# Bulletin No. 1997–12

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- **Document type:** Agency decision

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Bulletin No. 1997–12
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.

2

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.

3

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
Register (59 FR 67658) to provide
guidance under the Internal Revenue
Code of 1986 (Code) in sections 141
(relating to private activity bonds and to
qualified bonds), 142 (relating to
exempt-facility bonds), 145 (relating to
qualified 501(c)(3) bonds), 147 (relating
to other requirements applicable to certain private activity bonds), 148 (relating
to arbitrage), 150 (relating to change of
use), and 1394 (relating to enterprise
zone facility bonds). All subsequent references in this preamble to Code sec-

4

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-

5

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

6

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

7

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

8

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

9

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-

10

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

11

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–
1]
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.
(c) Elections.
(d) Related parties.
§ 1.141–2 Private activity bond tests.
(a) Overview.
(b) Scope.
(c) General definition of private activity bond.
(d) Reasonable expectations and deliberate actions.
(1) In general.
(2) Reasonable expectations test.
(3) Deliberate action defined.
(4) Special rule for dispositions of
personal property in the ordinary course
of an established governmental program.
(5) Special rule for general obligation
bond programs that finance a large
number of separate purposes.
(e) When a deliberate action occurs.
(f) Certain remedial actions.
(g) Examples.
§ 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.

12

(3) Leases.
(4) Management contracts.
(5) Output contracts.
(6) Research agreements.
(7) Other actual or beneficial use.
(c) Exception for general public use.
(1) In general.
(2) Use on the same basis.
(3) Long-term arrangements not
treated as general public use.
(4) Relation to other use.
(d) Other exceptions.
(1) Agents.
(2) Use incidental to financing arrangements.
(3) Exceptions for arrangements other
than arrangements resulting in ownership of financed property by a nongovernmental person.
(4) Temporary use by developers.
(5) Incidental use.
(6) Qualified improvements.
(e) Special rule for tax assessment
bonds.
(f) Examples.
(g) Measurement of private business
use.
(1) In general.
(2) Measurement period.
(3) Determining average percentage
of private business use.
(4) Determining the average amount
of private business use for a 1-year
period.
(5) Common areas.
(6) Allocation of neutral costs.
(7) Commencement of measurement
of private business use.
(8) Examples.
§ 1.141–4 Private security or payment
test.
(a) General rule.
(1) Private security or payment.
(2) Aggregation of private payments
and security.
(3) Underlying arrangement.
(b) Measurement of private payments
and security.
(1) Scope.
(2) Present value measurement.
(c) Private payments.
(1) In general.
(2) Payments taken into account.
(3) Allocation of payments.
(d) Private security.
(1) In general.
(2) Security taken into account.
(3) Pledge of unexpended proceeds.
(4) Secured by any interest in property or payments.
(5) Payments in respect of property.

(6) Allocation of security among issues.
(e) Generally applicable taxes.
(1) General rule.
(2) Definition of generally applicable
taxes.
(3) Special charges.
(4) Manner of determination and collection.
(5) Payments in lieu of taxes.
(f) Certain waste remediation bonds.
(1) Scope.
(2) Persons that are not private users.
(3) Persons that are private users.
(g) Examples.
§ 1.141–5 Private loan financing test.
(a) In general.
(b) Measurement of test.
(c) Definition of private loan.
(1) In general.
(2) Application only to purpose investments.
(3) Grants.
(4) Hazardous waste remediation
bonds.
(d) Tax assessment loan exception.
(1) General rule.
(2) Tax assessment loan defined.
(3) Mandatory tax or other assessment.
(4) Specific essential governmental
function.
(5) Equal basis requirement.
(6) Coordination with private business tests.
(e) Examples.
§ 1.141–6 Allocation and accounting
rules.
(a) Allocation of proceeds to expenditures.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds.
[Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
§ 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.
(c) Disproportionate 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.
(c) Disposition proceeds.
(1) Definition.
(2) Allocating disposition proceeds to
an issue.
(3) Allocating disposition proceeds to
different sources of funding.
(d) Redemption or defeasance of
nonqualified bonds.
(1) In general.
(2) Special rule for dispositions for
cash.
(3) Notice of defeasance.
(4) Special limitation.
(5) Defeasance escrow defined.
(e) Alternative use of disposition proceeds.
(1) In general.
(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.

