Bulletin No. 1997–12

Agency decision

Ask Donna

What actually matters in this document.

Text

March 24, 1997

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be relied

upon as authoritative interpretations.

INCOME TAX

EXCISE TAX

Rev. Rul. 97–15, page 42.

LIFO; price indexes, department stores. The January

1997 Bureau of Labor Statistics price indexes are

accepted for use by department stores employing the

retail inventory and last-in, first-out inventory methods

for valuing inventories for tax years ended on, or with

reference to, January 31, 1997.

Announcement 97–25, page 47.

Effective after March 6, 1997, the air transportation

taxes are reinstated; the tax rates on aviation fuel (other

than gasoline) and aviation gasoline are increased; and

floor stocks fuel taxes on aviation fuel (other than

gasoline) and aviation gasoline are imposed.

T.D. 8711, page 35.

REG–252665–96, page 46.

Final, temporary, and proposed regulations under sections 1060 and 338 of the Code relate to purchase

price allocations in taxable asset acquisitions and

deemed asset purchases. A public hearing on the

proposed regulations will be held on May 22, 1997.

T.D. 8712, page 4.

Final regulations under section 141 of the Code provide

the definition of private activity bonds applicable to

tax-exempt bonds issued by state and local governments.

EXEMPT ORGANIZATIONS

Announcement 97–26, page 48.

A list is given of organizations now classified as private

foundations.

Finding Lists begin on page 52.

Announcement of Disbarments and Suspensions begins on page 50.

ADMINISTRATIVE

Rev. Proc. 97–21, page 44.

Pilot pre-submission conference procedure. This procedure provides the rules for a new pilot program under

which pre-submission conferences may be held in the

national office for matters that a district director or a

chief, appeals office, is preparing to submit for technical

advice under Rev. Proc. 97–2, 1997–1 I.R.B. 64. Rev.

Proc. 97–2 amplified.

Announcement 97–22, page 47.

Environmental clean-up costs; letter rulings. Taxpayers are informed that they may now request a presubmission conference if they expect to file a request

for a private letter ruling under the revenue procedure

proposed in Notice 97–7, 1997–1 I.R.B. 8.

Mission of the Service

The purpose of the Internal Revenue Service is to

collect the proper amount of tax revenue at the least

cost; serve the public by continually improving the

quality of our products and services; and perform in a

manner warranting the highest degree of public

confidence in our integrity, efficiency and fairness.

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying

and administering the law in a reasonable,

practical manner. Issues should only be raised by

examining of ficers when they have merit, never

arbitrarily or for trading purposes. At the same

time, the examining officer should never hesitate

to raise a meritorious issue. It is also important

that care be exercised not to raise an issue or to

ask a court to adopt a position inconsistent with

an established Service position.

The function of the Internal Revenue Service is to

administer the Internal Revenue Code. Tax policy

for raising revenue is determined by Congress.

With this in mind, it is the duty of the Service to

carry out that policy by correctly applying the laws

enacted by Congress; to determine the reasonable

meaning of various Code provisions in light of the

Congressional purpose in enacting them; and to

perform this work in a fair and impartial manner,

with neither a government nor a taxpayer point of view.

Administration should be both reasonable and

vigorous. It should be conducted with as little

delay as possible and with great cour tesy and

considerateness. It should never try to overreach,

and should be reasonable within the bounds of law

and sound administration. It should, however, be

vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax

devices and fraud.

At the heart of administration is interpretation of the

Code. It is the responsibility of each person in the

Service, charged with the duty of interpreting the

law, to try to find the true meaning of the statutory

provision and not to adopt a strained construction in

the belief that he or she is ‘‘protecting the revenue.’’

The revenue is properly protected only when we ascertain and apply the true meaning of the statute.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for

announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation,

court decisions, and other items of general interest. It is

published weekly and may be obtained from the Superintendent of Documents on a subscription basis. Bulletin

contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold on a

single-copy basis.

court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are

cautioned against reaching the same conclusions in

other cases unless the facts and circumstances are

substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on

provisions of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all

substantive rulings necessary to promote a uniform

application of the tax laws, including all rulings that

supersede, revoke, modify, or amend any of those

previously published in the Bulletin. All published rulings

apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management

are not published; however, statements of internal

practices and procedures that affect the rights and

duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows:

Subpart A, Tax Conventions, and Subpart B, Legislation

and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and

Subparts. Also included in this part are Bank Secrecy

Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the

Treasury’s Office of the Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts

stated in the revenue ruling. In those based on positions

taken in rulings to taxpayers or technical advice to

Service field offices, identifying details and information

of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory

requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking and the disbarment and suspension list included in

this part, none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not

have the force and effect of Treasury Department

Regulations, but they may be used as precedents.

Unpublished rulings will not be relied on, used, or cited

as precedents by Service personnel in the disposition of

other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations,

The first Bulletin for each month includes an index for

the matters published during the preceding month.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin

of the succeeding quarterly and semi-annual period,

respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents U.S. Government Printing Office, Washington, D.C. 20402.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 141.—Private Activity

Bond; Qualified Bond

T.D. 8712

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Definition of Private Activity Bonds

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains

final regulations on the definition of

private activity bonds applicable to taxexempt bonds issued by state and local

governments. These final regulations reflect changes to the applicable law that

were made by the Technical and Miscellaneous Revenue Act of 1988. These

regulations affect issuers of tax-exempt

bonds and provide needed guidance for

applying the private activity bond restrictions.

DATES: These regulations are effective

May 16, 1997.

For dates of applicability of these

regulations, see §§ 1.141–15, 1.141–16,

1.148–6(a)(3) and 1.148–6(d)(1)(iii) of

these regulations.

FOR FURTHER INFORMATION CONTACT: Loretta J. Finger or Nancy M.

Lashnits, (202) 622–3980 (not a toll-free

number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have

been reviewed and approved by the

Office of Management and Budget in

accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control

number 1545–1451. Responses to these

collections of information are mandatory. Pursuant to comments received, the

collections of information have been

amended, but the estimated annual burden per respondent/recordkeeper has not

changed.

An agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information

unless the collection of information displays a valid control number.

The estimated average annual burden

hours per respondent/recordkeeper: 3

hours.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to

the Internal Revenue Service, Attn:

IRS Reports Clearance Officer, T:FP,

Washington, DC 20024, and to the Office of Management and Budget, Attn:

Desk Officer for the Department of the

Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503.

Books or records relating to collections of information must be retained as

long as their contents may become material in the administration of any internal revenue law. Generally, tax returns

and tax return information are confidential, as required by 26 U.S.C. 6103.

tions are to the Internal Revenue Code

of 1986. On June 8, 1995, the IRS held

a public hearing on the proposed regulations. Written comments responding to

the proposed regulations were received.

On May 31, 1996, final regulations

(FI–72–88) were published in the Federal Register (61 FR 106) to provide

guidance under Code section 1394 to

address the issues relating to enterprise

zone facility bonds. After consideration

of all the comments, certain of the

proposed regulations under Code sections 141, 142, 144, 145, 147, 148, and

150 are adopted as revised by this

Treasury decision. The principal revisions to the proposed regulations are

discussed below.

Background

Explanation of Provisions

Removal of existing regulations for repealed sections

Certain commentators suggested that

the proposed regulations, with certain

modifications, be published again as

proposed regulations. A number of other

commentators suggested that the proposed regulations, with certain modifications, should be promulgated as final

regulations to provide certainty at the

earliest possible time. After considering

these comments, the IRS and Treasury

concluded that state and local government issuers would benefit from the

adoption of the proposed regulations,

with certain modifications made in response to comments, as final regulations.

Prior to the enactment of the Tax

Reduction and Simplification Act of

1977 (Pub. L. 95–30), sections 141

through 144 contained provisions of the

Internal Revenue Code of 1954 relating

to the standard deduction. Sections 141

(‘‘Standard Deduction’’), 142 (‘‘Individuals Not Eligible for Standard Deduction’’), and 144 (‘‘Election of Standard Deduction’’) were repealed by

section 101(d)(1) of that act. Section

143 (‘‘Determination of Marital Status’’)

was redesignated section 7703 by section 1301(j)(2) of the Tax Reform Act of

1986 (Pub. L. 99–514). Therefore, existing regulations §§ 1.141–1, 1.142–1,

1.142–2, 1.144–1, 1.144–2, and 1.144–3

are being removed from the Code of

Federal Regulations (CFR), and regulation § 1.143–1 is being redesignated

§ 1.7703–1.

Proposed Regulations

On December 30, 1994, proposed

regulations (FI–72–88 [1995–1 C.B.

859]) were published in the Federal

guidance under the Internal Revenue

Code of 1986 (Code) in sections 141

(relating to private activity bonds and to

qualified bonds), 142 (relating to

exempt-facility bonds), 145 (relating to

qualified 501(c)(3) bonds), 147 (relating

to other requirements applicable to certain private activity bonds), 148 (relating

to arbitrage), 150 (relating to change of

use), and 1394 (relating to enterprise

zone facility bonds). All subsequent references in this preamble to Code sec-

A. Section 1.141–1 Definitions and

rules of general application

Replaced amounts. The proposed

regulations provide that the proceeds

taken into account under the private

activity bond tests include certain replacement proceeds that are reasonably

expected to be available during the

project period.

The final regulations treat replaced

amounts also as arising to the extent

that the issuer reasonably expects that

the term of the issue will be longer than

is reasonably necessary for the governmental purposes of the issue, in the

same manner as replacement proceeds

arise under the arbitrage regulations under Code section 148. Thus, replaced

amounts may arise under the private

activity bond tests if an issuer reasonably expects that there will be available

amounts during the period that the

bonds remain outstanding longer than

necessary for the governmental purposes

of the issue and if those amounts are

used for purposes that are inconsistent

with the private activity bond tests.

B. Section 1.141–2 Private activity bond

tests

1. Clarification of reasonable expectations test. Under the proposed regulations the private activity bond tests

depend on both reasonable expectations

as of the issue date and subsequent

deliberate actions of the issuer.

The final regulations clarify that, in

general, the reasonable expectations test

is met only if the issuer reasonably

expects, as of the issue date, that no

action or event during the entire term of

the bonds will cause either the private

business tests or the private loan financing test to be met. The final regulations

further provide, however, that, if certain

conditions are met, the period of expected compliance needs to extend only

to a mandatory redemption date. This

special rule is intended to accommodate

issuers that reasonably expect that bondfinanced property may be used by nongovernmental persons during the stated

term of the issue, but have not entered

into any arrangement with a nongovernmental person that will use the property

and are unable to predict the timing of

that nongovernmental use. This special

rule does not permit, however, reasonably expected ‘‘recycling’’ of disposition

proceeds because the special rule requires redemption of all nonqualified

bonds.

2. Definition of deliberate action. The

proposed regulations generally provide

that any action within the control of an

issuer is treated as a deliberate action

and that, if the financed property was

designed differently than is reasonably

necessary for the governmental purposes

of the issuer, an action with respect to

that property is treated as deliberate,

even if it is not within the issuer’s

control. Commentators suggested that

deliberate action should be more narrowly defined.

The final regulations make certain

changes that narrow the scope of the

deliberate action rule to minimize administrative burden on state and local

governments. First, the special rule for

property that is ‘‘designed differently’’ is

deleted. The reasonable expectations test

adequately addresses the concerns of

this special rule. Second, the final regulations clarify that an action taken by a

state or local government in response to

a regulatory directive of the federal

government is not a deliberate action.

Finally, the final regulations provide

that, if certain conditions are met, dispositions of personal property in the ordinary course of an established governmental program are not treated as a

deliberate action.

3. Special rule for general obligation

bond programs that finance a large

number of separate purposes. The proposed regulations provide a special exception to the definition of disposition

proceeds that is intended to minimize

the administrative burden of tracing the

use of proceeds of general obligation

bonds that finance a large number of

projects. Commentators suggested that

this exception should be available for

other types of bonds and that fewer

conditions should apply to the exception.

The final regulations provide a similar

rule that is broadly stated as an exception to the rule that a deliberate action

after the issue date can cause an issue to

meet the private activity bond tests. This

exception is intended to provide relief

for ‘‘cash flow’’ general obligation programs, where issuers use the proceeds of

an issue for a large number of projects

and spend proceeds promptly. These

programs merit special treatment in part

because they further the purposes of the

arbitrage rules.

4. When a deliberate action occurs.

The proposed regulations provide that a

deliberate action occurs on the earlier of

the date the parties agree on the consideration for the new use or the date on

which the new use occurs. Commentators suggested that the regulations

should not treat a deliberate action as

occurring before the date on which new

private business use actually commences, in part because it may not be

possible to take a remedial action with

disposition proceeds before the date on

which the disposition proceeds are received.

The final regulations provide in general that a deliberate action occurs on

the date the issuer enters into a binding

contract with a nongovernmental person

for use of the financed property that is

not subject to any material contingencies. In most cases, material conditions

to closing a transaction that results in

private business use will be treated as

material contingencies so that this date

will not occur before the date of receipt

of disposition proceeds.

C. Section 1.141–3 Definition of private

business use

1. Economic benefit as private busi-

ness use. Under the proposed regulations, economic benefit to a nongovernmental person may be treated as private

business use, even if the nongovernmental person has no special legal rights to

use the financed property.

Commentators suggested that the private business use test should not be met

unless special legal rights are provided

to a nongovernmental person pursuant to

an arrangement, and that mere economic

benefit is insufficient to give rise to

private business use.

The final regulations largely adopt

these suggestions. The final regulations

provide, however, that, if the financed

property is not available for use by the

general public, a nongovernmental person may be treated as a private business

user of the property based on all of the

facts and circumstances, even if that

nongovernmental person has no special

legal entitlements to use of the property.

2. Ownership. The proposed regulations provide that ownership of property

by a nongovernmental person is private

business use of that property.

Commentators suggested that ownership for this purpose should be defined

to mean ownership for general federal

income tax purposes and that mere

holding of title to property by a nongovernmental person should not necessarily

give rise to private business use. Commentators further suggested that certain

customary financing structures that require a nongovernmental person to be a

nominal owner of financed property

should be accommodated.

The final regulations adopt these suggestions.

3. Discharge of a primary legal obligation. The proposed regulations provide

that the use of bond proceeds to provide

property that discharges a primary and

unconditional legal obligation of a nongovernmental person results in private

business use of that property.

Commentators suggested that this rule

be deleted from the final regulations.

Many commentators indicated that this

rule would interfere with traditional tax

assessment bond financings for governmental projects such as roads and sidewalks. Some commentators also indicated that certain state and local

governments may be required or encouraged under state law to enter into development agreements with private developers that could result in private

business use of governmental projects

under the discharge of a primary legal

obligation rule.

The final regulations adopt this comment by deleting this rule.

4. Management contracts. The proposed regulations provide that management contracts other than qualified management contracts result in private

business use of the managed property.

Commentators suggested that the

qualified management contract rules

should be safe harbors, not substantive

rules, and that a management contract

should give rise to private business use

only if it transfers a proprietary interest

in financed property to a manager that is

a nongovernmental person. Commentators suggested that the permissible contract terms for qualified management

contracts should be further extended and

that limitations on the contract term

based on useful life of the financed

property should be deleted. In addition,

commentators suggested that contracts

for incidental services, such as janitorial

and equipment repair services, should

never give rise to private business use

of financed property.

