV of the facility might be approximated by using the issue price of the bonds.

One might ask whether to incorporate into the contract’s FMV the tax credits received by the operator of the solar panels.  Some bond counsel have concluded that this is not necessary because the tax credit does not accrue to the issuer – it accrues and is kept by the solar panel operator.

C.  Applying Private Activity Bond Restrictions to Refunding Issues

See the final regulations published in February 2006 (*bsnp regulations) regarding the private activity bonds test in connection with refundings.

  • Rules regarding private activity bonds:
    • The refunding regulations apply to private activity bond rules to the refunded and the refunding issue separately.  Treas. Reg. 1.141-13(a).
    • The proceeds of the refunding issue are allocated to the same expenditures and purpose investments as the refunded issue.  Treas. Reg. 1.141-13(b)(1).
    • The amount of private business use associated with a bond issue is based on the respective measurement period of the refunded issue and the refunding issue, calculated separately.  Treas. Reg. 1.141-13(b)(2).
    • Example:  Airport issues taxable bonds to construct a facility because it knows that the management contract creates private business use.  The management contract terminates and a “good” management contract is executed.  Airport issues refunding bonds to refund the taxable bonds.  This means that the refunding bonds do not carry over the “bad use” caused by the original management contract.
  • Rules regarding governmental bonds and qualified 501(c)(3) bonds:
    • General rule:  The private business use test is applied to a combined measurement period with respect to a refunding of a governmental obligation, so that the measurement period begins on the issue date of the refunded bond or the date the facility financed with the proceeds of such bond is placed in service, whichever is later, and ends on the date the refunding bonds are retired.  Treas. Reg. 1.141-13(b)(2)(ii)(A).  In a series of refundings, the measurement period begins by reference to the earliest bond issue.  Treas. Reg. 1.141-13(b)(2)(iii).
    • Option if good prior behavior:  If the refunded issue did not, based on actual use, satisfy the private business use test (i.e., if there was no excess bad use) by reference to the measurement period beginning on the date the refunded bonds were issued or the date the facility financed with the refunded bonds is placed in service, whichever is later, and ending on the issue date of the refunding bonds, the issuer has the option to treat the measurement periods for purposes of applying the private business use tests as separate.  Treas. Reg. 1.141-13(b)(2)(ii)(B).
    • Use of property refinanced with the proceeds of a refunding issue by a 501(c)(3) organization in activities that are not unrelated trade of business activities under Section 513(a) is treated as governmental use.  Solely for purposes of the refunding regulations, the use of proceeds of qualified 501(c)(3) bonds for the purpose of paying costs of issuance (which is normally a private business use) is treated as a governmental use of proceeds.
    • What this means, in other words, is that, by default, you must test private business use based on a combined measurement period.  This is disadvantageous if there was excess private business use for the refunded bonds (e.g., 12% PBU), and requires sufficient averaging to avoid causing the private business use test to be met with respect to the refunding issue.  If, however, there was no excess private business use for the refunded bonds (e.g., 9% PBU), the measurement period may be limited to the refunding bond period.
    • Conclusion:  Can no longer assume that the uses of the refunding bonds are good (on a prospective basis) even if the refunded bonds were taxable on account of “bad” prior use.  It will require an increased level of diligence to assure that the refunding bonds did not satisfy the private business use tests.  The IRS explicitly rejected comments that suggested a presumption that the refunded bonds satisfied the 10% private use test.
    • The private payment or security interest test is measured separately for the refunded and the refunding issue, if the private business use is measured separately.  Treas. Reg. 1.141-13(c)(1).  The private payment or security interest test is measured on a combined basis if the private business use test is measured on a combined basis.
    • Example 4 in Treas. Reg. 1.141-13 indicates that the combined measurement period does not apply with the refunded bonds are taxable bonds (or, for course, when the refunded bonds are not governmental or qualified 501(c)(3) bonds).