13

(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.
(c) Refunding bonds.
(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.
(c) Permissive application.
§ 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.
(c) Elections. Elections must be made
in writing on or before the issue date
and retained as part of the bond documents, and, once made, may not be
revoked without the permission of the
Commissioner.
(d) Related parties. Except as otherwise provided, all related parties are
treated as one person and any reference
to ‘‘person’’ includes any related party.
§ 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.

14

(b) Scope. Sections 1.141–0 through
1.141–16 apply generally for purposes
of the private activity bond limitations
under section 141.
(c) General definition of private activity bond. Under section 141, bonds
are private activity bonds if they meet
either the private business use test and
private security or payment test of 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;
(C) The issuer does not enter into
any arrangement with a nongovernmental person, as of the issue date, with
respect to that specific action; and
(D) The mandatory redemption of
bonds meets all of the conditions for
remedial action under § 1.141–12(a).
(3) Deliberate action defined—(i) In
general. Except as otherwise provided in
this paragraph (d)(3), a deliberate action
is any action taken by the issuer that is
within its control. An intent to violate

the requirements of section 141 is not
necessary for an action to be deliberate.
(ii) Safe harbor exceptions. An action
is not treated as a deliberate action if—
(A) It would be treated as an involuntary or compulsory conversion under
section 1033; or
(B) It is taken in response to a regulatory directive made by the federal
government.
(4) Special rule for dispositions of
personal property in the ordinary course
of an established governmental program—(i) In general. Dispositions of
personal property in the ordinary course
of an established governmental program
are not treated as deliberate actions if—
(A) The weighted average maturity of
the bonds financing that personal property is not greater than 120 percent of
the reasonably expected actual use of
that property for governmental purposes;
(B) The issuer reasonably expects on
the issue date that the fair market value
of that property on the date of disposition will be not greater than 25 percent
of its cost; and
(C) The property is no longer suitable
for its governmental purposes on the
date of disposition.
(ii) Reasonable expectations test. The
reasonable expectation that a disposition
described in paragraph (d)(4)(i) of this
section may occur in the ordinary course
while the bonds are outstanding will not
cause the issue to meet the private
activity bond tests if the issuer is required to deposit amounts received from
the disposition in a commingled fund
with substantial tax or other governmental revenues and the issuer reasonably
expects to spend the amounts on governmental programs within 6 months
from the date of commingling.
(iii) Separate issue treatment. An issuer may treat the bonds properly allocable to the personal property eligible
for this exception as a separate issue
under § 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:

15

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.

16

(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.
(C) A contract to provide for the
operation of a facility or system of
facilities that consists predominantly of
public utility property, if the only compensation is the reimbursement of actual
and direct expenses of the service provider and reasonable administrative
overhead expenses of the service provider.
(D) A contract to provide for services, if the only compensation is the
reimbursement of the service provider
for actual and direct expenses paid by
the service provider to unrelated parties.
(iv) Management contracts that are
properly treated as other types of private business use. A management contract with respect to financed property
results in private business use of that
property if the service provider is
treated as the lessee or owner of financed property for federal income tax
purposes, unless an exception under
paragraph (d) of this section applies to
the arrangement.
(5) Output contracts. See § 1.141–7
for special rules for contracts for the
purchase of output of output facilities.
(6) Research agreements—(i) Facts
and circumstances test. Except as provided in paragraph (d) of this section, an
agreement by a nongovernmental person
to sponsor research performed by a
governmental person may result in private business use of the property used
for the research, based on all of the
facts and circumstances.
(ii) Research agreements that are
properly treated as other types of private business use. A research agreement
with respect to financed property results
in private business use of that property
if the sponsor is treated as the lessee or