The final regulations provide more

flexible accommodation for management

contracts that implement cost-saving

‘‘privatization’’ measures for state and

local governments, but continue to reflect the view that Congress intended

that a management contract can give

rise to private business use even if it

does not in substance transfer a

leasehold or ownership interest to a

nongovernmental person for general federal income tax purposes. Thus, the final

regulations do not adopt the rule that a

management contract gives rise to private business use only if it transfers a

proprietary interest to a nongovernmental service provider. The final regulations provide that the determination of

whether a management contract that

does not meet the qualified management

contract safe harbors gives rise to private business use is based on all of the

facts and circumstances. In general, a

management contract gives rise to private business use if the compensation

under the contract is based on net

profits. The final regulations further provide, however, that contracts for services

solely incidental to the primary governmental function or functions of a financed facility do not otherwise give

rise to private business use under the

management contract rules. In addition,

the final regulations clarify the standards

to be applied in determining whether a

management contract is properly characterized as a lease.

A separate revenue procedure establishes safe harbors which expand the

types of management contracts that do

not result in private business use. This

revenue procedure in particular permits

longer term management contracts for

public utility facilities and systems, relaxes certain of the requirements for

permitted compensation arrangements,

and deletes the requirement that the

issuer not control the service provider.

5. Research agreements. The proposed regulations set forth bright line

rules for determining when corporatesponsored research agreements and cooperative research agreements do not

give rise to private business use. These

rules apply only to basic research.

The final regulations provide a facts

and circumstances rule, and a separate

revenue procedure establishes safe harbors for determining when corporatesponsored research agreements and cooperative research agreements do not

give rise to private business use. This

revenue procedure also expands the

definition of basic research, for purposes

of Code section 141, to include any

original investigation for the advancement of scientific knowledge not having

a specific commercial objective.

6. Exception for general public use.

The proposed regulations contain detailed quantitative rules for determining

when use of financed property by a

nongovernmental person is disregarded

because the nongovernmental person is

treated as using the property as a member of the general public. The proposed

regulations also provide that use by a

nongovernmental person of financed

property is not treated as general public

use if the property provides a significant

economic benefit to the nongovernmental person because it is functionally and

integrally related to other property used

by the nongovernmental person.

Commentators suggested that the

quantitative rules for defining general

public use should be deleted, because

they are not sufficiently flexible to accommodate the wide variety of state and

local government financings and because they disproportionately affect

small local governments.

The final regulations largely delete

the quantitative approach in the proposed regulations for general public use.

Instead, the final regulations adopt a

more qualitative test focusing on

whether financed property is intended to

be available and in fact is reasonably

available for use on the same basis by

natural persons not engaged in a trade

or business. This approach is more consistent with the requirement in Code

section 141 that any activity carried on

by a person that is not a natural person

is treated as a trade or business activity.

Because the final regulations generally

do not treat mere economic benefit as

private business use, the rules for functionally and integrally related property

are deleted. In light of this narrower

definition of private business use, the

special system improvement rules have

also been deleted. The final regulations

retain the rule in the proposed regulations that use under an arrangement that

conveys priority rights is not use on the

same basis as the general public and

clarifies that an arrangement for longterm use (defined as more than 180

days) is not treated as general public

use. The final regulations provide that

use of financed property by a nongovernmental person that is not general

public use is not necessarily private

business use. Under the approach taken

in the final regulations, the definition of

general public use is significant for

determining when economic benefit

alone can give rise to private business

use and for determining the permitted

terms of short-term arrangements that

are not treated as private business use.

7. Exceptions for short-term arrangements. The proposed regulations provide

that a lease or similar arrangement that

has a term of 1 year or less and that is

not renewed or renewable is generally

disregarded. Commentators suggested

that longer term arrangements should be

disregarded.

The final regulations provide different

exceptions for various short-term contracts. The exceptions for short-term

contracts are based on a hierarchy depending on how broadly contracts with

the same terms are offered to other

users. Under this approach, a contract

that is available to the general public

may have a term up to 180 days; a

contract not treated as general public

use, but offered on the basis of generally applicable or uniformly applied

rates, may have a term of up to 90 days;

and a specially negotiated contract that

provides fair market value compensation

may have a term of up to 30 days. In

each case, the exception applies only if

the property is not financed for a principal purpose of providing that property

for use by the nongovernmental person

entering into the contract. The final

regulations delete the 1-year exception

for non-renewable short-term contracts

because the final regulations adopt a

more flexible rule for measuring private

business use, as discussed below.

8. Exception for temporary use by

developers. The proposed regulations

provide an exception for temporary use

by a developer of an improvement that

carries out an essential governmental

function during an initial development

period not exceeding 3 years.

Commentators suggested that the

3-year limitation on the exception is too

short for many developments and that a

requirement that development proceed

with reasonable speed should suffice.

The final regulations largely adopt

this comment. This approach focuses

more on whether financed property serving an essential governmental function

is transferred to a governmental person

with reasonable speed than on a specific

time frame for development of the property benefited by the improvement.

9. Exceptions for incidental use and

qualified improvements. The final regulations remove certain conditions to exceptions for incidental use and qualified

improvements.

10. Measurement of private business

use. The proposed regulations generally

provide that private business use is

measured on an annual basis, except for

private business use of output facilities.

Commentators suggested that private

business use should be measured on an

average or cumulative basis over the

term of an issue.

The final regulations largely adopt the

suggestion that private business use

should be measured over the term of an

issue. In general, the percentage of

private business use of financed property is determined according to the

average annual private business use of

that property over the measurement period. The measurement period begins on

the later of the issue date of the issue or

the date the property is placed in service

and ends on the earlier of the last date

of the reasonably expected economic

life of the property or the latest maturity

date of any bond of the issue. For

certain bonds that are issued in contemplation of refinancing, such as bond

anticipation notes, the measurement period is based on the final maturity date

of any bond of the refunding issue.

Under an anti-abuse rule, however, if an

issuer extends the term of an issue for a

principal purpose of increasing the permitted amount of private business use,

the Commissioner may determine the

amount of private business use according to the greatest percentage of private

business use in any 1-year period. Fur-

ther, if an issuer reasonably expects on

the issue date that bonds will be redeemed before the final maturity of the

issue because of a deliberate action, the

measurement period ends on the reasonably expected date of redemption. In

addition, for arrangements that result in

ownership of financed property by a

nongovernmental person, the amount of

private business use is the greatest percentage of private business use in any

1-year period.

This approach of looking to the average amount of private business use over

the expected economic life of financed

property is more consistent with the

approach adopted for measuring private

payments and security, which also in

effect looks over the term of an issue.

This approach also provides issuers with

significantly greater flexibility to spread

out de minimis private business use over

the term of an issue.

The final regulations adopt the

measurement-over-the-term rule for private business use, however, only for

purposes of determining whether an issue has no more than the permitted

amount of private business use (that is,

in most cases, the 10 percent threshold).

This general approach reflects the view

that adoption of the measurement-overthe-term rule for purposes other than the

de minimis rules would be unduly complex to administer and could distort the

economic substance.

This general approach also simplifies

the regulations by providing a single

rule for measuring private business use

that applies to both output facilities and

other governmental facilities. The final

regulations reflect the view that all

governmental facilities generally would

benefit from more flexible private business use measurement rules.

11. Determining average use within

an annual period. The proposed regulations generally provide that the average

amount of private business use within a

year is based on the amount of time

financed property is actually used for

private business use as a percentage of

total time for all actual use, provided

that significant differences in fair market

value of different times of use must be

taken into account.

Some commentators suggested that

the average amount of private business

use should be based on a comparison of

time of private business use to time the

financed property is available for use,

not to time it is actually used.

The final regulations continue to determine private business use for certain

purposes as a percentage of actual use.

This method more accurately reflects

economic substance. The final regulations also clarify that, in certain cases,

the determination of fair market value of

private business use must take into

account the amount of private payments

for that use.

D. Section 1.141–4 Private security or

payment test

1. Payments not directly made by

private business users. The proposed

regulations provide that payments made

with respect to property used for a

private business use are taken into account under the private payment test,

even if not made by persons that are

private business users of proceeds. Commentators suggested that payments by

persons that are not private business

users should be taken into account only

if they can be imputed to a private

business user of proceeds.

The final regulations retain the general rule in the proposed regulations but

clarify that only payments made for the

period of private business use are taken

into account. The definition of private

business use in the final regulations

narrows the application of this general

rule.

2. Allocation of private payments to

different sources of funding. The proposed regulations provide that a payment from a private business user of

property may be allocated first to repay

any costs of the property paid by the

issuer from a source other than a borrowing (‘‘equity’’). The proposed regulations also provide, however, that, if a

payment is made for property financed

with two or more issues (including

issues that are not tax-exempt), the

payment must be allocated among those

issues according to the relative amount

of proceeds of those issues used to

finance the property. Commentators generally favored the rule permitting allocations first to equity, but suggested that

the same rule should apply to costs

financed with taxable bonds.

The final regulations provide a more

general facts and circumstances test for

the allocation of private payments that

looks to the nexus between the private

payment and both the property financed

and the source of funding. Thus, under

the approach of the final regulations,

allocations of private payments first to

equity before other sources of funding

are generally permitted only to the extent that there is a specific nexus between the payment and a prior expendi-

ture. The final regulations do not adopt

the recommendation that issuers also be

permitted in all cases to allocate private

payments first to repayment of taxable

bonds, but treat the obligation to pay

debt service in future years under the

taxable debt as establishing a nexus to

future private payments. The final regulations retain the rule that allocations of

private payments among issues according to relative amounts of those sources

of funding that are expended on the

property is generally appropriate, but the

final regulations provide issuers with

more flexibility to match these allocations to debt service payments associated with various sources of funding.

3. Allocation of private security

among issues. The proposed regulations

provide that, for bonds other than parity

bonds, property or payments securing

more than one issue must be fully

allocated to each issue under the private

security test. Commentators suggested

that the rule for allocation of private

security among issues should reasonably

reflect foreclosure and default scenarios

under the bond documents. The final

regulations in general adopt this comment.

4. Limitations on private security.

The proposed regulations provide that

any property that is used for a private

business use is taken into account under

the private security test if it secures

payment of debt service on an issue.

The final regulations provide that

only financed property and property that

is provided directly or indirectly by a

nongovernmental person that is treated

as a user of proceeds are taken into

account under the private security test.

5. Exception for generally applicable

taxes. The proposed regulations contain

specific rules for when a special agreement with respect to a generally applicable tax may cause tax payments to be

treated as private payments.

In response to comments, the final

regulations are more flexible for arrangements that reduce the amount of

tax paid and permit a wider range of tax

equivalency payments. The final regulations also clarify that an impermissible

agreement entered into by one taxpayer

does not affect whether payments made

by other taxpayers are treated as generally applicable taxes.

E. Section 1.141–5 Private loan financing test

1. Definition of proceeds for purposes

of the private loan financing test. The

proposed regulations provide that the

private loan financing test is met if

more than the lesser of 5 percent of the

‘‘proceeds’’ or $5 million of ‘‘sale proceeds’’ is used to make or finance loans

to nongovernmental persons. Commentators suggested that the definition of

proceeds for purposes of the test should

be consistent.

The final regulations apply the general private activity bond definition of

‘‘proceeds’’ to both parts of the test.

This approach reflects the view that

investment proceeds that are used to

make or finance loans should be taken

into account in determining whether the

private loan financing test is met.

2. Requirements for the ‘‘tax assessment loan’’ exception. The proposed

regulations provide that a number of

special requirements apply to the exception in Code section 141(c)(2) from the

private loan financing test for loans that

enable the borrower to finance a governmental tax or assessment of general

application for a specific essential governmental function. Commentators suggested that these requirements would

improperly restrict traditional special tax

and assessment tax-exempt financing for

governmental infrastructure in some

states.

In general, special state law restrictions (for example, state constitutional

limitations on issuing general obligation

bonds) should not necessarily foreclose

state and local governments from access

to tax-exempt financing for traditional

governmental infrastructure projects. Accordingly, the final regulations relax the

requirements for the tax assessment

bond exception. The requirement that a

tax or assessment of general application

be proportionate to the benefit to the

taxpayer is deleted. Further, the definition of improvements that serve essential governmental functions is expanded.

Under the new definition, all improvements to utilities and systems that are

owned by a governmental person and

that are available for use by the general

public serve essential governmental

functions for this purpose. In addition,

the final regulations provide that guarantees provided by persons treated as

borrowers in most cases will not cause

taxes or assessments to fail to qualify

for the tax assessment bond exception.

F. Section 1.141–6 Allocation and accounting rules

1. Allocations of proceeds to expenditures. The proposed regulations in

general provide that proceeds must be

allocated to expenditures consistently for

private activity bond purposes and

arbitrage purposes. Commentators suggested that, in light of the different

purposes of the private activity bond

rules and the arbitrage rules, this consistency should not be required.

The final regulations continue the

approach of the proposed regulations.

Final regulations are also adopted under

Code section 148 clarifying that allocations of proceeds to expenditures for

both purposes must be made by a

definite time (in no event later than the

date that rebate is, or would be, due).

2. Other allocation rules. The proposed regulations contain detailed rules

in §§ 1.141–1 and 1.141–6 for allocations of proceeds and bonds, including

rules for mixed use facilities and partnerships.

The final regulations reserve these

provisions. The IRS and Treasury are

considering more flexible rules to accommodate public/private partnerships.

G. Section 1.141–7 Special rules for

output contracts

The proposed regulations contain detailed rules in § 1.141–7 for determining the private business use and private

payments resulting from output contracts.

Regulatory changes are dramatically

affecting the electric power industry. In

order to further consider the issues

raised by these changes, the final regulations reserve this section. The final

regulations, however, otherwise apply to

bonds issued to finance output facilities.

H. Section 1.141–8 $15 million limitation for output facilities

Clarification of computation of

nonqualified amount. The proposed

regulations provide guidance on the special $15 million limitation on output

facilities of Code section 141(b)(4). The

final regulations reserve this section.

I. Section 1.141–12 Remedial actions

1. Remedial actions generally. The

proposed regulations provide that an

action that causes the private business

tests or the private loan financing test to

be met is not treated as a deliberate

action if the issuer takes an appropriate

remedial action.

The final regulations clarify that a

remedial action affects only compliance

with the private activity bond rules

relating to use of proceeds and does not

affect compliance with rules relating to

security or payment. This clarification is

important for purposes of determining

the amount of ‘‘nonqualified bonds’’

with respect to which a remedial action

must be taken.

2. Relationship of disposition proceeds and remedial actions. The proposed regulations contain separate rules

for use of proceeds derived from the

disposition of bond-financed property

(‘‘disposition proceeds’’) and remedial

actions. Commentators suggested that

the relationship between the disposition

proceeds rules and the remedial action

rules should be clarified and that, in

particular, additional rules should be

provided indicating when it is appropriate to treat an issue as financing disposition proceeds rather than the transferred

property.

