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Taxation

IRS Finds D.C. Bonds for Oyster School P3 Taxable

WASHINGTON – The Internal Revenue Service has determined that PILOT revenue bonds issued by the District of Columbia as part of a much lauded public-private partnership to build a new elementary school are taxable.

The district received a Jan. 19 "Proposed Adverse Determination" from the IRS, according to a notice filed on the Municipal Securities Rulemaking Board's EMMA website. The Proposed Adverse Determination is the final step by the IRS' tax-exempt bond office (TEB) in determining taxability. It can be appealed to the IRS' Office of Appeals.

The notice said, "The District of Columbia is evaluating how it will respond to the Proposed Adverse Determination, including whether it will appeal."

The district issued $11 million of PILOT revenue bonds in late 1999 for the James F. Oyster Elementary School P3.

Mark Scott, the former head of the TEB, who examined the financing for a client under the IRS' whistleblower program, tweeted last year that the transaction was a "PPP disaster" and "a tax scam … that cost the district residents millions in tax dollars."

D.C. officials had touted the financing as one that should possibly be replicated by a P3 office launched by Mayor Muriel Bowser in 2015.

Scott claimed the bonds are actually taxable private activity bonds (PABs) because the district made an indirect private loan to the developer, LCOR New Oyster School LLC (LCOR).

According to the official statement for the bonds and information from D.C., some of which was obtained by Scott from Freedom of Information Act requests, the $11 million of proceeds were mostly used by the developer to finance the demolishment of an old school and the design and construction of a new Oyster Elementary School within two years. The school was completed and is now operating.

The bonds were to be entirely repaid by payments-in-lieu of taxes (PILOTs) to be made by the developer. The school was built on .79 of an acre.

D.C. transferred to LCOR about .88 of an acre next to the school on which the developer constructed a 210-unit luxury apartment complex with an estimated value, in 1999, of $23 million. D.C. had no financial interest in the apartment complex. But the developer was exempted from paying property taxes on the apartment complex property in return for making PILOTS to the district for debt service on the bonds.

Scott contends that the transaction did not really benefit the district overall because D.C. made an indirect loan to the developer of between $3.2 million and $3.76 million and then allowed the developer to pay for it with the PILOTS, based on a tax-exempt rate.

He claims the deal was abusive and that the IRS commissioner should reallocate $3.2 million to $3.76 million of bond proceeds as a loan to the developer.

Under federal tax laws, bonds are PABs if more than the lesser of 5% or $5 million of the bond proceeds are used directly or indirectly to make or finance loans to private parties. PABs are not tax-exempt unless they finance projects that fall into one of several specific categories, none of which include elementary schools.

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