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IRS Proposes CDD Bond Settlement

WASHINGTON - The Internal Revenue Service is urging two community development districts in central Florida to settle tax law violations relating to tax-exempt bonds issued for The Villages retirement community by redeeming $355.35 million of them, paying the federal government at least $2.85 million, and agreeing to refrain from issuing any more tax-free bonds.

IRS agent Dominick Servadio Jr. outlined the terms of the proposed settlement in a two-page letter sent May 18 to Charles H. Smith, the chairman of the Village Center Community Development District and a broker at Morgan Stanley Smith Barney at The Villages. The letter was obtained and released by the Orlando Sentinel on Sunday.

Servadio wrote in the letter if that the Village Center CDD and the Sumter Landing Community Development District did not want to settle under the proposed terms, or if they decided to appeal the determination that the bonds should not be tax-exempt, the IRS could expand its investigation of two 2003 bond issues to include seven others sold from November 1993 through November 2005.

The nine issues would have a total tax exposure of $16.46 million, or more than five times the $2.85 million currently being sought by the IRS. And the estimate of tax exposure would be even higher for bonds that remained outstanding, a source said.

Neither Servadio nor Smith would comment on the letter or the dispute.

The Bond Buyer reported in February that the IRS had sent the Village Center CDD a letter Jan. 23 that identified three concerns the IRS had with the $64.3 million of recreational revenue bonds that were issued in 2003 to finance the acquisition of golf courses, parks and facilities for The Villages.

One concern is that the Village Center CDD does not qualify as a political subdivision or as an "on behalf of" issuer of tax-exempt bonds. Another is that the appraisals of property do not support the prices the issuer paid to the developer for facilities, and the purchases did not constitute governmental use of bond proceeds. A third concern is that the bonds are private-activity bonds but are not tax-exempt, because they are not "qualified."

Under a Florida law enacted in 1980, a private development can create community development districts to finance public infrastructure projects with tax-exempt debt, either by financing the projects directly or by purchasing them from the developer. The districts must consist of a five-member board of supervisors that is elected every two years.

Though landowners can initially serve on such boards, developers are supposed to turn over control of CDDs to residents of the community once they have been established.

But Servadio had complained in correspondence with the VCCDD that the board of supervisors is made up mostly of people affiliated with the developer. He pointed out that no residents had served on the VCCDD during its 16-year existence, and he wrote that it was structured "apparently to ensure the developer's control over the board of supervisors."

As a result, the board of supervisors could not have exercised independent oversight of the bond transaction, he told the VCCDD.

Servadio told the VCCDD that the bonds appear to have been overissued, because at least 19 facilities acquired with the 2003 bond proceeds were overvalued.

Appraisals provided to the VCCDD by Fishkind & Associates Inc. and Public Resources Management Group Inc. had established a purchase price for the facilities of about $60 million. However, Servadio told the VCCDD that he determined through a third-party contact that the facilities were worth only between $6.8 million and $7.5 million.

As a result, the bonds appear to be taxable arbitrage bonds, he wrote in his correspondence with the CDD.

He noted that Fishkind not only provided appraisals for four earlier VCCDD bond issues, but also served as its financial adviser for the deals.

Fishkind was "working both sides of the fence," according to Servadio's letter. "There is no 'independence' at all in this situation."

Servadio wrote that the bonds met the private payment and use tests for private activity bonds, but they did not fall within one of the PAB categories for tax-exemption.

Under the tax law, bonds are private-activity bonds if more than 10% of the proceeds are for private use and more than 10% of the proceeds are from private payments. But only certain categories of projects can be financed with tax-exempt PABs.

Servadio wrote that the PAB tests were met because the golf courses purchased with the 2003 bond proceeds are only used by the VCCDD residents, not the general public, and that the so-called amenity fees that residents of other districts in the retirement community pay in exchange for the right to use the facilities go toward debt service on the bonds.

The bonds were all underwritten by Prager Sealy & Co. LLC. Akerman Senterfitt was bond counsel. Neither Village Center District Manager Janet Tutt nor bond counsel Michael Williams could be reached for comment. Perry Israel, a lawyer with his own firm in Sacramento who is representing the CCDs, would not comment.

The IRS had audited similar bonds issued in 1998, but it closed that audit without taking any action.

At that time, the IRS told the VCCDD that it was reserving the right to reopen the audit if new information emerged.

In December the IRS announced that it had begun conducting a research project on CDDs that could result in audits if violations of tax law were suspected to have occurred.

There are least 580 other CDDs in Florida, according to the Florida Department of Community Affairs, but it is unclear if they have conducted bond transactions similar to those conducted by the VCCDD.

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