Unrelated or Disproportionate Use Test

Under I.R.C. 141(b)(3), an issue meets the private business tests if the amount of private business use and private security or payments attributable to any unrelated or disproportionate private business use exceeds 5 percent (not 10 percent) of the proceeds.  The regulations provide that whether private business use is related to a government use of the proceeds of an issue is determined on a case-by-case basis, emphasizing the operational relationship of the financed facilities.  Generally, facilities used for a private business use are related to a governmental use only if the private use occurs in the same facility or an adjacent facility.  The regulations provide that a single facility that is used for both governmental use and a private business use of the same type (for example, governmental and private parking) generally does not result in unrelated use.

Disproportionate private business use occurs when the amount of proceeds used for a private business use exceeds the amount of proceeds used for the related government use.  The proposed regulations provide allocation rules designed to simplify the application of the disproportionate use rules.  For example, where a private business use relates to more than one government use, in determining the amount of disproportionate use the private business use may be allocated either entirely to the government use to which it primarily related or among each of the government uses.  A number of examples are provided illustrating the application of the unrelated and disproportionate use rules.

Noncompliance Hospitals under I.R.C. 501(r)

On December 29, 2014, the Treasury Department released final regulations under I.R.C. 501(r).  The regulations provide that noncompliance under 501(r) is not to be treated as an unrelated trade or business or affect the tax-exempt status of bonds issued for the facility.

(4) Interaction with other Code provisions–(i) Hospital organization operating a noncompliant hospital facility continues to be treated as tax-exempt. A hospital organization operating a noncompliant hospital facility subject to tax under this paragraph (d) shall continue to be treated as an organization that is exempt from tax under section 501(a) because it is described in section 501(c)(3) for all purposes of the Code. In addition, the application of this paragraph (d) shall not, by itself, result in the operation of the noncompliant hospital facility being considered an unrelated trade or business described in section 513 with respect to the hospital organization. Thus, for example, the application of this paragraph (d) shall not, by itself, affect the tax-exempt status of bonds issued to finance the noncompliant hospital facility.


Letter Ruling 201216009, January 4, 2012.  Hospital district and public university have established a “strategic alliance” under which a separate board will oversee the district’s healthcare facilities in an integrated manner with the university’s patient service programs.  If the arrangement has created a partnership the result would be private business use of the district’s bond-financed facilities.  That is, if the partnership were an “entity.”  But it is, rather, an “aggregate” of the district and university; and the alliance will not create private business use.

Letter Ruling 201213010, December 20, 2011.  Focus of this ruling is on the exception to private business use when the business use is on the same basis as the general public.  The ruling also analyzes the definition of “common area” under Treas. Reg. 1.141-3(g)(5) to determine whether the train connector constitutes a “common area” of the terminal (and must therefore be treated as partly used in the trade or business to which the terminal is subject) or is a separate facility (and does not need to be treated as partly used in such trade or business).  Proceeds of the bonds are intended to be used to improve the train connector (which connects terminals and is only available to passengers, employees, contractors, etc.), improve the bus connector (which connects other parts of the airport and is available to anyone) and pay costs of issuance.  The issuers intend to treat the bonds as governmental bonds that are not private activity bonds.  Costs of issuance to be paid from bond proceeds were to exceed two percent of the proceeds of the bonds – therefore the need to avoid private activity bond status.

Matters concerning prison transactions

July 6, 2011

Noteworthy Articles:

Texas Prison Debt Gets Adverse Determination Letter,” The Bond Buyer of June 29, 2011

Qualified Management Contracts (Treas. Reg. 1.141-3(b)(4); Rev. Proc. 97-13; Rev. Proc. 2016-44; Notice 2014-67)