owner of financed property for federal
income tax purposes, unless an exception under paragraph (d) of this section
applies to the arrangement.
(7) Other actual or beneficial use—
(i) In general. Any other arrangement
that conveys special legal entitlements
for beneficial use of bond proceeds or
of financed property that are comparable
to special legal entitlements described in
paragraphs (b)(2), (3), (4), (5), or (6) of
this section results in private business
use. For example, an arrangement that
conveys priority rights to the use or
capacity of a facility generally results in
private business use.
(ii) Special rule for facilities not used
by the general public. In the case of
financed property that is not available
for use by the general public (within the
meaning of paragraph (c) of this section), private business use may be established solely on the basis of a special
economic benefit to one or more nongovernmental persons, even if those
nongovernmental persons have no special legal entitlements to use of the
property. In determining whether special
economic benefit gives rise to private
business use it is necessary to consider
all of the facts and circumstances, including one or more of the following
factors—
(A) Whether the financed property is
functionally related or physically proximate to property used in the trade or
business of a nongovernmental person;
(B) Whether only a small number of
nongovernmental persons receive the
special economic benefit; and
(C) Whether the cost of the financed
property is treated as depreciable by any
nongovernmental person.
(c) Exception for general public
use—(1) In general. Use as a member
of the general public (general public
use) is not private business use. Use of
financed property by nongovernmental
persons in their trades or businesses is
treated as general public use only if the
property is intended to be available and
in fact is reasonably available for use on
the same basis by natural persons not
engaged in a trade or business.
(2) Use on the same basis. In general, use under an arrangement that
conveys priority rights or other preferential benefits is not use on the same basis
as the general public. Arrangements providing for use that is available to the
general public at no charge or on the
basis of rates that are generally applicable and uniformly applied do not
convey priority rights or other 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-

17

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
(C) The property is not financed for a
principal purpose of providing that property for use by that nongovernmental
person.
(ii) Negotiated arm’s-length arrangements. Use by a nongovernmental person pursuant to an arrangement, other
than an arrangement resulting in ownership of financed property by a nongovernmental person, is not private business
use if—
(A) The term of the use under the
arrangement, including all renewal options, is not longer than 30 days;
(B) The arrangement is a negotiated
arm’s-length arrangement, and compensation under the arrangement is at fair
market value; and
(C) The property is not financed for a
principal purpose of providing that property for use by that nongovernmental
person.
(4) Temporary use by developers. Use
during an initial development period by
a developer of an improvement that
carries out an essential governmental
function is not private business use if
the issuer and the developer reasonably
expect on the issue date to proceed with
all reasonable speed to develop the
improvement and property benefited by
that improvement and to transfer the
improvement to a governmental person,
and if the improvement is in fact 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
(C) All nonpossessory uses of the
facility do not, in the aggregate, involve
the use of more than 2.5 percent of the
facility.
(ii) Illustrations. Incidental uses may
include pay telephones, vending machines, advertising displays, and use for
television cameras, but incidental uses
may not include output purchases.
(6) Qualified improvements. Proceeds
that provide a governmentally owned
improvement to a governmentally
owned building (including its structural
components and land functionally related and subordinate to the building)
are not used for a private business use
if—
(i) The building was placed in service
more than 1 year before the construction
or acquisition of the improvement is
begun;
(ii) The improvement is not an enlargement of the building or an improvement of interior space occupied
exclusively for any private business use;
(iii) No portion of the improved
building or any payments in respect of
the improved building are taken into
account under section 141(b)(2)(A) (the
private security test); and
(iv) No more than 15 percent of the
improved building is used for a private
business use.
(e) Special rule for tax assessment
bonds. In the case of a tax assessment
bond that satisfies the requirements of
§ 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

18

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-

19

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 Unit

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A10134cbc0c752333. Public record. Not legal advice.