IRS Ruling Against Fla. CDD May Have Limited Reach

The Internal Revenue Service’s ruling against the Village Center Community Development District in Florida may not be as far-ranging as originally thought because of the unique set of facts that were found to be abusive by the IRS, market participants said Thursday.

However, several lawyers said the ruling is causing some bond financings to be postponed in Florida and Colorado and raises some questions. They complained the IRS is trying to create new standards for CDDs through an enforcement action rather than through rulemaking, which permits public comment.

The IRS has been investigating the Village Center CDD for five-and-a-half years. Last November, its chief counsel notified the CDD that it had “tentatively” decided it was not a political subdivision and its bonds were not tax-exempt. The National Association of Bond Lawyers and members of Congress subsequently warned the IRS that such a ruling could have a major adverse impact on other CDDs in Florida and similarly structured issuers in other states like California and Colorado.

The IRS’ chief counsel on May 30 sent the Village Center CDD a final technical advice memorandum concluding the CDD was not a political subdivision and could not have issued tax-exempt bonds. But the IRS’ conclusion was based on its finding that the CDD was organized and operated in a way that ensured it would always be under the control of the developer or developer affiliates, rather than board members elected by residents.

Market participants said the TAM will not likely apply to many CDD’s or similar issuers that are controlled by state or local governments or board members elected by residents.

“We believe the ruling was somewhat favorable because it was very deal-specific,” said Stephen Sanford, a shareholder with Greenberg Traurig, P.A. who cautioned his firm has not taken a position on the TAM. “It could have been written more generally, but it wasn’t.”

Technically, the TAM is only supposed to apply to the Village Center CDD.  But as Dee Wisor, a lawyer with Sherman & Howard LLC in Denver, said, “The practitioners all pay attention to these and think they are precedent-setting.”

An attorney in Florida who did not want to be named said he has a CDD client preparing to issue bonds, but that the deal could be held up because of the TAM. “At first blush looking at this TAM, I don’t know if there will be a firm issuing a tax-exempt opinion right now unless there’s further comment or something of a national scope narrowing this TAM,” he said, adding, “We may have to see if the district can get a private-letter ruling.”

Another attorney who did not want to be named said he had heard some deals were being postponed in Florida and Colorado because of the TAM.

The Stonegate Community Development District in Florida on Wednesday issued a supplement to its preliminary limited offering memorandum for $8 million of special assessment revenue refunding bonds that said the TAM is “non-precedential” and “appears only to address the specific facts related to the Village Center and [its] audited bonds.”

Nevertheless, the supplement warned the IRS “may commence additional audits of bonds issued by other [CDDs] on the same basis ... and may conclude that [they] are not political subdivisions.” The district urged bondholders to read the Village Center’s TAM “in its entirety.”

Sanford said the facts in the Village Center CDD are unusual. CDDs typically are initially created by developers, which issue bonds to finance the development of infrastructure in a community, and then sell lots to homeowners. While the developer or related parties may initially control the board of supervisors that governs the CDD, under Florida law once there are 250 residents members of the board must be elected by the “qualified electorate,” meaning residents who can vote.

The Village Center CDD was set up as a non-residential CDD with a board of supervisors controlled by the developer or affiliated parties for about 20 years, according to the IRS. The CDD’s bond documents stated that because of the non-residential nature of the development, there would never be “qualified electors” of board members, the IRS said.

The CDD’s board petitioned four times to shrink or otherwise move the district’s boundaries so that it would not include residences. Sanford said he had never seen a CDD take such actions.

The Village Center CDD contained recreational, water and sewer, and postal facilities as well as fire stations, that were constructed or acquired, owned and operated by the developer. Bonds were issued by the CDD to finance the purchase of these facilities from the developer. In its TAM, the IRS said that in some cases the “amount of [bond] proceeds paid to the developer and its affiliates significantly exceeded the developer’s costs of the assets acquired.”

Lots sold in other nearby CDDs were subject to deed restrictions requiring services to be provided by the developer, including an obligation by the developer to “perpetually provide the recreational facilities.” Property owners were required to pay the developer a monthly “amenities fee,” even if recreational facilities were located outside of their districts.

The IRS said in its TAM: “The issuer [CDD] was organized and operated to perpetuate private control and avoid indefinitely responsibility to a public electorate, either directly or through another elected state or local governmental body. That fact is not consistent with qualification as a political subdivision.”

Wisor said “All of the bond lawyers who work on these deals in Colorado are thinking about whether the TAM has application to some of the structures used in the state.” 

He said that they may be a few metropolitan districts in Colorado that are set up similarly to the Village Center CDD with the developer playing a key role. But he added that in those districts “there are also variations from the [Village Center CDD] that could mitigate tax concerns.”

Typically a developer sets up a metropolitan district and issues tax-exempt bonds payable from property taxes. Initially the developer controls the district’s board, but eventually as development occurs, residents vote for board members, he said.

“This TAM has created a focus for us,” he said. But he added, “It seems wrong to us that this happened through enforcement action. It ought to happen through rulemaking where there’s an opportunity for public comment.”

Carol Lew, a partner with Stradling Yocca Carlson & Rauth in Newport Beach, Calif., said that in California there are assessment districts set up by state and local units where bonds are payable from assessments on property owners, and Mello Roos financings, or land-based bond deals, where special property taxes are used to pay bonds. But she said that under California law, “the state and local governmental unit is in complete control” of each of these districts.

“It will vary according to what state you are in and what it’s laws are,” she said.

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