February 9, 2011


  • Rev. Proc. 97-13, as modified and amplified by Notice 2014-67, thanks to the publicfinancetaxblog.
  • Rev. Proc. 2016-44, as revised on September 2, 2016 with the extended transition period.  Modifies and supersedes Rev. Proc. 97-13 and Rev. Proc. 2001-39.
  • Under Treas. Reg. 1.141-1(b), a “renewal option” is defined as a provision under which either party has a legally enforceable right to renew the contract.  For example, a provision under which a contract is automatically renewed for 1-year periods (an “evergreen provision”) absent cancellation by either party is not a “renewal option” (even if it is expected to be renewed).
  • PLR 200651012 (Dec. 22, 2006):  Professional art college’s contract to manage student resident hall with corporation which provides management, administrative and operational services to the college won’t result in private business use of the dormitory.  The contract provides for a fixed fee over a 15-year term.  The fee is adjusted based on the CPI.  The contract also provides for reimbursements.  The contract has a renewal option for one-year periods.  The manager does not have any role or relationship with the university that substantially limits the university’s ability to exercise its rights, including cancellation rights, under the agreement.  The manager was created by the university.
  • PLR 200222006 (Feb. 19, 2002): Very helpful discussion regarding separation of agreements and compensation, and deferral of compensation and incentives:
    • Management contract between a hotel owner and a management contract, and separate preopening contract between the two, for (1) preopening services and (2) multiple operating services.  Provides for multiple fee structures: A fixed monthly fee for preopening, for 3 years; a fixed management fee with a deferral component; a one-time productivity reward that is subject to deferral; a centralized service fee with CPI adjustment; an inducement fee deemed repayment (treated as a reduction in fees paid by the owner); and expense reimbursement to third parties and not executive staff, for 15 years.
    • The IRS suggests that it may be appropriate to aggregate the terms of the two contracts so that the total term of the contracts is 18 years.  Nevertheless, assuming aggregation, the emphasis of the preopening contract is on supervision of the design and construction of the hotel prior to the date the hotel is placed in service – therefore the management phase of the contract occurs “primarily” during the 15-year term of the management contract.
    • The management fee (the fixed fee) is subject to adjustment based on percentage change in total RevPAR of the competitive set (excluding the hotel).  Beginning in the third year, the owner has the right to defer paying a stated dollar amount of the management fee if revenues of the hotel are not sufficient to pay certain senior expenses such as capital replacement reserves and a preferred return to the owner.  The deferred fee will accrue, however, and is payable in full if the contract is terminated or ends pursuant to its terms.
    • The IRS concludes that the non-deferrable portion of the management fee is a periodic fixed fee arrangement and the adjustment based on RevPAR is an acceptable external standard.
    • However, the IRS finds that the deferrable portion of the management fee could be viewed as a net profits-based payment.  The circumstances, however, suggest that the arrangement is acceptable – though outside of the safe harbor – because the full amount of the deferred fees will be payable regardless of the existence of net profits when the contract is terminated.  In addition, the amount of the deferred fees is a stated dollar amount and not itself a percentage of hotel net profits.  Finally, a feasibility study suggests that no deferrals will even occur with respect to the deferrable portion of the management fee and the incentive reward (which is also deferrable).
  • PLR 200926005 (Jun. 26, 2009):  Agreements with outside physicians relating to compensation based on “Net Professional Patient Billings” determined not to give rise to private business use based on all facts and circumstances.  Agreement exceeded the permissible term under Sec. 5.03(6) (2 years where, among other things, the services are provided primarily to third parties).
  • PLR 201145005 (Aug. 4, 2011): Though it does not meet all the requirements of sec. 5 of Rev. Proc. 97-13, company’s management contract for authority’s bond-financed exhibition and convention facility will not cause a private business use of the facility under sec. 1.141-3(b)(4).  Though the agreement’s term is some two months longer than five years, the deviation is insignificant.  November 11 Tax Notes.
  • PLR 201228029 (Mar. 30, 2012):  IRS determines, based all on facts and circumstances and not based on the safe habors in Rev. Rul. 97-13, that an agreement providing for (1) fixed direct fee (with adjustment based on credit support provided by service provider), (2) incentive compensation component, (3) reimbursement of pass-through expenditures (including partially marked-up costs from affiliates of the service provider) does not cause private use.  The arrangement does not, in any of these compensation parts, fall within the safe harbors, but the IRS, in its ability to make a facts and circumstances determination, holds that the agreement does not give rise to private use.
  • PLR 201338031 (May 20, 2013):  Amending an agreement in a material manner causes the contract to be treated as a contract that is newly entered into as of the date of the material change.  A contract for the management of a hotel does not meet the requirements of section 5 of Rev. Proc. 97-13.  The contract provides for the payment of a base fee and an incentive fee.  The base fee is the greater of (1) an amount that would be a periodic fixed fee if it were paid every year or (2) a percent of the hotel’s actual gross receipts.  The incentive fee is a percentage of adjusted gross receipts if a certain RevPAR rate is achieved.  However, because the base fee and the incentive fee, both independently and in combination, are not based on a share of net profits, the IRS determined that the contract would not result in private business use of the hotel, based on all the facts and circumstances.
  • FSA 199932017 (Aug. 13, 1999):  Whether a private corporation’s operation of a prison constructed with proceeds of bonds that are tax-exempt results in private business use; whether a private corporation’s guarantee of the payment of debt service on the bonds satisfies the private payment or security test; and whether an examining agent should rely on the Trust Indenture or the Official Statement when the two documents are inconsistent with respect to the property that secures payment of debt service on the bonds.  Not enough information to make a determination on any of these questions.
  • PLR 200501003 (Jan. 1, 2005):  Service provider managing and serving output facility pool of generator equipment is providing services incidental to the governmental users’ use of the financed property.