The final regulations take the view

that, if an issuer disposes of bondfinanced property, it is generally appropriate under Code section 141 for the

Commissioner to treat the issue as financing either the transferred property

or the disposition proceeds. This is

because any disposition of bondfinanced property has the potential to

transfer the benefits of tax-exempt financing to the purchaser, and the private

activity bond rules extend to transactions that have significant potential to

transfer these benefits, as well as transactions that actually transfer these benefits. As a matter of administrative convenience, however, the final regulations

in certain cases permit an issuer to

choose to treat an issue as financing

either the transferred property or the

disposition proceeds, provided that certain conditions are met that protect

against abuse. The final regulations accordingly treat the disposition proceeds

rules as conditions to taking certain

remedial actions. For example, in order

for an issue to be eligible for a remedial

action, the disposition proceeds of an

issue must generally be treated as proceeds for purposes of the arbitrage regulations.

3. Conditions to taking a remedial

action. The proposed regulations provide

that an issuer may take a remedial

action to prevent bonds of an issue from

becoming private activity bonds only if

it made certain covenants and certifications on the issue date. Commentators

suggested that these specific requirements should be deleted because they

are unnecessary in light of standard

industry practice to require similar covenants and certifications. The final regulations adopt this comment.

4. Maturity limitations and remedial

actions. The proposed regulations provide that an issuer cannot take advantage of certain favorable rules involving

disposition proceeds if the weighted average maturity of an issue is greater

than 120 percent of the economic life of

the financed property. Commentators

suggested that use of this 120 percent

maturity limitation as a condition to

favorable treatment in taking remedial

actions is burdensome for issuers of

governmental bonds.

The final regulations provide that an

issue is eligible for the remedial action

rules only if the term of the issue is not

longer than is reasonably necessary for

the governmental purposes of the issue.

To determine whether the term of an

issue is unreasonably long, the final

regulations adopt the same standard that

is used for purposes of determining

whether replacement proceeds arise because the term of an issue is unreasonably long under § 1.148–1(c)(4). This

standard provides that the 120 percent

maturity limitation is a safe harbor,

rather than a requirement in all cases.

5. Special rules for identifying disposition proceeds. Under the proposed

regulations, many of the rules for remedial actions depend on identification of

disposition proceeds. The final regulations clarify how disposition proceeds

are to be allocated to an issue when the

transferred property has been financed

with different sources of funding. In

general, the final regulations provide

that disposition proceeds should be allocated first to the outstanding bonds that

financed the property (both tax-exempt

and taxable) in proportion to the outstanding principal amounts of those outstanding bonds. Only amounts in excess

of these outstanding principal amounts

may be allocated to other sources of

funding, such as equity of an issuer or

bonds that are no longer outstanding.

6. Redemption and defeasance as remedial actions. The proposed regulations

generally provide that redemption and

defeasance of nonqualified bonds are

permitted remedial actions. In cases

where the disposition is exclusively for

cash, only the disposition proceeds need

to be used to redeem or defease bonds;

in other cases, the entire amount of

nonqualified bonds is required to be

redeemed or defeased. The proposed

regulations also provide, however, that

defeasance of bonds to a date that is

more than six months from the date of a

deliberate action is permitted only if the

possibility of a disposition was remote

as of the issue date of the bonds.

Commentators suggested that this special limitation should be deleted because

the remoteness standard is vague and

would require governmental issuers to

use special call provisions that would

substantially increase borrowing costs.

The final regulations delete the ‘‘remote possibility’’ limitation on use of

defeasance as a remedial action. Instead,

the final regulations permit defeasance

as a remedial action only if the first call

date of the nonqualified bonds is not

greater than 10 1/2 years from the issue

date. This limitation presents an administrable standard that will not unduly

interfere with customary financing practices of state and local governments,

while at the same time preventing improper use of defeasance as a remedial

action for bonds that cannot be called

for an extended period of time.

7. Alternative qualifying use of a facility as a remedial action. The proposed

regulations provide that alternative

qualifying use of a bond-financed facility is a permitted remedial action if the

facility is used in a manner that meets

the requirements for any type of qualified private activity bonds and the bonds

are treated as reissued as of the date of

the deliberate action for purposes of the

tax-exempt bond rules concerning use of

bond-financed property. Commentators

suggested that for purposes of determining whether bonds that are treated as

reissued as of the date of the deliberate

action satisfy all of the applicable requirements for qualified bonds, the rules

contained in Code section 146 relating

to volume cap and the rules contained in

Code sections 55 and 57 should not

apply. Commentators also suggested that

the regulations should clarify whether

any limitations are placed on an issuer’s

use of disposition proceeds when it

chooses to use this remedial action.

The final regulations provide that, in

order to qualify for this remedial action,

an issuer must deposit any disposition

proceeds that it receives into a yieldrestricted escrow to pay the nonqualified

bonds. This requirement is different than

the defeasance remedial action, because

an issuer is permitted to leave bonds

outstanding until maturity (rather than

the first call date) and is not subject to

the special 10 1/2-year call protection

limitation on the defeasance remedial

action. Also, if an issuer chooses to use

this rule, it may receive compensation in

installments and use any payments received either to pay debt service or to

deposit into a yield-restricted escrow to

pay debt service. This requirement is

appropriate because it establishes the

necessary nexus between the new user

and the nonqualified bonds. In effect,

the new user is treated, as far as is

reasonably practicable, as if it were the

conduit borrower of the bond proceeds.

The final regulations also clarify that,

for purposes of determining whether

nonqualified bonds that are deemed to

be reissued meet all of the requirements

for qualified private activity bonds, the

law in effect on the date of the deliberate action applies. The final regulations

do not adopt the suggestion that the

rules contained in Code section 146

relating to volume cap and the rules

contained in Code sections 55 and 57

should not apply. The IRS and Treasury

are issuing a revenue procedure (discussed in paragraph 10 below) to address the change in status of bonds from

governmental bonds to qualified private

activity bonds and the application of the

alternative minimum tax provisions. The

final regulations provide that the rules

contained in Code section 147(d) relating to the acquisition of existing property do not apply to this remedial action.

8. Nonqualified bonds. The proposed

regulations permit an issuer to take a

remedial action with respect to a portion

of the bonds of an issue, rather than the

entire issue. In general, the proposed

regulations require that these ‘‘nonqualified bonds’’ be a pro rata portion

(among the maturities) of the outstanding bonds of an issue. Commentators

suggested that issuers should have

greater flexibility to allocate uses of

proceeds to bonds when a deliberate

action occurs.

The final regulations permit an issuer

to redeem or defease bonds with longer

maturities than the nonqualified bonds

in a remedial action, but in general

continue to require that nonqualified

bonds be identified on a pro rata basis.

Issuers have significant flexibility to

allocate bonds of an issue to separate

purposes on or before the issue date

under § 1.150–1(c)(3).

Under the final regulations, the percentage of outstanding bonds that are

nonqualified bonds is equal to the highest percentage of private business use in

any 1-year period commencing with the

deliberate action.

9. Effect of deliberate actions and

remedial actions on bonds that have

been advance refunded. The proposed

regulations do not specifically address

how deliberate actions and remedial actions affect bonds that have been ad-

vance refunded. Commentators suggested that a deliberate action should

not affect the status of an advance

refunded bond under Code section 141.

The final regulations provide that a

remedial action taken with respect to

advance refunding bonds proportionately

‘‘cures’’ the bonds that have been advance refunded.

10. Remedial payment revenue procedure. The preamble to the proposed

regulations indicates that the IRS and

Treasury are considering issuance of a

revenue procedure pursuant to which an

issuer may request a closing agreement

with respect to outstanding bonds. Under the closing agreement, the issuer

would make a payment to the IRS to

prevent the interest on bonds from being

includible in gross income of bondholders as a result of a deliberate action that

results in satisfaction of the private

activity bond test. In general, the payment would be based on the difference

between applicable federal rates for taxable and tax-exempt obligations. The

preamble to the proposed regulations

indicates that this revenue procedure is

being considered in lieu of permitting

defeasance as a remedial action. Commentators generally favored the publication of such a revenue procedure but

suggested that it should apply in addition to defeasance as a remedial action.

Commentators also suggested that an

issuer should be permitted to make a

payment to the IRS in those cases where

the bonds were issued as governmental

bonds, the interest on which was not

treated as an item of tax preference for

purposes of the alternative minimum tax

provisions, but the bonds become qualified private activity bonds, the interest

on which is treated as an item of tax

preference for purposes of the alternative minimum tax provisions as a consequence of a remedial action taken by the

issuer.

The IRS and Treasury are issuing a

revenue procedure in addition to permitting defeasance as a remedial action.

Under this revenue procedure the

amount of the remedial payment is

based on a factor that roughly approximates revenue loss to the United States

rather than the difference between taxable and tax-exempt applicable federal

rates. While this approach may in many

cases require greater remedial payments

than under the approach described in the

proposed regulations, the fluctuation in

the difference between taxable and taxexempt applicable federal rates would

result in inconsistent treatment of issu-

ers. Further, a more rigorous standard

for determining the remedial payment is

appropriate because the revenue procedure is adopted in addition to all of the

remedial actions set forth in the final

regulations.

In response to comments, this revenue

procedure also provides that an issuer

may make a payment to prevent the

application of the alternative minimum

tax provisions to interest payable on

bonds that were issued as governmental

bonds but, as a consequence of a remedial action taken by an issuer, are

qualified private activity bonds. This

approach recognizes the difficulty state

and local government issuers may have

in notifying bondholders of this change

in status.

J. Section 1.141–13 Refunding issues

The final regulations reserve on the

treatment of refunding bonds under

Code section 141.

K. Section 1.141–14 Anti-abuse rules

Application of the rule to override

specific tracing. The proposed regulations provide that if an issuer enters into

a transaction or series of transactions

with a principal purpose of transferring

to nongovernmental persons (other than

as members of the general public) significant benefits of tax-exempt financing

in a manner that is inconsistent with the

purposes of Code section 141, the Commissioner may take any action to reflect

the substance of the transaction or transactions.

The final regulations adopt this rule

and add examples to clarify that it may

be invoked in appropriate cases to override specific tracing of the use of proceeds.

L. Section 1.145–1 Special rules for

qualified 501(c)(3) bonds

1. Application of private activity

bond rules to Code section 145(a). The

proposed regulations provide that the

regulations under Code section 141 interpreting the private activity bond tests

apply for purposes of Code section

145(a)(2).

The final regulations in general continue this approach but also provide that

certain provisions under Code section

141, which are intended to apply only to

governmental programs, do not apply to

qualified 501(c)(3) bonds. The final

regulations also clarify that regulations

under Code section 141 apply in the

same manner to the ownership test of

Code section 145(a)(1) and to the modified private activity bond test of Code

section 145(a)(2).

2. Application of deliberate action

and remedial action rules to other provisions of Code section 145. The proposed

regulations provide that the deliberate

action rules of § 1.141–2 and the remedial action rules of § 1.141–12 generally apply to Code section 145.

The final regulations do not apply to

Code sections 145(b), (c), or (d). The

$150 million limitation on bonds other

than hospital bonds of Code sections

145(b) and (c) involves a number of

special considerations, which the IRS

and Treasury believe would be more

appropriate to consider in a project

comprehensively interpreting the operation of the special volume cap rules.

Similarly, the restrictions on bonds used

to provide residential rental housing for

family units of Code section 145(d)

involve a number of special considerations, which the IRS and Treasury

believe would be more appropriate to

consider in a project comprehensively

interpreting the special rules for bonds

financing residential rental housing.

M. Special rules for other qualified

bonds

1. General standard for compliance.

The proposed regulations provide that

the requirements for qualified bonds

(other than qualified 501(c)(3) bonds)

generally must be actually met throughout the term of an issue. Commentators

suggested that this rule should be deleted because the compliance standard

for each type of qualified bond should

be separately considered. Other commentators suggested that the compliance

standard applicable to governmental

bonds, looking to reasonable expectations and deliberate actions, is generally

appropriate for qualified bonds.

The final regulations do not address

the general compliance standard for

qualified bonds (other than qualified

501(c)(3) bonds). The IRS and Treasury

believe that further consideration should

be given to whether special rules apply

to different types of qualified bonds.

Accordingly, the final regulations address only whether remedial actions may

be taken to prevent certain types of

qualified bonds from failing to meet

requirements relating to use of proceeds.

Thus, no implication is intended that the

measurement-over-the-term rule for private business use under Code sections

141 and 145 applies in any manner to

other qualified bonds.

2. Remedial actions for change in

use. The proposed regulations in general

provide that, if an action results in

nonqualified use of proceeds, the remedial actions that apply to governmental

bonds also apply to qualified bonds. The

permitted remedial actions include redemption and defeasance of bonds and

alternative qualifying use of a facility.

The final regulations address only

whether remedial actions may be taken

for exempt facility bonds under Code

section 142 and qualified small issue

bonds under Code section 144(a) and

with respect to certain provisions of

147. The final regulations continue to

provide that redemption and defeasance

are permitted remedial actions for these

types of issues, under rules that are

similar to the remedial action rules that

apply to governmental bonds. The requirements for these types of qualified

bonds focus on the use of a particular

facility for a particular qualifying use,

and, unlike governmental bonds and

qualified 501(c)(3) bonds, do not generally focus on the status of the borrower.

For this reason, the final regulations

generally do not permit an issuer of

exempt facility bonds or qualified small

issue bonds to take a remedial action

based on use of disposition proceeds.

Accordingly, the final regulations clarify

that the amount of bonds required to be

redeemed or defeased under a remedial

action is not limited to the amount of

disposition proceeds. For administrative

convenience, however, the final regulations permit the use of disposition proceeds from the sale of personal property

that is incidental to a qualifying facility

to replace the personal property that is

sold. The final regulations do not permit

alternative qualifying use of a facility as

a remedial action for exempt facility

bonds or qualified small issue bonds.

3. Remedial actions for failure to

spend proceeds. The proposed regulations provide that a remedial action may

be taken to correct a failure to spend

proceeds as required under Code sections 142 and 144. This rule replaces

Rev. Proc. 79–5, 1979–1 C.B. 485, and

Rev. Proc. 81–22, 1981–1 C.B. 692,

which provide guidance on how the

requirement in the predecessor to Code

section 142 that substantially all of the

proceeds be spent for a qualifying purpose is met when excess bond proceeds

remain on hand after acquisition or

construction has been completed.

The final regulations clarify that the

requirements for remedial action in the

case of failure to spend proceeds for a

qualifying purpose are comparable to

the requirements for remedial action in

the case of change in use of a qualifying

facility. Accordingly, the final regulations require that nonqualified bonds

must be redeemed at their first call date,

regardless of the amount of call premium that is required to be paid, and

that defeasance is permitted only if the

first call date is no later than 10 1/2

years after the issue date.

4. Refundings of qualified bonds. The

final regulations reserve on the treatment of refundings of qualified bonds.

