WASHINGTON - An Internal Revenue Service audit of bonds issued in connection with a Montana continuing care retirement facility could have widespread implications regarding whether refundable entrance fees common to CCRCs are so-called "replacement proceeds" whose investment must be yield-restricted for arbitrage purposes.
"We've very aware of [the audit]," said Steve Maag, director of assisted living and continuing care for the American Association of Homes and Services for the Aging, a national organization of 5000 nonprofit retirement facilities. "We view this as something that ultimately could put at risk the way CCRCs currently operate and ultimately cause seniors to either have less services or have to pay more money for their services."
"It's something that ought to go on people's radar screens," said Lauren K. Mack, an attorney at Sonnenschein Nath & Rosenthal LLP in San Francisco. "Refundable entrance fees are a standard in the business."
The IRS has taken the stance that the entrance fees are "replacement proceeds" in an audit of $14.2 million of 2002 variable-rate bonds issued by the Montana Facility Finance Authority to finance an expansion to a CCRC called Mission Ridge.
The IRS issued a "notice of proposed issue" - which has replaced the preliminary adverse determination in the IRS' muni bond enforcement program - on Oct. 1, saying that the bonds are arbitrage bonds and, as a result, are taxable.
The authority disclosed the IRS action in a material event notice filed last month with the nationally recognized municipal securities information repositories.
But the Montana agency said in the notice that it and the conduit borrower, Missions United Inc., "strongly disagree with the proposed issue/adjustment described in the NOPI and intend to continue working with the IRS to protect the exclusion from gross income of interest on the bonds."
The IRS contends that the entrance fees the CCRC collects when a resident moves in, but refunds when they vacate, are technically replacement proceeds, whose investment should be yield-restricted in accordance with arbitrage regulations.
Treasury Department regulations define replacement proceeds as having "a sufficiently direct nexus to the issue or to the governmental purpose of the issue to conclude that the amounts would have been used for that governmental purpose if the proceeds of the issue were not used or to be used for that governmental purpose."
The IRS' interpretation of these rules is that bondholders could reasonably assume that the fees would be available for debt service payments if needed.
However, Mission Ridge contends that it does not set aside the fees for debt service, and in fact spends them on its day-to-day operations like the rest of its revenue.
The bonds were issued by the authority to finance the expansion of Mission Ridge, which consists of an independent living facility, an assisted living facility, and a nursing home with full-time care. According to bond documents, bond proceeds financed the construction and equipping of 37 additional independent living units and 20 additional assisted living units, together with common areas and parking.
The IRS began the examination on March 19, 2007, as part of a project initiative looking into 501(c)(3) bond issues, the notice stated.
Bradley S. Waterman, the tax controversy attorney representing the Montana authority, declined to discuss the notice yesterday.
Gottlieb, Fisher & Andrews PLLC in Seattle served as bond counsel on the deal. Ziegler Capital Markets was remarketing agent. The letter of credit was provided by Lasalle Bank National Association, which is now part of Bank of America.