Private Use Generally

September 16, 2010

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).

Remedial Actions (Treas. Reg. 1.141-12, and Elsewhere)

July 13, 2010

General Rule:

Under the private activity bond regulations, any deliberate act by the issuer after bond issuance that results in a satisfaction of the private business tests or the private loan test will result in private activity bond status unless one or more qualifying remedial actions is taken by the issuer.  An action is not treated as a deliberate action if (a) five conditional requirements are met and (b) one of three remedial actions is taken with respect to “nonqualified bonds.”  Tax compliance certificates will commonly refer to these requirements. A deliberate act or action means any action, occurrence or omission by the issuer that is within the control of the issuer which causes either (a) the Private Business Use Test to be satisfied with respect to the bonds (without regard to the private security or payment test of Section 141(b) of the Code), or (b) the Private Loan Financing Test to be satisfied with respect to the bonds or the proceeds thereof.  An action, occurrence or omission is not a deliberate action if (a) the action, occurrence or omission would be treated as an involuntary or compulsory conversion under Section 1033 of the Code, or (b) the action, occurrence or omission is in response to a regulatory directive made by the government of the United States.

Until alternate guidance is issued, remedial action provisions in Treas. Reg. 1.141-12 apply to build America bonds, based on conversations with the Internal Revenue Service and based on I.R.M.

Conditional Requirements:

  1. Reasonable expectations:  Issuer must have reasonably expected that it would not meet the private business tests or the private loan test;
  2. Reasonable bond maturity:  Term of the issue must not be unreasonably long.  This requirement is met if the WAM of the bond issue is not greater than 120% of the expected economic life of the bond-financed property (e.g., “The Bonds have a weighted average maturity (___ years) that does not exceed 120% of the average reasonably expected economic life of the capital improvements financed or refinanced by the Bonds (such economic life is at least ___ years).”);
  3. Fair market value consideration:  Terms of any agreement must be bona fide and on an arm’s-length basis, and the new user must pay a fair market value consideration for the use of the bond financed property;
  4. Disposition proceeds are gross proceeds:  The issuer must treat any disposition proceeds as gross proceeds subject to arbitrage/rebate restrictions. Disposition proceeds are the moneys received from the sale of bond financed property (generally, but see full definition).
  5. Proceeds spent for governmental purposes:  Prior to the deliberate action, the affected proceeds must have been spent for a governmental purpose (or, for the 501(c)(3) purpose).

Remedial Actions:

  1. Redemption or defeasance of non-qualified bonds:  Note, there is a special rule in section 1.1001-3(e)(5)(ii)(B)(1) that prevents defeasance of a tax-exempt bond from being a signficant modification in certain cases.  Also note that this remedial action is not available (i.e., that the establishment of a defeasance escrow does not satisfy the requirements of the remedial action) if the period between the issue date and the first call date of the bonds is more than 10 1/2 years (see also description under next heading).
  2. Alternative use of disposition proceeds:  Requires a disposition for which the consideration is exclusively cash.
  3. Alternative use of facility.