N. Section 1.150–4 Statutory change of

use rules for qualified private activity

bonds

The proposed regulations provide that

the change of use provisions of Code

section 150(b) apply even if an issuer

takes a remedial action that enables an

issue of qualified private activity bonds

to continue to meet use of proceeds

requirements. Commentators suggested

that a remedial action that preserves the

tax-exempt status of a qualified private

activity bond should also prevent application of the interest deduction denial

and imputed unrelated business income

provisions of Code section 150(b).

The final regulations more specifically address the effect of each type of

remedial action on the application of the

Code section 150(b) consequences. In

general, defeasance of bonds does not

prevent application of Code section

150(b). If other remedial actions are

taken promptly after the date of the

remedial action, however, Code section

150(b) does not apply.

O. Effective dates

The final regulations generally apply

to bonds issued after May 16, 1997. To

promote compliance, the final regulations generally permit elective, retroactive application of the regulations in

whole, but not in part, to outstanding

issues. In addition, the final regulations

permit elective, retroactive application to

outstanding issues of any of the following sections of the regulations: § 1.141–

12 (the remedial action rules); § 1.141–

3(b)(4) (the management contract rules);

and § 1.141–3(b)(6) (the research agreement rules).

Effect on Other Documents

In part because the existing industrial

development bond regulations under

§ 1.103–7 may continue to apply to

refunding bonds issued after the effec-

tive date of the private activity bond

regulations, § 1.103–7 is not being removed from the Code of Federal Regulations.

For bonds to which the final regulations apply, the following publications

are obsolete:

Notice 87–69, 1987–2 C.B. 378.

Notice 89–9, 1989–1 C.B. 630.

For actions that occur on or after May

16, 1997, the following publications are

obsolete:

Rev. Proc. 93–17, 1993–1 C.B. 507.

Rev. Proc. 81–22, 1981–1 C.B. 692.

Rev. Proc. 79–5, 1979–1 C.B. 485.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.

Therefore, a regulatory assessment is not

required. It also has been determined

that section 553(b) of the Administrative

Procedure Act (5 U.S.C. chapter 5) does

not apply to these regulations, and because the notice of proposed rulemaking

preceding the regulations was issued

prior to March 29, 1996, the Regulatory

Flexibility Act (5 U.S.C. chapter 6) does

not apply. Pursuant to section 7805(f) of

the Internal Revenue Code, the notice of

proposed rulemaking preceding these

regulations was submitted to the Chief

Counsel for Advocacy of the Small

Business Administration for comment on

its impact on small business.

Drafting Information

The principal authors of these regulations are Michael G. Bailey, Loretta J.

Finger, and Nancy M. Lashnits, Office

of Assistant Chief Counsel (Financial

Institutions and Products), and Linda B.

Schakel of the Office of Tax Legislative

Counsel. However, other personnel from

the IRS and Treasury Department participated in their development.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation

for part 1 is amended by adding an

entry in numerical order to read as

follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.148–6 also issued under 26

U.S.C. 148(f), (g), and (i). * * *

Section 1.150–4 also issued under 26

U.S.C. 150(c)(5). * * *

Par. 2. The center heading immediately preceding § 1.141–1 is revised to

read as follows:

TAX EXEMPTION REQUIREMENTS

FOR STATE AND LOCAL BONDS

Par. 3. Section 1.141–1 is revised.

§ 1.143–1 [Redesignated as § 1.7703–

Par. 4. Section 1.143–1 is redesignated as § 1.7703–1.

§ 1.144–3 [Removed]

Par. 5. Section 1.144–3 is removed.

Par. 6. Sections 1.141–0 and 1.141–2

through 1.141–16 are added.

The revised and added sections read

as follows:

§ 1.141–0 Table of contents.

This section lists the captioned paragraphs contained in §§ 1.141–1 through

1.141–16.

§ 1.141–1 Definitions and rules of general application.

(a) In general.

(b) Certain general definitions.

(d) Related parties.

§ 1.141–2 Private activity bond tests.

(a) Overview.

(b) Scope.

(d) Reasonable expectations and deliberate actions.

(1) In general.

(2) Reasonable expectations test.

(3) Deliberate action defined.

(4) Special rule for dispositions of

personal property in the ordinary course

of an established governmental program.

(5) Special rule for general obligation

bond programs that finance a large

number of separate purposes.

(e) When a deliberate action occurs.

(f) Certain remedial actions.

(g) Examples.

§ 1.141–3 Definition of private business use.

(a) General rule.

(1) In general.

(2) Indirect use.

(3) Aggregation of private business

use.

(b) Types of private business use arrangements.

(1) In general.

(2) Ownership.

(3) Leases.

(4) Management contracts.

(5) Output contracts.

(6) Research agreements.

(7) Other actual or beneficial use.

(1) In general.

(2) Use on the same basis.

(3) Long-term arrangements not

treated as general public use.

(4) Relation to other use.

(d) Other exceptions.

(1) Agents.

(2) Use incidental to financing arrangements.

(3) Exceptions for arrangements other

than arrangements resulting in ownership of financed property by a nongovernmental person.

(4) Temporary use by developers.

(5) Incidental use.

(6) Qualified improvements.

(e) Special rule for tax assessment

bonds.

(f) Examples.

(g) Measurement of private business

use.

(1) In general.

(2) Measurement period.

(3) Determining average percentage

of private business use.

(4) Determining the average amount

of private business use for a 1-year

period.

(5) Common areas.

(6) Allocation of neutral costs.

(7) Commencement of measurement

of private business use.

(8) Examples.

§ 1.141–4 Private security or payment

test.

(a) General rule.

(1) Private security or payment.

(2) Aggregation of private payments

and security.

(3) Underlying arrangement.

(b) Measurement of private payments

and security.

(1) Scope.

(2) Present value measurement.

(1) In general.

(2) Payments taken into account.

(3) Allocation of payments.

(d) Private security.

(1) In general.

(2) Security taken into account.

(3) Pledge of unexpended proceeds.

(4) Secured by any interest in property or payments.

(5) Payments in respect of property.

(6) Allocation of security among issues.

(e) Generally applicable taxes.

(1) General rule.

(2) Definition of generally applicable

taxes.

(3) Special charges.

(4) Manner of determination and collection.

(5) Payments in lieu of taxes.

(f) Certain waste remediation bonds.

(1) Scope.

(2) Persons that are not private users.

(3) Persons that are private users.

(g) Examples.

§ 1.141–5 Private loan financing test.

(a) In general.

(b) Measurement of test.

(1) In general.

(2) Application only to purpose investments.

(3) Grants.

(4) Hazardous waste remediation

bonds.

(d) Tax assessment loan exception.

(1) General rule.

(2) Tax assessment loan defined.

(3) Mandatory tax or other assessment.

(4) Specific essential governmental

function.

(5) Equal basis requirement.

(6) Coordination with private business tests.

(e) Examples.

§ 1.141–6 Allocation and accounting

rules.

(a) Allocation of proceeds to expenditures.

(b) Allocation of proceeds to property. [Reserved]

(d) Allocation of proceeds to common areas. [Reserved]

(e) Allocation of proceeds to bonds.

[Reserved]

(f) Treatment of partnerships. [Reserved]

(g) Examples. [Reserved]

§ 1.141–7

contracts.

Special rules for output

[Reserved]

§ 1.141–8 $15 million limitation for

output facilities.

[Reserved]

§ 1.141–9 Unrelated or disproportionate use test.

(a) General rules.

(1) Description of test.

(2) Application of unrelated or disproportionate use test.

(b) Unrelated use.

(1) In general.

(2) Use for the same purpose as

government use.

(1) Definition of disproportionate use.

(2) Aggregation of related uses.

(3) Allocation rule.

(d) Maximum use taken into account.

(e) Examples.

§ 1.141–10

cap.

Coordination with volume

[Reserved]

§ 1.141–11 Acquisition of nongovernmental output property.

[Reserved]

§ 1.141–12 Remedial actions.

(a) Conditions to taking remedial action.

(1) Reasonable expectations test met.

(2) Maturity not unreasonably long.

(3) Fair market value consideration.

(4) Disposition proceeds treated as

gross proceeds for arbitrage purposes.

(5) Proceeds expended on a governmental purpose.

(b) Effect of a remedial action.

(1) In general.

(2) Effect on bonds that have been

advance refunded.

(1) Definition.

(2) Allocating disposition proceeds to

an issue.

(3) Allocating disposition proceeds to

different sources of funding.

(d) Redemption or defeasance of

nonqualified bonds.

(1) In general.

(2) Special rule for dispositions for

cash.

(3) Notice of defeasance.

(4) Special limitation.

(5) Defeasance escrow defined.

(e) Alternative use of disposition proceeds.

(1) In general.

(2) Special rule for use by 501(c)(3)

organizations.

(f) Alternative use of facility.

(g) Rules for deemed reissuance.

(h) Authority of Commissioner to

provide for additional remedial actions.

(i) Effect of remedial action on continuing compliance.

(j) Nonqualified bonds.

(1) Amount of nonqualified bonds.

(2) Allocation of nonqualified bonds.

(k) Examples.

§ 1.141–13 Refunding issues.

[Reserved]

§ 1.141–14 Anti-abuse rules.

(a) Authority of Commissioner to reflect substance of transactions.

(b) Examples.

§ 1.141–15 Effective dates.

(a) Scope.

(b) Effective dates.

(d) Permissive application of regulations.

(e) Permissive retroactive application

of certain sections.

§ 1.141–16 Effective dates for qualified

private activity bond provisions.

(a) Scope.

(b) Effective dates.

§ 1.141–1 Definitions and rules of general application.

(a) In general. For purposes of

§§ 1.141–0 through 1.141–16, the following definitions and rules apply: the

definitions in this section, the definitions

in § 1.150–1, the definition of placed in

service under § 1.150–2(c), the definition of grant under § 1.148–6(d)(4)(iii),

the definition of reasonably required

reserve or replacement fund in § 1.148–

2(f), and the following definitions under

§ 1.148–1: bond year, commingled

fund, fixed yield issue, higher yielding

investments, investment, investment proceeds, issue price, issuer, nonpurpose

investment, purpose investment, qualified guarantee, qualified hedge, reasonable expectations or reasonableness, rebate amount, replacement proceeds, sale

proceeds, variable yield issue, and yield.

(b) Certain general definitions. Common areas means portions of a facility

that are equally available to all users of

a facility on the same basis for uses that

are incidental to the primary use of the

facility. For example, hallways and elevators generally are treated as common

areas if they are used by the different

lessees of a facility in connection with

the primary use of that facility.

Consistently applied means applied

uniformly to account for proceeds and

other amounts.

Deliberate action is defined in

§ 1.141–2(d)(3).

Discrete portion means a portion of a

facility that consists of any separate and

discrete portion of a facility to which

use is limited, other than common areas.

A floor of a building and a portion of a

building separated by walls, partitions,

or other physical barriers are examples

of a discrete portion.

Disposition is defined in § 1.141–

12(c)(1).

Disposition proceeds is defined in

§ 1.141–12(c)(1).

Essential governmental function is defined in § 1.141–5(d)(4)(ii).

Financed means constructed, reconstructed, or acquired with proceeds of an

issue.

Governmental bond means a bond

issued as part of an issue no portion of

which consists of private activity bonds.

Governmental person means a state or

local governmental unit as defined in

§ 1.103–1 or any instrumentality

thereof. It does not include the United

States or any agency or instrumentality

thereof.

Hazardous waste remediation bonds

is defined in § 1.141–4(f)(1).

Measurement period is defined in

§ 1.141–3(g)(2).

Nongovernmental person means a

person other than a governmental person.

Output facility means electric and gas

generation, transmission, distribution,

and related facilities, and water collection, storage, and distribution facilities.

Private business tests means the private business use test and the private

security or payment test of section

141(b).

Proceeds means the sale proceeds of

an issue (other than those sale proceeds

used to retire bonds of the issue that are

not deposited in a reasonably required

reserve or replacement fund). Proceeds

also include any investment proceeds

from investments that accrue during the

project period (net of rebate amounts

attributable to the project period). Disposition proceeds of an issue are treated

as proceeds to the extent provided in

§ 1.141–12. The Commissioner may

treat any replaced amounts as proceeds.

Project period means the period beginning on the issue date and ending on

the date that the project is placed in

service. In the case of a multipurpose

issue, the issuer may elect to treat the

project period for the entire issue as

ending on either the expiration of the

temporary period described in § 1.148–

2(e)(2) or the end of the fifth bond year

after the issue date.

Public utility property means public

utility property as defined in section

168(i)(10).

Qualified bond means a qualified

bond as defined in section 141(e).

Renewal option means a provision

under which either party has a legally

enforceable right to renew the contract.

Thus, for example, a provision under

which a contract is automatically renewed for 1-year periods absent cancellation by either party is not a renewal

option (even if it is expected to be

renewed).

Replaced amounts means replacement

proceeds other than amounts that are

treated as replacement proceeds solely

because they are sinking funds or

pledged funds.

Weighted average maturity is determined under section 147(b).

Weighted average reasonably expected economic life is determined under section 147(b). The reasonably expected economic life of property may be

determined by reference to the class life

of the property under section 168.

in writing on or before the issue date

and retained as part of the bond documents, and, once made, may not be

revoked without the permission of the

Commissioner.

(d) Related parties. Except as otherwise provided, all related parties are

treated as one person and any reference

to ‘‘person’’ includes any related party.

§ 1.141–2 Private activity bond tests.

(a) Overview. Interest on a private

activity bond is not excludable from

gross income under section 103(a) unless the bond is a qualified bond. The

purpose of the private activity bond tests

of section 141 is to limit the volume of

tax-exempt bonds that finance the activities of nongovernmental persons, without regard to whether a financing actually transfers benefits of tax-exempt

financing to a nongovernmental person.

The private activity bond tests serve to

identify arrangements that have the potential to transfer the benefits of taxexempt financing, as well as arrangements that actually transfer these

benefits. The regulations under section

141 may not be applied in a manner that

is inconsistent with these purposes.

(b) Scope. Sections 1.141–0 through

1.141–16 apply generally for purposes

of the private activity bond limitations

under section 141.

are private activity bonds if they meet

either the private business use test and

private security or payment test of section 141(b) or the private loan financing

test of section 141(c). The private business use and private security or payment

tests are described in §§ 1.141–3 and

1.141–4. The private loan financing test

is described in § 1.141–5.

(d) Reasonable expectations and deliberate actions—(1) In general. An

issue is an issue of private activity

bonds if the issuer reasonably expects,

as of the issue date, that the issue will

meet either the private business tests or

the private loan financing test. An issue

is also an issue of private activity bonds

if the issuer takes a deliberate action,

subsequent to the issue date, that causes

the conditions of either the private business tests or the private loan financing

test to be met.

(2) Reasonable expectations test—(i)

In general. In general, the reasonable

expectations test must take into account

reasonable expectations about events

and actions over the entire stated term

of an issue.

(ii) Special rule for issues with mandatory redemption provisions. An action

that is reasonably expected, as of the

issue date, to occur after the issue date

and to cause either the private business

tests or the private loan financing test to

be met may be disregarded for purposes

of those tests if—

(A) The issuer reasonably expects, as

of the issue date, that the financed

property will be used for a governmental purpose for a substantial period before the action;

(B) The issuer is required to redeem

all nonqualifying bonds (regardless of

the amount of disposition proceeds actually received) within 6 months of the

date of the action;

any arrangement with a nongovernmental person, as of the issue date, with

respect to that specific action; and

(D) The mandatory redemption of

bonds meets all of the conditions for

remedial action under § 1.141–12(a).

(3) Deliberate action defined—(i) In

general. Except as otherwise provided in

this paragraph (d)(3), a deliberate action

is any action taken by the issuer that is

within its control. An intent to violate

the requirements of section 141 is not

necessary for an action to be deliberate.

(ii) Safe harbor exceptions. An action

is not treated as a deliberate action if—

(A) It would be treated as an involuntary or compulsory conversion under

section 1033; or

(B) It is taken in response to a regulatory directive made by the federal

government.

(4) Special rule for dispositions of

personal property in the ordinary course

of an established governmental program—(i) In general. Dispositions of

personal property in the ordinary course

of an established governmental program

are not treated as deliberate actions if—

(A) The weighted average maturity of

the bonds financing that personal property is not greater than 120 percent of

the reasonably expected actual use of

that property for governmental purposes;

(B) The issuer reasonably expects on

the issue date that the fair market value

of that property on the date of disposition will be not greater than 25 percent

of its cost; and

for its governmental purposes on the

date of disposition.

(ii) Reasonable expectations test. The

reasonable expectation that a disposition

described in paragraph (d)(4)(i) of this

section may occur in the ordinary course

while the bonds are outstanding will not

cause the issue to meet the private

activity bond tests if the issuer is required to deposit amounts received from

the disposition in a commingled fund

with substantial tax or other governmental revenues and the issuer reasonably

expects to spend the amounts on governmental programs within 6 months

from the date of commingling.

(iii) Separate issue treatment. An issuer may treat the bonds properly allocable to the personal property eligible

for this exception as a separate issue

under § 1.150–1(c)(3).

(5) Special rule for general obligation bond programs that finance a large

number of separate purposes. The determination of whether bonds of an issue

are private activity bonds may be based

solely on the issuer’s reasonable expectations as of the issue date if all of the

requirements of paragraphs (d)(5)(i)

through (vii) of this section are met.

(i) The issue is an issue of general

obligation bonds of a general purpose

governmental unit that finances at least

25 separate purposes (as defined in

§ 1.150–1(c)(3)) and does not predominantly finance fewer than 4 separate

purposes.

(ii) The issuer has adopted a fund

method of accounting for its general

governmental purposes that makes tracing the bond proceeds to specific expenditures unreasonably burdensome.

(iii) The issuer reasonably expects on

the issue date to allocate all of the net

proceeds of the issue to capital expenditures within 6 months of the issue date

and adopts reasonable procedures to

verify that net proceeds are in fact so

expended. A program to randomly spot

check that 10 percent of the net proceeds were so expended generally is a

reasonable verification procedure for

this purpose.

(iv) The issuer reasonably expects on

the issue date to expend all of the net

proceeds of the issue before expending

proceeds of a subsequent issue of similar general obligation bonds.

(v) The issuer reasonably expects on

the issue date that it will not make any

loans to nongovernmental persons with

the proceeds of the issue.

(vi) The issuer reasonably expects on

the issue date that the capital expenditures that it could make during the

6-month period beginning on the issue

date with the net proceeds of the issue

that would not meet the private business

tests are not less than 125 percent of the

capital expenditures to be financed with

the net proceeds of the issue.

(vii) The issuer reasonably expects on

the issue date that the weighted average

maturity of the issue is not greater than

120 percent of the weighted average

reasonably expected economic life of

the capital expenditures financed with

the issue. To determine reasonably expected economic life for this purpose an

issuer may use reasonable estimates

based on the type of expenditures made

from a fund.

(e) When a deliberate action occurs.

A deliberate action occurs on the date

the issuer enters into a binding contract

with a nongovernmental person for use

of the financed property that is not

subject to any material contingencies.

(f) Certain remedial actions. See

§ 1.141–12 for certain remedial actions

that prevent a deliberate action with

respect to property financed by an issue

from causing that issue to meet the

private business use test or the private

loan financing test.

(g) Examples. The following examples illustrate the application of this

section:

Example 1. Involuntary action. City B issues

bonds to finance the purchase of land. On the

issue date, B reasonably expects that it will be the

sole user of the land for the entire term of the

bonds. Subsequently, the federal government acquires the land in a condemnation action. B sets

aside the condemnation proceeds to pay debt

service on the bonds but does not redeem them on

their first call date. The bonds are not private

activity bonds because B has not taken a deliberate action after the issue date. See, however,

§ 1.141–14(b), Example 2.

Example 2. Reasonable expectations test—

involuntary action. The facts are the same as in

Example 1, except that, on the issue date, B

reasonably expects that the federal government

will acquire the land in a condemnation action

during the term of the bonds. On the issue date,

the present value of the amount that B reasonably

expects to receive from the federal government is

greater than 10 percent of the present value of the

debt service on the bonds. The terms of the bonds

do not require that the bonds be redeemed within

6 months of the acquisition by the federal government. The bonds are private activity bonds because the issuer expects as of the issue date that

the private business tests will be met.

Example 3. Reasonable expectations test—

mandatory redemption. City C issues bonds to

rehabilitate an existing hospital that it currently

owns. On the issue date of the bonds, C reasonably expects that the hospital will be used for a

governmental purpose for a substantial period. On

the issue date, C also plans to construct a new

hospital, but the placed in service date of that new

hospital is uncertain. C reasonably expects that,

when the new hospital is placed in service, it will

sell or lease the rehabilitated hospital to a private

hospital corporation. The bond documents require

that the bonds must be redeemed within 6 months

of the sale or lease of the rehabilitated hospital

(regardless of the amount actually received from

the sale). The bonds meet the reasonable expectations requirement of the private activity bond tests

if the mandatory redemption of bonds meets all of

the conditions for a remedial action under

§ 1.141–12(a).

Example 4. Dispositions in the ordinary course

of an established governmental program. City D

issues bonds with a weighted average maturity of

6 years for the acquisition of police cars. D

reasonably expects on the issue date that the

police cars will be used solely by its police

department, except that, in the ordinary course of

its police operations, D sells its police cars to a

taxicab corporation after 5 years of use because

they are no longer suitable for police use. Further,

D reasonably expects that the value of the police

cars when they are no longer suitable for police

use will be no more than 25 percent of cost. D

subsequently sells 20 percent of the police cars

after only 3 years of actual use. At that time, D

deposits the proceeds from the sale of the police

cars in a commingled fund with substantial tax

revenues and reasonably expects to spend the

proceeds on governmental programs within 6

months of the date of deposit. D does not trace the

actual use of these commingled amounts. The sale

of the police cars does not cause the private

activity bond tests to be met because the requirements of paragraph (d)(4) of this section are met.

§ 1.141–3 Definition of private business use.

(a) General rule—(1) In general. The

private business use test relates to the

use of the proceeds of an issue. The 10

percent private business use test of

section 141(b)(1) is met if more than 10

percent of the proceeds of an issue is

used in a trade or business of a nongovernmental person. For this purpose, the

use of financed property is treated as the

direct use of proceeds. Any activity

carried on by a person other than a

natural person is treated as a trade or

business. Unless the context or a provision clearly requires otherwise, this section also applies to the private business

use test under sections 141(b)(3) (unrelated or disproportionate use), 141(b)(4)

($15 million limitation for certain output

facilities), and 141(b)(5) (the coordination with the volume cap where the

nonqualified amount exceeds $15 million).

(2) Indirect use. In determining

whether an issue meets the private business use test, it is necessary to look to

both the indirect and direct uses of

proceeds. For example, a facility is

treated as being used for a private

business use if it is leased to a nongovernmental person and subleased to a

governmental person or if it is leased to

a governmental person and then subleased to a nongovernmental person,

provided that in each case the nongovernmental person’s use is in a trade or

business. Similarly, the issuer’s use of

the proceeds to engage in a series of

financing transactions for property to be

used by nongovernmental persons in

their trades or businesses may cause the

private business use test to be met. In

addition, proceeds are treated as used in

the trade or business of a nongovernmental person if a nongovernmental person, as a result of a single transaction or

a series of related transactions, uses

property acquired with the proceeds of

an issue.

(3) Aggregation of private business

use. The use of proceeds by all nongovernmental persons is aggregated to determine whether the private business use

test is met.

(b) Types of private business use arrangements—(1) In general. Both actual

and beneficial use by a nongovernmental person may be treated as private

business use. In most cases, the private

business use test is met only if a

nongovernmental person has special legal entitlements to use the financed

property under an arrangement with the

issuer. In general, a nongovernmental

person is treated as a private business

user of proceeds and financed property

as a result of ownership; actual or

beneficial use of property pursuant to a

lease, or a management or incentive

payment contract; or certain other arrangements such as a take or pay or

other output-type contract.

(2) Ownership. Except as provided in

paragraph (d)(1) or (d)(2) of this section, ownership by a nongovernmental

person of financed property is private

business use of that property. For this

purpose, ownership refers to ownership

for federal income tax purposes.

(3) Leases. Except as provided in

paragraph (d) of this section, the lease

of financed property to a nongovernmental person is private business use of

that property. For this purpose, any

arrangement that is properly characterized as a lease for federal income tax

purposes is treated as a lease. In determining whether a management contract

is properly characterized as a lease, it is

necessary to consider all of the facts and

circumstances, including the following

factors—

(i) The degree of control over the

property that is exercised by a nongovernmental person; and

(ii) Whether a nongovernmental person bears risk of loss of the financed

property.

(4) Management contracts—(i) Facts

and circumstances test. Except as provided in paragraph (d) of this section, a

management contract (within the meaning of paragraph (b)(4)(ii) of this section) with respect to financed property

may result in private business use of

that property, based on all of the facts

and circumstances. A management contract with respect to financed property

generally results in private business use

of that property if the contract provides

for compensation for services rendered

with compensation based, in whole or in

part, on a share of net profits from the

operation of the facility.

(ii) Management contract defined.

For purposes of this section, a management contract is a management, service,

or incentive payment contract between a

governmental person and a service provider under which the service provider

provides services involving all, a portion

of, or any function of, a facility. For

example, a contract for the provision of

management services for an entire hospital, a contract for management services for a specific department of a

hospital, and an incentive payment contract for physician services to patients of

a hospital are each treated as a management contract.

(iii) Arrangements generally not

treated as management contracts. The

arrangements described in paragraphs

(b)(4)(iii)(A) through (D) of this section

generally are not treated as management

contracts that give rise to private business use.

(A) Contracts for services that are

solely incidental to the primary governmental function or functions of a financed facility (for example, contracts

for janitorial, office equipment repair,

hospital billing, or similar services).

(B) The mere granting of admitting

privileges by a hospital to a doctor, even

if those privileges are conditioned on

the provision of de minimis services, if

those privileges are available to all

qualified physicians in the area, consistent with the size and nature of its

facilities.

operation of a facility or system of

facilities that consists predominantly of

public utility property, if the only compensation is the reimbursement of actual

and direct expenses of the service provider and reasonable administrative

overhead expenses of the service provider.

(D) A contract to provide for services, if the only compensation is the

reimbursement of the service provider

for actual and direct expenses paid by

the service provider to unrelated parties.

(iv) Management contracts that are

properly treated as other types of private business use. A management contract with respect to financed property

results in private business use of that

property if the service provider is

treated as the lessee or owner of financed property for federal income tax

purposes, unless an exception under

paragraph (d) of this section applies to

the arrangement.

(5) Output contracts. See § 1.141–7

for special rules for contracts for the

purchase of output of output facilities.

(6) Research agreements—(i) Facts

and circumstances test. Except as provided in paragraph (d) of this section, an

agreement by a nongovernmental person

to sponsor research performed by a

governmental person may result in private business use of the property used

for the research, based on all of the

facts and circumstances.

(ii) Research agreements that are

properly treated as other types of private business use. A research agreement

with respect to financed property results

in private business use of that property

if the sponsor is treated as the lessee or

owner of financed property for federal

income tax purposes, unless an exception under paragraph (d) of this section

applies to the arrangement.

(7) Other actual or beneficial use—

(i) In general. Any other arrangement

that conveys special legal entitlements

for beneficial use of bond proceeds or

of financed property that are comparable

to special legal entitlements described in

paragraphs (b)(2), (3), (4), (5), or (6) of

this section results in private business

use. For example, an arrangement that

conveys priority rights to the use or

capacity of a facility generally results in

private business use.

(ii) Special rule for facilities not used

by the general public. In the case of

financed property that is not available

for use by the general public (within the

meaning of paragraph (c) of this section), private business use may be established solely on the basis of a special

economic benefit to one or more nongovernmental persons, even if those

nongovernmental persons have no special legal entitlements to use of the

property. In determining whether special

economic benefit gives rise to private

business use it is necessary to consider

all of the facts and circumstances, including one or more of the following

factors—

(A) Whether the financed property is

functionally related or physically proximate to property used in the trade or

business of a nongovernmental person;

(B) Whether only a small number of

nongovernmental persons receive the

special economic benefit; and

property is treated as depreciable by any

nongovernmental person.

use—(1) In general. Use as a member

of the general public (general public

use) is not private business use. Use of

financed property by nongovernmental

persons in their trades or businesses is

treated as general public use only if the

property is intended to be available and

in fact is reasonably available for use on

the same basis by natural persons not

engaged in a trade or business.

(2) Use on the same basis. In general, use under an arrangement that

conveys priority rights or other preferential benefits is not use on the same basis

as the general public. Arrangements providing for use that is available to the

general public at no charge or on the

basis of rates that are generally applicable and uniformly applied do not

convey priority rights or other preferen-

tial benefits. For this purpose, rates may

be treated as generally applicable and

uniformly applied even if—

(i) Different rates apply to different

classes of users, such as volume purchasers, if the differences in rates are

customary and reasonable; or

(ii) A specially negotiated rate arrangement is entered into, but only if

the user is prohibited by federal law

from paying the generally applicable

rates, and the rates established are as

comparable as reasonably possible to the

generally applicable rates.

(3) Long-term arrangements not

treated as general public use. An arrangement is not treated as general

public use if the term of the use under

the arrangement, including all renewal

options, is greater than 180 days. For

this purpose, a right of first refusal to

renew use under the arrangement is not

treated as a renewal option if—

(i) The compensation for the use under the arrangement is redetermined at

generally applicable, fair market value

rates that are in effect at the time of

renewal; and

(ii) The use of the financed property

under the same or similar arrangements

is predominantly by natural persons who

are not engaged in a trade or business.

(4) Relation to other use. Use of

financed property by the general public

does not prevent the proceeds from

being used for a private business use

because of other use under this section.

(d) Other exceptions—(1) Agents.

Use of proceeds by nongovernmental

persons solely in their capacity as agents

of a governmental person is not private

business use. For example, use by a

nongovernmental person that issues obligations on behalf of a governmental

person is not private business use to the

extent the nongovernmental person’s use

of proceeds is in its capacity as an agent

of the governmental person.