Note: It has been suggested that, for Build America Bonds, an additional remedy should be considered that might allow the IRS to simply disqualify subsidy payments from non-qualified bonds. 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. Note in the case of 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.

Does a lease constitute a disposition for which the consideration is exclusively cash? Perhaps it is not a disposition at all, and the alternative use of disposition proceeds remedial action cannot be used.  (  “Lease of property should not be a disposition, provided it qualified as a ‘true lease.'” (  In Rev. Rul. 75-457, the IRS concluded that a disposition occurs when the seller’s rights are materially disposed of or altered.  See IRS Publication 544, Sales and Other Dispositions of Assets.

Reasonable Expectations Exception:

The first condition to remedial action is that the issuer must reasonably expect, on the issue date of the bonds, that the private activity bond tests will not be met during the entire term of the bonds.  “Term of the bonds” means the stated term.  However, there is an exception where the issuer in fact expects as of the issue date to take action that causes either the private activity bond tests to be met. To take advantage of this exception, the issuer must provide for redemption of the nonqualifying bonds within six months of the offending action and meet the regulatory conditions for remedial action.  The “term of the bonds” in the case of this exception will then be the term from the issuance of the bonds through the mandatory redemption date.  See Section 12:9 of White, “Private Activity Bond Tests,” 2012 Edition. Here are the regulatory requirements:

  1. The issuer must reasonably expect, as of the issue date, that the bond-financed property will be used for a governmental purpose for a substantial period before the action is taken. “Substantial period” is not defined.  One might look to the measurement period provisions relating to the private business use where, for purposes of determining the date of commencement of the private business use, 10% of the measurement period is generally treated as a substantial period.  As an overall rule, however, “Private Activity Bond Tests” in Section 10:5 suggests that facts and circumstances related to the particular matter will apply.  Some firms believe that 3 to 5 years is a substantial period.
  2. As of the issue date, the issuer may not enter into any arrangement with a nongovernmental person with respect to the specific action which is reasonably expected to cause the private activity bond tests to be met.  For example, if an issuer as of the issue date enters into an agreement to sell a bond-financed facility to an identified nongovernmental person five years after completion of the facility, such contract is an arrangement in violation of the condition, and the reasonable expectation as of the issue date will cause the bonds to be private activity bonds.  (Remedial action otherwise permitted by the regulation is not available in this case because remedial action only cures satisfaction of the private business use test caused by deliberate action after the issue date that is not reasonably expected as of the issue date.)
  3. The mandatory redemption of the bonds must meet the conditions otherwise required for remedial action under the regulations.  This includes the following:
    1. The term of the issue must not be longer than reasonably necessary for the governmental purposes of the issue;
    2. Any arrangement which causes the private activity bond tests to be met must be bona fide and arm’s length;
    3. The new user must pay a fair market value for the use of the financed property;
    4. Disposition proceeds must be treated as gross proceeds for arbitrage and rebate purposes; and
    5. The proceeds of the issue affected by the deliberate action must be spent on a governmental purpose before the date of the deliberate action.

The above discussion is taken in large part, and to certain extents verbatim from White, “Private Activity Bond Tests,” 2012 Edition, published by WEST.

The 10 1/2 Call Limitation Requirement:

This 10 1/2 call limitation requirement is set forth as a condition to satisfying the defeasance remedial action.  It is important to note (as a panelist at a recent NABL Tax and Securities Law Conference session noted) that, where a bond is changed from one interest mode to the fixed rate mode, the fixed rate investors may require a 10 1/2 call period starting on that conversion date.  However, because the 10 1/2 call limitation for remedial action purposes begins on the issue date, the bonds, upon such conversion, will not satisfy this requirement.  The result is that either the fixed rate bonds can be callable with much shorter n0-call restrictions or the bondholders forfeit call protection, which will result in increased interest costs. Otherwise, the issuer will run the risk that this defeasance remedial action is not available.  If the initial interest mode (e.g., a weekly mode) contained the ability to optionally redeem within the 10 1/2 year window, but the subsequent mode does not provide a call until more than 10.5 years after the conversion, some bond counsel have decided to disregard the initial interest mode redemption ability and find that the bonds do not meet the call limitation requirement.  Other counsel have provided for special redemption provisions that permit an early redemption in the event that a change in use situation occurs. Note that “first call date” for purposes of this limitation does not require a first call date at which no redemption penalty is paid.  A transaction will still satisfy the first call date limitation even if there is a make whole or other redemption penalty.