(2) Use incidental to financing arrangements. Use by a nongovernmental

person that is solely incidental to a

financing arrangement is not private

business use. A use is solely incidental

to a financing arrangement only if the

nongovernmental person has no substantial rights to use bond proceeds or

financed property other than as an agent

of the bondholders. For example, a

nongovernmental person that acts solely

as an owner of title in a sale and

leaseback financing transaction with a

city generally is not a private business

user of the property leased to the city,

provided that the nongovernmental per-

son has assigned all of its rights to use

the leased facility to the trustee for the

bondholders upon default by the city.

Similarly, bond trustees, servicers, and

guarantors are generally not treated as

private business users.

(3) Exceptions for arrangements

other than arrangements resulting in

ownership of financed property by a

nongovernmental person—(i) Arrangements not available for use on the same

basis by natural persons not engaged in

a trade or business. Use by a nongovernmental person pursuant to an arrangement, other than an arrangement

resulting in ownership of financed property by a nongovernmental person, is

not private business use if—

(A) The term of the use under the

arrangement, including all renewal options, is not longer than 90 days;

(B) The arrangement would be

treated as general public use, except that

it is not available for use on the same

basis by natural persons not engaged in

a trade or business because generally

applicable and uniformly applied rates

are not reasonably available to natural

persons not engaged in a trade or business; and

principal purpose of providing that property for use by that nongovernmental

person.

(ii) Negotiated arm’s-length arrangements. Use by a nongovernmental person pursuant to an arrangement, other

than an arrangement resulting in ownership of financed property by a nongovernmental person, is not private business

use if—

(A) The term of the use under the

arrangement, including all renewal options, is not longer than 30 days;

(B) The arrangement is a negotiated

arm’s-length arrangement, and compensation under the arrangement is at fair

market value; and

principal purpose of providing that property for use by that nongovernmental

person.

(4) Temporary use by developers. Use

during an initial development period by

a developer of an improvement that

carries out an essential governmental

function is not private business use if

the issuer and the developer reasonably

expect on the issue date to proceed with

all reasonable speed to develop the

improvement and property benefited by

that improvement and to transfer the

improvement to a governmental person,

and if the improvement is in fact trans-

ferred to a governmental person

promptly after the property benefited by

the improvement is developed.

(5) Incidental use—(i) General rule.

Incidental uses of a financed facility are

disregarded, to the extent that those uses

do not exceed 2.5 percent of the proceeds of the issue used to finance the

facility. A use of a facility by a nongovernmental person is incidental if—

(A) Except for vending machines,

pay telephones, kiosks, and similar uses,

the use does not involve the transfer to

the nongovernmental person of possession and control of space that is separated from other areas of the facility by

walls, partitions, or other physical barriers, such as a night gate affixed to a

structural component of a building (a

nonpossessory use);

(B) The nonpossessory use is not

functionally related to any other use of

the facility by the same person (other

than a different nonpossessory use); and

facility do not, in the aggregate, involve

the use of more than 2.5 percent of the

facility.

(ii) Illustrations. Incidental uses may

include pay telephones, vending machines, advertising displays, and use for

television cameras, but incidental uses

may not include output purchases.

(6) Qualified improvements. Proceeds

that provide a governmentally owned

improvement to a governmentally

owned building (including its structural

components and land functionally related and subordinate to the building)

are not used for a private business use

if—

(i) The building was placed in service

more than 1 year before the construction

or acquisition of the improvement is

begun;

(ii) The improvement is not an enlargement of the building or an improvement of interior space occupied

exclusively for any private business use;

(iii) No portion of the improved

building or any payments in respect of

the improved building are taken into

account under section 141(b)(2)(A) (the

private security test); and

(iv) No more than 15 percent of the

improved building is used for a private

business use.

(e) Special rule for tax assessment

bonds. In the case of a tax assessment

bond that satisfies the requirements of

§ 1.141–5(d), the loan (or deemed loan)

of the proceeds to the borrower paying

the assessment is disregarded in determining whether the private business use

test is met. However, the use of the loan

proceeds is not disregarded in determining whether the private business use test

is met.

(f) Examples. The following examples illustrate the application of paragraphs (a) through (e) of this section. In

each example, assume that the arrangements described are the only arrangements with nongovernmental persons for

use of the financed property.

Example 1. Nongovernmental ownership. State

A issues 20-year bonds to purchase land and equip

and construct a factory. A then enters into an

arrangement with Corporation X to sell the factory

to X on an installment basis while the bonds are

outstanding. The issue meets the private business

use test because a nongovernmental person owns

the financed facility. See also § 1.141–2 (relating

to the private activity bond tests), and § 1.141–5

(relating to the private loan financing test).

Example 2. Lease to a nongovernmental person.

(i) The facts are the same as in Example 1, except

that A enters into an arrangement with X to lease

the factory to X for 3 years rather than to sell it to

X. The lease payments will be made annually and

will be based on the tax-exempt interest rate on

the bonds. The issue meets the private business

use test because a nongovernmental person leases

the financed facility. See also § 1.141–14 (relating

to anti-abuse rules).

(ii) The facts are the same as in Example 2(i),

except that the annual payments made by X will

equal fair rental value of the facility and exceed

the amount necessary to pay debt service on the

bonds for the 3 years of the lease. The issue meets

the private business use test because a nongovernmental person leases the financed facility and the

test does not require that the benefits of taxexempt financing be passed through to the nongovernmental person.

Example 3. Management contract in substance

a lease. City L issues 30-year bonds to finance the

construction of a city hospital. L enters into a

15-year contract with M, a nongovernmental person that operates a health maintenance organization relating to the treatment of M’s members at

L’s hospital. The contract provides for reasonable

fixed compensation to M for services rendered

with no compensation based, in whole or in part,

on a share of net profits from the operation of the

hospital. However, the contract also provides that

30 percent of the capacity of the hospital will be

exclusively available to M’s members and M will

bear the risk of loss of that portion of the capacity

of the hospital so that, under all of the facts and

circumstances, the contract is properly characterized as a lease for federal income tax purposes.

The issue meets the private business use test

because a nongovernmental person leases the

financed facility.

Example 4. Ownership of title in substance a

leasehold interest. Nonprofit corporation R issues

bonds on behalf of City P to finance the construction of a hospital. R will own legal title to the

hospital. In addition, R will operate the hospital,

but R is not treated as an agent of P in its capacity

as operator of the hospital. P has certain rights to

the hospital that establish that it is properly treated

as the owner of the property for federal income

tax purposes. P does not have rights, however, to

directly control operation of the hospital while R

owns legal title to it and operates it. The issue

meets the private business use test because the

arrangement provides a nongovernmental person

an interest in the financed facility that is comparable to a leasehold interest. See paragraphs (a)(2)

and (b)(7)(i) of this section.

Example 5. Rights to control use of property

treated as private business use—parking lot. Corporation C and City D enter into a plan to finance

the construction of a parking lot adjacent to C’s

factory. Pursuant to the plan, C conveys the site

for the parking lot to D for a nominal amount,

subject to a covenant running with the land that

the property be used only for a parking lot. In

addition, D agrees that C will have the right to

approve rates charged by D for use of the parking

lot. D issues bonds to finance construction of the

parking lot on the site. The parking lot will be

available for use by the general public on the basis

of rates that are generally applicable and uniformly applied. The issue meets the private business use test because a nongovernmental person

has special legal entitlements for beneficial use of

the financed facility that are comparable to an

ownership interest. See paragraph (b)(7)(i) of this

section.

Example 6. Other actual or beneficial use—

hydroelectric enhancements. J, a political subdivision, owns and operates a hydroelectric generation

plant and related facilities. Pursuant to a take or

pay contract, J sells 15 percent of the output of

the plant to Corporation K, an investor-owned

utility. K is treated as a private business user of

the plant. Under the license issued to J for

operation of the plant, J is required by federal

regulations to construct and operate various facilities for the preservation of fish and for public

recreation. J issues its obligations to finance the

fish preservation and public recreation facilities. K

has no special legal entitlements for beneficial use

of the financed facilities. The fish preservation

facilities are functionally related to the operation

of the plant. The recreation facilities are available

to natural persons on a short-term basis according

to generally applicable and uniformly applied

rates. Under paragraph (c) of this section, the

recreation facilities are treated as used by the

general public. Under paragraph (b)(7) of this

section, K’s use is not treated as private business

use of the recreation facilities because K has no

special legal entitlements for beneficial use of the

recreation facilities. The fish preservation facilities

are not of a type reasonably available for use on

the same basis by natural persons not engaged in a

trade or business. Under all of the facts and

circumstances (including the functional relationship of the fish preservation facilities to property

used in K’s trade or business) under paragraph

(b)(7)(ii) of this section, K derives a special

economic benefit from the fish preservation facilities. Therefore, K’s private business use may be

established solely on the basis of that special

economic benefit, and K’s use of the fish preservation facilities is treated as private business use.

Example 7. Other actual or beneficial use—

pollution control facilities. City B issues obligations to finance construction of a specialized

pollution control facility on land that it owns

adjacent to a factory owned by Corporation N. B

will own and operate the pollution control facility,

and N will have no special legal entitlements to

use the facility. B, however, reasonably expects

that N will be the only user of the facility. The

facility will not be reasonably available for use on

the same basis by natural persons not engaged in a

trade or business. Under paragraph (b)(7)(ii) of

this section, because under all of the facts and

circumstances the facility is functionally related

and is physically proximate to property used in

N’s trade or business, N derives a special economic benefit from the facility. Therefore, N’s

private business use may be established solely on

the basis of that special economic benefit, and N’s

use is treated as private business use of the

facility. See paragraph (b)(7)(ii) of this section.

Example 8. General public use—airport runway.

(i) City I issues bonds and uses all of the proceeds

to finance construction of a runway at a new

city-owned airport. The runway will be available

for take-off and landing by any operator of an

aircraft desiring to use the airport, including

general aviation operators who are natural persons

not engaged in a trade or business. It is reasonably

expected that most of the actual use of the runway

will be by private air carriers (both charter airlines

and commercial airlines) in connection with their

use of the airport terminals leased by those

carriers. These leases for the use of terminal space

provide no priority rights or other preferential

benefits to the air carriers for use of the runway.

Moreover, under the leases the lease payments are

determined without taking into account the revenues generated by runway landing fees (that is,

the lease payments are not determined on a

‘‘residual’’ basis). Although the lessee air carriers

receive a special economic benefit from the use of

the runway, this economic benefit is not sufficient

to cause the air carriers to be private business

users, because the runway is available for general

public use. The issue does not meet the private

business use test. See paragraphs (b)(7)(ii) and (c)

of this section.

(ii) The facts are the same as in Example 8(i),

except that the runway will be available for use

only by private air carriers. The use by these

private air carriers is not general public use,

because the runway is not reasonably available for

use on the same basis by natural persons not

engaged in a trade or business. Depending on all

of the facts and circumstances, including whether

there are only a small number of lessee private air

carriers, the issue may meet the private business

use test solely because the private air carriers

receive a special economic benefit from the runway. See paragraph (b)(7)(ii) of this section.

(iii) The facts are the same as in Example 8(i),

except that the lease payments under the leases

with the private air carriers are determined on a

residual basis by taking into account the net

revenues generated by runway landing fees. These

leases cause the private business use test to be met

with respect to the runway because they are

arrangements that convey special legal entitlements to the financed facility to nongovernmental

persons. See paragraph (b)(7)(i) of this section.

Example 9. General public use—airport parking

garage. City S issues bonds and uses all of the

proceeds to finance construction of a city-owned

parking garage at the city-owned airport. S reasonably expects that more than 10 percent of the

actual use of the parking garage will be by

employees of private air carriers (both charter

airlines and commercial airlines) in connection

with their use of the airport terminals leased by

those carriers. The air carriers’ use of the parking

garage, however, will be on the same basis as

passengers and other members of the general

public using the airport. The leases for the use of

the terminal space provide no priority rights to the

air carriers for use of the parking garage, and the

lease payments are determined without taking into

account the revenues generated by the parking

garage. Although the lessee air carriers receive a

special economic benefit from the use of the

parking garage, this economic benefit is not

sufficient to cause the air carriers to be private

business users, because the parking garage is

available for general public use. The issue does

not meet the private business use test. See paragraphs (b)(7)(ii) and (c) of this section.

Example 10. Long-term arrangements not

treated as general public use—insurance fund.

Authority T deposits all of the proceeds of its

bonds in its insurance fund and invests all of those

proceeds in tax-exempt bonds. The insurance fund

provides insurance to a large number of businesses

and natural persons not engaged in a trade or

business. Each participant receives insurance for a

term of 1 year. The use by the participants, other

than participants that are natural persons not

engaged in a trade or business, is treated as

private business use of the proceeds of the bonds

because the participants have special legal entitlements to the use of bond proceeds, even though

the contractual rights are not necessarily properly

characterized as ownership, leasehold, or similar

interests listed in paragraph (b) of this section.

Use of the bond proceeds is not treated as general

public use because the term of the insurance is

greater than 180 days. See paragraphs (b)(7)(i) and

(c)(3) of this section.

Example 11. General public use—port road.

Highway Authority W uses all of the proceeds of

its bonds to construct a 25-mile road to connect an

industrial port owned by Corporation Y with

existing roads owned and operated by W. Other

than the port, the nearest residential or commercial

development to the new road is 12 miles away.

There is no reasonable expectation that development will occur in the area surrounding the new

road. W and Y enter into no arrangement (either

by contract or ordinance) that conveys special

legal entitlements to Y for the use of the road. Use

of the road will be available without restriction to

all users, including natural persons who are not

engaged in a trade or business. The issue does not

meet the private business use test because the road

is treated as used only by the general public.

Example 12. General public use of governmentally owned hotel. State Q issues bonds to purchase land and construct a hotel for use by the

general public (that is, tourists, visitors, and

business travelers). The bond documents provide

that Q will own and operate the project for the

term of the bonds. Q will not enter into a lease or

license with any user for use of rooms for a period

longer than 180 days (although users may actually

use rooms for consecutive periods in excess of

180 days). Use of the hotel by hotel guests who

are travelling in connection with trades or businesses of nongovernmental persons is not a private

business use of the hotel by these persons because

the hotel is intended to be available and in fact is

reasonably available for use on the same basis by

natural persons not engaged in a trade or business.

See paragraph (c)(1) of this section.

Example 13. General public use with rights of

first refusal. Authority V uses all of the proceeds

of its bonds to construct a parking garage. At least

90 percent of the spaces in the garage will be

available to the general public on a monthly

first-come, first-served basis. V reasonably expects

that the spaces will be predominantly leased to

natural persons not engaged in a trade or business

who have priority rights to renew their spaces at

then current fair market value rates. More than 10

percent of the spaces will be leased to nongovernmental persons acting in a trade or business. These

leases are not treated as arrangements with a term

of use greater than 180 days. The rights to renew

are not treated as renewal options because the

compensation for the spaces is redetermined at

generally applicable, fair market value rates that

will be in effect at the time of renewal and the use

of the spaces under similar arrangements is predominantly by natural persons who are not en-

gaged in a trade or business. The issue does not

meet the private business use test because at least

90 percent of the use of the parking garage is

general public use. See paragraph (c)(3) of this

section.

Example 14. General public use with a specially

negotiated rate agreement with agency of United

States. G, a sewage collection and treatment

district, operates facilities that were financed with

its bonds. F, an agency of the United States, has a

base located within G. Approximately 20 percent

of G’s facilities are used to treat sewage produced

by F under a specially negotiated rate agreement.

Under the specially negotiated rate agreement, G

uses its best efforts to charge F as closely as

possible the same amount for its use of G’s

services as its other customers pay for the same

amount of services, although those other customers pay for services based on standard district

charges and tax levies. F is prohibited by federal

law from paying for the services based on those

standard district charges and tax levies. The use of

G’s facilities by F is on the same basis as the

general public. See paragraph (c)(2)(ii) of this

section.

Example 15. Arrangements not available for use

by natural persons not engaged in a trade or

business—federal use of prisons. Authority E uses

all of the proceeds of its bonds to construct a

prison. E contracts with federal agency F to house

federal prisoners on a space-available, first-come,

first-served basis, pursuant to which F will be

charged approximately the same amount for each

prisoner as other persons that enter into similar

transfer agreements. It is reasonably expected that

other persons will enter into similar agreements.

The term of the use under the contract is not

longer than 90 days, and F has no right to renew,

although E reasonably expects to renew the contract indefinitely. The prison is not financed for a

principal purpose of providing the prison for use

by F. It is reasonably expected that during the

term of the bonds, more than 10 percent of the

prisoners at the prison will be federal prisoners.

F’s use of the facility is not general public use

because this type of use (leasing space for prisoners) is not available for use on the same basis by

natural persons not engaged in a trade or business.

The issue does not meet the private business use

test, however, because the leases satisfy the exception of paragraph (d)(3)(i) of this section.

Example 16. Negotiated arm’s-length arrangements—auditorium reserved in advance. (i) City Z

issues obligations to finance the construction of a

municipal auditorium that it will own and operate.

The use of the auditorium will be open to anyone

who wishes to use it for a short period of time on

a rate-scale basis. Z reasonably expects that the

auditorium will be used by schools, church groups,

sororities, and numerous commercial organizations. Corporation H, a nongovernmental person,

enters into an arm’s-length arrangement with Z to

use the auditorium for 1 week for each year for a

10-year period (a total of 70 days), pursuant to

which H will be charged a specific price reflecting

fair market value. On the date the contract is

entered into, Z has not established generally

applicable rates for future years. Even though the

auditorium is not financed for a principal purpose

of providing use of the auditorium to H, H is not

treated as using the auditorium as a member of the

general public because its use is not on the same

basis as the general public. Because the term of

H’s use of the auditorium is longer than 30 days,

the arrangement does not meet the exception under

paragraph (d)(3)(ii) of this section.

(ii) The facts are the same as in Example 16(i),

except that H will enter into an arm’s-length

arrangement with Z to use the auditorium for 1

week for each year for a 4-year period (a total of

28 days), pursuant to which H will be charged a

specific price reflecting fair market value. H is not

treated as a private business user of the auditorium

because its contract satisfies the exception of

paragraph (d)(3)(ii) of this section for negotiated

arm’s-length arrangements.

(g) Measurement of private business

use—(1) In general. In general, the

private business use of proceeds is allocated to property under § 1.141–6. The

amount of private business use of that

property is determined according to the

average percentage of private business

use of that property during the measurement period.

(2) Measurement period—(i) General

rule. Except as provided in this paragraph (g)(2), the measurement period of

property financed by an issue begins on

the later of the issue date of that issue

or the date the property is placed in

service and ends on the earlier of the

last date of the reasonably expected

economic life of the property or the

latest maturity date of any bond of the

issue financing the property (determined

without regard to any optional redemption dates). In general, the period of

reasonably expected economic life of

the property for this purpose is based on

reasonable expectations as of the issue

date.

(ii) Special rule for refundings of

short-term obligations. For an issue of

short-term obligations that the issuer

reasonably expects to refund with a

long-term financing (such as bond anticipation notes), the measurement period is based on the latest maturity date

of any bond of the last refunding issue

with respect to the financed property

(determined without regard to any optional redemption dates).

(iii) Special rule for reasonably expected mandatory redemptions. If an

issuer reasonably expects on the issue

date that an action will occur during the

term of the bonds to cause either the

private business tests or the private loan

financing test to be met and is required

to redeem bonds to meet the reasonable

expectations test of § 1.141–2(d)(2), the

measurement period ends on the reasonably expected redemption date.

(iv) Special rule for ownership by a

nongovernmental person. The amount of

private business use resulting from ownership by a nongovernmental person is

the greatest percentage of private business use in any 1-year period.

(v) Anti-abuse rule. If an issuer establishes the term of an issue for a

period that is longer than is reasonably

necessary for the governmental purposes

of the issue for a principal purpose of

increasing the permitted amount of private business use, the Commissioner

may determine the amount of private

business use according to the greatest

percentage of private business use in

any 1-year period.

(3) Determining average percentage

of private business use. The average

percentage of private business use is the

average of the percentages of private

business use during the 1-year periods

within the measurement period. Appropriate adjustments must be made for

beginning and ending periods of less

than 1 year.

(4) Determining the average amount

of private business use for a 1-year

period—(i) In general. The percentage

of private business use of property for

any 1-year period is the average private

business use during that year. This average is determined by comparing the

amount of private business use during

the year to the total amount of private

business use and use that is not private

business use (government use) during

that year. Paragraphs (g)(4)(ii) through

(v) of this section apply to determine

the average amount of private business

use for a 1-year period.

(ii) Uses at different times. For a

facility in which actual government use

and private business use occur at different times (for example, different days),

the average amount of private business

use generally is based on the amount of

time that the facility is used for private

business use as a percentage of the total

time for all actual use. In determining

the total amount of actual use, periods

during which the facility is not in use

are disregarded.

(iii) Simultaneous use. In general, for

a facility in which government use and

private business use occur simultaneously, the entire facility is treated as

having private business use. For example, a governmentally owned facility

that is leased or managed by a nongovernmental person in a manner that results in private business use is treated as

entirely used for a private business use.

If, however, there is also private business use and actual government use on

the same basis, the average amount of

private business use may be determined

on a reasonable basis that properly reflects the proportionate benefit to be

derived by the various users of the

facility (for example, reasonably expected fair market value of use). For

example, the average amount of private

business use of a garage with unassigned spaces that is used for government use and private business use is

generally based on the number of spaces

used for private business use as a percentage of the total number of spaces.

(iv) Discrete portion. For purposes of

this paragraph (g), measurement of the

use of proceeds allocated to a discrete

portion of a facility is determined by

treating that discrete portion as a separate facility.

(v) Relationship to fair market value.

For purposes of paragraphs (g)(4)(ii)

through (iv) of this section, if private

business use is reasonably expected as

of the issue date to have a significantly

greater fair market value than government use, the average amount of private

business use must be determined according to the relative reasonably expected

fair market values of use rather than

another measure, such as average time

of use. This determination of relative

fair market value may be made as of the

date the property is acquired or placed

in service if making this determination

as of the issue date is not reasonably

possible (for example, if the financed

property is not identified on the issue

date). In general, the relative reasonably

expected fair market value for a period

must be determined by taking into account the amount of reasonably expected payments for private business use

for the period in a manner that properly

reflects the proportionate benefit to be

derived from the private business use.

(5) Common areas. The amount of

private business use of common areas

within a facility is based on a reasonable method that properly reflects the

proportionate benefit to be derived by

the users of the facility. For example, in

general, a method that is based on the

average amount of private business use

of the remainder of the entire facility

reflects proportionate benefit.

(6) Allocation of neutral costs. Proceeds that are used to pay costs of

issuance, invested in a reserve or replacement fund, or paid as fees for a

qualified guarantee or a qualified hedge

must be allocated ratably among the

other purposes for which the proceeds

are used.

(7) Commencement of measurement

of private business use. Generally, private business use commences on the

first date on which there is a right to

actual use by the nongovernmental per-

son. However, if an issuer enters into an

arrangement for private business use a

substantial period before the right to

actual private business use commences

and the arrangement transfers ownership

or is an arrangement for other long-term

use (such as a lease for a significant

portion of the remaining economic life

of financed property), private business

use commences on the date the arrangement is entered into, even if the right to

actual use commences after the measurement period. For this purpose, 10

percent of the measurement period is

generally treated as a substantial period.

(8) Examples. The following examples illustrate the application of this

paragraph (g):

Example 1. Research facility. University U, a

state owned and operated university, owns and

operates a research facility. U proposes to finance

general improvements to the facility with the

proceeds of an issue of bonds. U enters into

sponsored research agreements with nongovernmental persons that result in private business use

because the sponsors will own title to any patents

resulting from the research. The governmental

research conducted by U and the research U

conducts for the sponsors take place simultaneously in all laboratories within the research

facility. All laboratory equipment is available

continuously for use by workers who perform both

types of research. Because it is not possible to

predict which research projects will be successful,

it is not reasonably practicable to estimate the

relative revenues expected to result from the

governmental and nongovernmental research. U

contributed 90 percent of the cost of the facility

and the nongovernmental persons contributed 10

percent of the cost. Under this section, the nongovernmental persons are using the facility for a

private business use on the same basis as the

government use of the facility. The portions of the

costs contributed by the various users of the

facility provide a reasonable basis that properly

reflects the proportionate benefit to be derived by

the users of the facility. The nongovernmental

persons are treated as using 10 percent of the

proceeds of the issue.

Example 2. Stadium. (i) City L issues bonds and

uses all of the proceeds to construct a stadium. L

enters into a long-term contract with a professional

sports team T under which T will use the stadium

20 times during each year. These uses will occur

on nights and weekends. L reasonably expects that

the stadium will be used more than 180 other

times each year, none of which will give rise to

private business use. This expectation is based on

a feasibility study and historical use of the old

stadium that is being replaced by the new stadium.

There is no significant difference in the value of

T’s uses when compared to the other uses of the

stadium, taking into account the payments that T

is reasonably expected to make for its use.

Assuming no other private business use, the issue

does not meet the private business use test because

not more than 10 percent of the use of the facility

is for a private business use.

(ii) The facts are the same as in Example 2(i),

except that L reasonably expects that the stadium

will be used not more than 60 other times each

year, none of which will give rise to private

business use. The issue meets the private business

use test because 25 percent of the proceeds are

used for a private business use.

Example 3. Airport terminal areas treated as

common areas. City N issues bonds to finance the

construction of an airport terminal. Eighty percent

of the leasable space of the terminal will be leased

to private air carriers. The remaining 20 percent of

the leasable space will be used for the term of the

bonds by N for its administrative purposes. The

common areas of the terminal, including waiting

areas, lobbies, and hallways are treated as 80

percent used by the air carriers for purposes of the

private business use test.

§ 1.141–4 Private security or payment

test.

(a) General rule—(1) Private security

or payment. The private security or

payment test relates to the nature of the

security for, and the source of, the

payment of debt service on an issue.

The private payment portion of the test

takes into account the payment of the

debt service on the issue that is directly

or indirectly to be derived from payments (whether or not to the issuer or

any related party) in respect of property,

or borrowed money, used or to be used

for a private business use. The private

security portion of the test takes into

account the payment of the debt service

on the issue that is directly or indirectly

secured by any interest in property used

or to be used for a private business use

or payments in respect of property used

or to be used for a private business use.

For additional rules for output facilities,

see § 1.141–7.

(2) Aggregation of private payments

and security. For purposes of the private

security or payment test, payments taken

into account as private payments and

payments or property taken into account

as private security are aggregated. However, the same payments are not taken

into account as both private security and

private payments.

(3) Underlying arrangement. The security for, and payment of debt service

on, an issue is determined from both the

terms of the bond documents and on the

basis of any underlying arrangement. An

underlying arrangement may result from

separate agreements between the parties

or may be determined on the basis of all

of the facts and circumstances surrounding the issuance of the bonds. For

example, if the payment of debt service

on an issue is secured by both a pledge

of the full faith and credit of a state or

local governmental unit and any interest

in property used or to be used in a

private business use, the issue meets the

private security or payment test.

(b) Measurement of private payments

and security—(1) Scope. This paragraph

(b) contains rules that apply to both

private security and private payments.

(2) Present value measurement—(i)

Use of present value. In determining

whether an issue meets the private security or payment test, the present value of

the payments or property taken into

account is compared to the present value

of the debt service to be paid over the

term of the issue.

(ii) Debt service—(A) Debt service

paid from proceeds. Debt service does

not include any amount paid or to be

paid from sale proceeds or investment

proceeds. For example, debt service

does not include payments of capitalized

interest funded with proceeds.

(B) Adjustments to debt service. Debt

service is adjusted to take into account

payments and receipts that adjust the

yield on an issue for purposes of section

148(f). For example, debt service includes fees paid for qualified guarantees

under § 1.148–4(f) and is adjusted to

take into account payments and receipts

on qualified hedges under § 1.148–4(h).

(iii) Computation of present value—

(A) In general. Present values are determined by using the yield on the issue as

the discount rate and by discounting all

amounts to the issue date. See, however,

§ 1.141–13 for special rules for refunding bonds.

(B) Fixed yield issues. For a fixed

yield issue, yield is determined on the

issue date and is not adjusted to take

into account subsequent events.

on a variable yield issue is determined

over the term of the issue. To determine

the reasonably expected yield as of any

date, the issuer may assume that the

future interest rate on a variable yield

bond will be the then-current interest

rate on the bonds determined under the

formula prescribed in the bond documents. A deliberate action requires a

recomputation of the yield on the variable yield issue to determine the present

value of payments under that arrangement. In that case, the issuer must use

the yield determined as of the date of

the deliberate action for purposes of

determining the present value of payments under the arrangement causing

the deliberate action. See paragraph (g)

of this section, Example 3.

(iv) Application to private security.

For purposes of determining the present

value of debt service that is secured by

property, the property is valued at fair

market value as of the first date on

which the property secures bonds of the

issue.

This paragraph (c) contains rules that

apply to private payments.

(2) Payments taken into account—(i)

Payments for use—(A) In general. Both

direct and indirect payments made by

any nongovernmental person that is

treated as using proceeds of the issue

are taken into account as private payments to the extent allocable to the

proceeds used by that person. Payments

are taken into account as private payments only to the extent that they are

made for the period of time that proceeds are used for a private business

use. Payments for a use of proceeds

include payments (whether or not to the

issuer) in respect of property financed

(directly or indirectly) with those proceeds, even if not made by a private

business user. Payments are not made in

respect of financed property if those

payments are directly allocable to other

property being directly used by the

person making the payment and those

payments represent fair market value

compensation for that other use. See

paragraph (g) of this section, Example 4

and Example 5. See also paragraph

(c)(3) of this section for rules relating to

allocation of payments to the source or

sources of funding of property.

(B) Payments not to exceed use. Payments with respect to proceeds that are

used for a private business use are not

taken into account to the extent that the

present value of those payments exceeds

the present value of debt service on

those proceeds. Payments need not be

directly derived from a private business

user, however, to be taken into account.