Proposed 2003 Regulations:

The Treasury Department on July 21, 2003, published proposed regulations (REG 132483-03) to revise various sections of Treas. Reg. 1.141-12.  See I.R.B. 2003-34.

Remedial Actions Elsewhere in the Code and Regulations:

Formal remediation provisions:

  • Private use regulations under Treas. Reg. 1.141-12 (see discussion above)
  • Expected private use under Treas. Reg. 1.141-1(d)(4)
  • Non-qualified use of exempt facility under Treas. Reg. 1.141-2
  • Private ownership prohibition for 501(c)(3) financings under Treas. Reg. 1.145-2(b)(3)
  • Small issue and redevelopment bond violations under Treas. Reg. 1.144-2
  • Prepayment under Treas. Reg. 1.148-1(e)(2)(iii)(F)
  • Long term working capital under Prop. Treas. Reg. 1.148-1(c)(4)(ii)(B)
  • Skyboxes, public approval, etc. under Treas. Reg. 1.147-2
  • Expanded service area under I.R.C. 142(f)(4)
  • Unspent proceeds of tax credit bonds under I.R.C. 54A(d)(2)(B)(i)
  • Proposed rule for substantial deviations from public approval under Prop. Treas. Reg. 1.147(f)-1(b)(6)(iii)
  • Correction of single family mortgage bond requirement failures under Treas. Reg. 6a.103A-2(c)(1)(iii) and I.R.C. 143(a)(2)(B)(iii)
  • Borrower consequences for violations under I.R.C. 150 and Treas. Reg. 1.150-4
  • Late elections option for a ruling under Treas. Reg. 301.9100-1 et seq.

Less formal remediation provisions:

  • Yield reduction payments under Treas. Reg. 1.148-5(c)
  • Late rebate payments under Treas. Reg. 1.148-3(h)
  • Reallocations under Treas. Reg. 1.148-6(d)(1)(iii)
  • Post-issuance multipurpose allocations under Treas. Reg. 1.148-9(h)(2), Treas. Reg. 1.141-13(d)(1) (but not Treas. Reg. 1.140-1(c)(3), where the election needs to be made on or before the issue date)

Other Information:

In Rev. Proc. 97-15, the IRS provides a program in which issuers which cannot meet a listed remedial action can enter into a closing agreement with the IRS to avoid private activity bond status. The final regulations also contain remedial action rules for exempt facility bonds, qualified small issue bonds, qualified 501(c)(3) bonds and bonds that violate certain of the special private bond rules of section 147 of the Code. For purposes of applying the private activity bond rules, 501(c)(3) organizations that do not engage in unrelated trades or businesses are treated as governmental units.  Thus, the general remedial action rules described above are applicable for qualified 501(c)(3) bonds.

Can bank qualification issues under I.R.C. 265(b)(3) be remediated?  LB&I has jurisdiction, and coordination between TEB and LB&I may be difficult.


See this IRS publication of May 2012 re: “Sale of Assets Financed with Tax-Exempt Bond” (As of February 6, 2018, this Web site is no longer available.  Click here: (sale) for a PDF copy.)

PLR 9345031, regarding (deliberate) actions in connection with the sale/transfer/lease by a governmental entity of its hospital facilities to a 501(c)(3) organization.  Applies concepts relating to Rev. Proc. 93-17.

PLR 9522025 (Mar. 2, 1995): Application of remedial action rule under Rev. Proc. 93-17.  Sale of hotel to private operator, tender offer of bonds and defeasance of bonds.

See Rev. Proc. 79-5 (Jan. 1, 1979) regarding excess bond proceeds in the context of private activity bonds.  Under the procedure, the excess bond proceeds must be used to redeem the outstanding bonds or establish an escrow for redemption.