Thus, if 7 percent of the proceeds of an

issue is used by a person over the

measurement period, payments with respect to the property financed with those

proceeds are taken into account as private payments only to the extent that the

present value of those payments does

not exceed the present value of 7 percent of the debt service on the issue.

Payments by a person for a use of

proceeds do not include the portion of

any payment that is properly allocable

to the payment of ordinary and necessary expenses (as defined under section

162) directly attributable to the operation and maintenance of the financed

property used by that person. For this

purpose, general overhead and administrative expenses are not directly attributable to those operations and maintenance. For example, if an issuer receives

$5,000 rent during the year for use of

space in a financed facility and during

the year pays $500 for ordinary and

necessary expenses properly allocable to

the operation and maintenance of that

space and $400 for general overhead

and general administrative expenses

properly allocable to that space, $500 of

the $5,000 received would not be considered a payment for the use of the

proceeds allocable to that space (regardless of the manner in which that $500 is

actually used).

(ii) Refinanced debt service. Payments of debt service on an issue to be

made from proceeds of a refunding

issue are taken into account as private

payments in the same proportion that

the present value of the payments taken

into account as private payments for the

refunding issue bears to the present

value of the debt service to be paid on

the refunding issue. For example, if all

the debt service on a note is paid with

proceeds of a refunding issue, the note

meets the private security or payment

test if (and to the same extent that) the

refunding issue meets the private security or payment test. This paragraph

(c)(2)(ii) does not apply to payments

that arise from deliberate actions that

occur more than 3 years after the retirement of the prior issue that are not

reasonably expected on the issue date of

the refunding issue. For purposes of this

paragraph (c)(2)(ii), whether an issue is

a refunding issue is determined without

regard to § 1.150–1(d)(2)(i) (relating to

certain payments of interest).

(3) Allocation of payments—(i) In

general. Private payments for the use of

property are allocated to the source or

different sources of funding of property.

The allocation to the source or different

sources of funding is based on all of the

facts and circumstances, including

whether an allocation is consistent with

the purposes of section 141. In general,

a private payment for the use of property is allocated to a source of funding

based upon the nexus between the payment and both the financed property and

the source of funding. For this purpose,

different sources of funding may include

different tax-exempt issues, taxable issues, and amounts that are not derived

from a borrowing, such as revenues of

an issuer (equity).

(ii) Payments for use of discrete

property. Payments for the use of a

discrete facility (or a discrete portion of

a facility) are allocated to the source or

different sources of funding of that

discrete property.

(iii) Allocations among two or more

sources of funding. In general, except as

provided in paragraphs (c)(3)(iv) and (v)

of this section, if a payment is made for

the use of property financed with two or

more sources of funding (for example,

equity and a tax-exempt issue), that

payment must be allocated to those

sources of funding in a manner that

reasonably corresponds to the relative

amounts of those sources of funding that

are expended on that property. If an

issuer has not retained records of

amounts expended on the property (for

example, records of costs of a building

that was built 30 years before the allocation), an issuer may use reasonable

estimates of those expenditures. For this

purpose, costs of issuance and other

similar neutral costs are allocated ratably among expenditures in the same

manner as in § 1.141–3(g)(6). A payment for the use of property may be

allocated to two or more issues that

finance property according to the relative amounts of debt service (both paid

and accrued) on the issues during the

annual period for which the payment is

made, if that allocation reasonably reflects the economic substance of the

arrangement. In general, allocations of

payments according to relative debt service reasonably reflect the economic

substance of the arrangement if the

maturity of the bonds reasonably corresponds to the reasonably expected economic life of the property and debt

service payments on the bonds are approximately level from year to year.

(iv) Payments made under an arrangement entered into in connection

with issuance of bonds. A private payment for the use of property made under

an arrangement that is entered into in

connection with the issuance of the

issue that finances that property generally is allocated to that issue. Whether

an arrangement is entered into in connection with the issuance of an issue is

determined on the basis of all of the

facts and circumstances. An arrangement

is ordinarily treated as entered into in

connection with the issuance of an issue

if—

(A) The issuer enters into the arrangement during the 3-year period beginning 18 months before the issue date;

and

(B) The amount of payments reflects

all or a portion of debt service on the

issue.

(v) Allocations to equity. A private

payment for the use of property may be

allocated to equity before payments are

allocated to an issue only if—

(A) Not later than 60 days after the

date of the expenditure of those

amounts, the issuer adopts an official

intent (in a manner comparable to

§ 1.150–2(e)) indicating that the issuer

reasonably expects to be repaid for the

expenditure from a specific arrangement; and

(B) The private payment is made not

later than 18 months after the later of

the date the expenditure is made or the

date the project is placed in service.

(d) Private security—(1) In general.

This paragraph (d) contains rules that

relate to private security.

(2) Security taken into account. The

property that is the security for, or the

source of, the payment of debt service

on an issue need not be property financed with proceeds. For example, unimproved land or investment securities

used, directly or indirectly, in a private

business use that secures an issue provides private security. Private security

(other than financed property and private payments) for an issue is taken into

account under section 141(b), however,

only to the extent it is provided, directly

or indirectly, by a user of proceeds of

the issue.

(3) Pledge of unexpended proceeds.

Proceeds qualifying for an initial temporary period under § 1.148–2(e)(2) or (3)

or deposited in a reasonably required

reserve or replacement fund (as defined

in § 1.148–2(f)(2)(i)) are not taken into

account under this paragraph (d) before

the date on which those amounts are

either expended or loaned by the issuer

to an unrelated party.

(4) Secured by any interest in property or payments. Property used or to be

used for a private business use and

payments in respect of that property are

treated as private security if any interest

in that property or payments secures the

payment of debt service on the bonds.

For this purpose, the phrase any interest

in is to be interpreted broadly and

includes, for example, any right, claim,

title, or legal share in property or payments.

(5) Payments in respect of property.

The payments taken into account as

private security are payments in respect

of property used or to be used for a

private business use. Except as otherwise provided in this paragraph (d)(5)

and paragraph (d)(6) of this section, the

rules in paragraphs (c)(2)(i)(A) and (B)

and (c)(2)(ii) of this section apply to

determine the amount of payments

treated as payments in respect of property used or to be used for a private

business use. Thus, payments made by

members of the general public for use

of a facility used for a private business

use (for example, a facility that is the

subject of a management contract that

results in private business use) are taken

into account as private security to the

extent that they are made for the period

of time that property is used by a

private business user.

(6) Allocation of security among issues. In general, property or payments

from the disposition of that property that

are taken into account as private security are allocated to each issue secured

by the property or payments on a reasonable basis that takes into account

bondholders’ rights to the payments or

property upon default.

(e) Generally applicable taxes—(1)

General rule. For purposes of the private security or payment test, generally

applicable taxes are not taken into account (that is, are not payments from a

nongovernmental person and are not

payments in respect of property used for

a private business use).

(2) Definition of generally applicable

taxes. A generally applicable tax is an

enforced contribution exacted pursuant

to legislative authority in the exercise of

the taxing power that is imposed and

collected for the purpose of raising

revenue to be used for governmental

purposes. A generally applicable tax

must have a uniform tax rate that is

applied to all persons of the same

classification in the appropriate jurisdiction and a generally applicable manner

of determination and collection.

(3) Special charges. A payment for a

special privilege granted or service rendered is not a generally applicable tax.

Special assessments paid by property

owners benefiting from financed improvements are not generally applicable

taxes. For example, a tax or a payment

in lieu of tax that is limited to the

property or persons benefited by an

improvement is not a generally applicable tax.

(4) Manner of determination and collection—(i) In general. A tax does not

have a generally applicable manner of

determination and collection to the extent that one or more taxpayers make

any impermissible agreements relating

to payment of those taxes. An impermissible agreement relating to the payment

of a tax is taken into account whether or

not it is reasonably expected to result in

any payments that would not otherwise

have been made. For example, if an

issuer uses proceeds to make a grant to

a taxpayer to improve property, agreements that impose reasonable conditions

on the use of the grant do not cause a

tax on that property to fail to be a

generally applicable tax. If an agreement

by a taxpayer causes the tax imposed on

that taxpayer not to be treated as a

generally applicable tax, the entire tax

paid by that taxpayer is treated as a

special charge, unless the agreement is

limited to a specific portion of the tax.

(ii) Impermissible agreements. The

following are examples of agreements

that cause a tax to fail to have a

generally applicable manner of determination and collection: an agreement to

be personally liable on a tax that does

not generally impose personal liability,

to provide additional credit support such

as a third party guarantee, or to pay

unanticipated shortfalls; an agreement

regarding the minimum market value of

property subject to property tax; and an

agreement not to challenge or seek

deferral of the tax.

(iii) Permissible agreements. The following are examples of agreements that

do not cause a tax to fail to have a

generally applicable manner of determination and collection: an agreement to

use a grant for specified purposes

(whether or not that agreement is secured); a representation regarding the

expected value of the property following

the improvement; an agreement to insure the property and, if damaged, to

restore the property; a right of a grantor

to rescind the grant if property taxes are

not paid; and an agreement to reduce or

limit the amount of taxes collected to

further a bona fide governmental purpose. For example, an agreement to

abate taxes to encourage a property

owner to rehabilitate property in a distressed area is a permissible agreement.

(5) Payments in lieu of taxes. A tax

equivalency payment and any other payment in lieu of a tax is treated as a

generally applicable tax if—

(i) The payment is commensurate

with and not greater than the amounts

imposed by a statute for a tax of general

application; and

(ii) The payment is designated for a

public purpose and is not a special

charge (as described in paragraph (e)(3)

of this section). For example, a payment

in lieu of taxes made in consideration

for the use of property financed with

tax-exempt bonds is treated as a special

charge.

(f) Certain

waste

remediation

bonds—(1) Scope. This paragraph (f)

applies to bonds issued to finance hazardous waste clean-up activities on privately owned land (hazardous waste

remediation bonds).

(2) Persons that are not private users. Payments from nongovernmental

persons who are not (other than coincidentally) either users of the site being

remediated or persons potentially responsible for disposing of hazardous

waste on that site are not taken into

account as private security. This paragraph (f)(2) applies to payments that

secure (directly or indirectly) the payment of principal of, or interest on, the

bonds under the terms of the bonds.

This paragraph (f)(2) applies only if the

payments are made pursuant to either a

generally applicable state or local taxing

statute or a state or local statute that

regulates or restrains activities on an

industry-wide basis of persons who are

engaged in generating or handling hazardous waste, or in refining, producing,

or transporting petroleum, provided that

those payments do not represent, in

substance, payment for the use of proceeds. For this purpose, a state or local

statute that imposes payments that have

substantially the same character as those

described in Chapter 38 of the Code are

treated as generally applicable taxes.

(3) Persons that are private users. If

payments from nongovernmental persons who are either users of the site

being remediated or persons potentially

responsible for disposing of hazardous

waste on that site do not secure (directly

or indirectly) the payment of principal

of, or interest on, the bonds under the

terms of the bonds, the payments are not

taken into account as private payments.

This paragraph (f)(3) applies only if at

the time the bonds are issued the payments from those nongovernmental persons are not material to the security for

the bonds. For this purpose, payments

are not material to the security for the

bonds if—

(i) The payments are not required for

the payment of debt service on the

bonds;

(ii) The amount and timing of the

payments are not structured or designed

to reflect the payment of debt service on

the bonds;

(iii) The receipt or the amount of the

payment is uncertain (for example, as of

the issue date, no final judgment has

been entered into against the nongovernmental person);

(iv) The payments from those nongovernmental persons, when and if received, are used either to redeem bonds

of the issuer or to pay for costs of any

hazardous waste remediation project;

and

(v) In the case when a judgment (but

not a final judgment) has been entered

by the issue date against a nongovernmental person, there are, as of the issue

date, costs of hazardous waste remediation other than those financed with the

bonds that may be financed with the

payments.

(g) Examples. The following examples illustrate the application of this

section:

Example 1. Aggregation of payments. State B

issues bonds with proceeds of $10 million. B uses

$9.7 million of the proceeds to construct a 10story office building. B uses the remaining

$300,000 of proceeds to make a loan to Corporation Y. In addition, Corporation X leases 1 floor of

the building for the term of the bonds. Under all

of the facts and circumstances, it is reasonable to

allocate 10 percent of the proceeds to that 1 floor.

As a percentage of the present value of the debt

service on the bonds, the present value of Y’s loan

repayments is 3 percent and the present value of

X’s lease payments is 8 percent. The bonds meet

the private security or payment test because the

private payments taken into account are more than

10 percent of the present value of the debt service

on the bonds.

Example 2. Indirect private payments. J, a

political subdivision of a state, will issue several

series of bonds from time to time and will use the

proceeds to rehabilitate urban areas. Under all of

the facts and circumstances, the private business

use test will be met with respect to each issue that

will be used for the rehabilitation and construction

of buildings that will be leased or sold to nongovernmental persons for use in their trades or

businesses. Nongovernmental persons will make

payments for these sales and leases. There is no

limitation either on the number of issues or the

aggregate amount of bonds that may be outstanding. No group of bondholders has any legal claim

prior to any other bondholders or creditors with

respect to specific revenues of J, and there is no

arrangement whereby revenues from a particular

project are paid into a trust or constructive trust,

or sinking fund, or are otherwise segregated or

restricted for the benefit of any group of bondholders. There is, however, an unconditional obligation by J to pay the principal of, and the interest

on, each issue. Although not directly pledged

under the terms of the bond documents, the leases

and sales are underlying arrangements. The payments relating to these leases and sales are taken

into account as private payments to determine

whether each issue of bonds meets the private

security or payment test.

Example 3. Computation of payment in variable

yield issues. (i) City M issues general obligation

bonds with proceeds of $10 million to finance a

5-story office building. The bonds bear interest at

a variable rate that is recomputed monthly according to an index that reflects current market yields.

The yield that the interest index would produce on

the issue date is 6 percent. M leases 1 floor of the

office building to Corporation T, a nongovernmental person, for the term of the bonds. Under all of

the facts and circumstances, T is treated as using

more than 10 percent of the proceeds. Using the 6

percent yield as the discount rate, M reasonably

expects on the issue date that the present value of

lease payments to be made by T will be 8 percent

of the present value of the total debt service on

the bonds. After the issue date of the bonds,

interest rates decline significantly, so that the yield

on the bonds over their entire term is 4 percent.

Using this actual 4 percent yield as the discount

rate, the present value of lease payments made by

T is 12 percent of the present value of the actual

total debt service on the bonds. The bonds are not

private activity bonds because M reasonably expected on the issue date that the bonds would not

meet the private security or payment test and

because M did not take any subsequent deliberate

action to meet the private security or payment test.

(ii) The facts are the same as Example 3(i),

except that 5 years after the issue date M leases a

second floor to Corporation S, a nongovernmental

person, under a long-term lease. Because M has

taken a deliberate action, the present value of the

lease payments must be computed. On the date

this lease is entered into, M reasonably expects

that the yield on the bonds over their entire term

will be 5.5 percent, based on actual interest rates

to date and the then-current rate on the variable

yield bonds. M uses this 5.5 percent yield as the

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.