IRS: Village Center CDD Bonds Are Taxable PABs

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WASHINGTON - Bonds issued by the Village Center Community Development District in Florida, the subject of a years-long audit and a controversial technical advice memorandum, are taxable private-activity bonds, the IRS said in a new notice of proposed issue.

The notice was dated Dec. 17 but not posted on the Municipal Securities Rulemaking Board's EMMA system until Thursday.

This latest IRS notice supplements notices with the same proposed taxable bond findings that the IRS issued in January 2009: one saying that the bonds are taxable PABs, another saying that the CDD isn't a political subdivision that can issue tax-exempt bonds; and another saying that the appraisals of bond-financed property don't support the prices the issuer paid to the developer for the facilities. But this latest notice on PABs includes some different reasoning than the earlier one, said Perry Israel, a Sacramento, Calif.-based lawyer representing the CDD.

In May 2013, the IRS chief counsel's office issued a technical advice memorandum concluding that the CDD isn't a political subdivision for bond purposes, and a few months later, the IRS came out with another notice of proposed issue concluding the bonds may be taxable because of that. This matter is still pending, and the chief counsel's office still hasn't ruled whether the TAM would be applied retroactively or prospectively to the CDD's bonds.

The IRS has not concluded the audit yet. Ultimately, it could reach a final determination that the bonds are taxable on either or both of the political subdivision and the PAB issues.

The district expected to receive the recent notice and has until March 2 to respond to it, said Israel. "It's another step in the process," he said.

Israel said the district disagrees with the IRS' finding. "We do not believe that the bonds are private-activity bonds," he said.

The notice pertains to more than $200 million of bonds issued from 1998 to 2004 that were used to finance recreational facilities. It does not cover the bonds used to finance utilities.

The CDD is a commercial district that was created in 1992 and includes part of a retirement community in Central Florida. The CDD and one other commercial district run the utilities, recreational facilities, and other services for the entire development.

The CDD issued the more than $200 million of bonds to purchase recreational facilities that the developer built and the amenity fees that residents pay to use the facilities. The developer retained the right to sell new residences to people who can use the facilities. New residents pay amenity fees to the developer until the right to receive their fees is sold to the CDD.

Under federal tax law, bonds are private activity bonds if more than 10% of the proceeds are for private business use and more than 10% of the debt service is paid by, or secured from, private parties. Private activity bonds are taxable unless they are used for certain "qualified" purposes, which do not include recreational facilities.

The IRS gave three reasons why the bonds meet the private business use test.

The first reason is that the developer retained control over the bond-financed property because it controlled the CDD's board.

The CDD's board was selected by the developer or its affiliates during the relevant time period, since there were never enough residents living in the district to require the board to be elected by residents.

"The developer's control permeated every aspect of the issuer's powers, duties, responsibilities, contracts and control over the issuer's tax-exempt financed assets," the IRS said.

Bond lawyers not directly involved in the audit pointed out that in the TAM finding that the CDD is not a political subdivision, the IRS chief counsel's office also found fault with the fact that the developer controlled the district's board.

The theory that the CDD is the developer's alter ego "continues to rear its head," said National Association of Bond Lawyers president Tony Martini.

The second reason why the IRS thinks the facilities have private business use is because, even if the developer didn't have control over the property, it maintained "special legal entitlements" to the facilities. It maintained the exclusive right to tell future residents they could use the bond-financed facilities and it kept the legal right to amenity fees paid by the future residents, even the part of the fees relating to the facilities it already sold the CDD.

"The developer is using the bond financed facilities when, in its private business activities, it contracts with new homeowners for amenity fees that grants the use of bond-financed facilities and services," the IRS said.

The third reason for the IRS' conclusion is that there is private business use is because the developer kept "special economic benefits" to bond-financed property that cannot be used by the general public. Under Treasury Department regulations, a private party receiving a special economic benefit to bond-financed property can give rise to private business use when the property is not available to the general public, even if the private party has no legal entitlements to the property.

"It is undeniable that the arrangements between the center district, controlled by the developer, and the developer, provided the developer with the significant special economic benefits, including the economic benefit from being able to sell future residents land that included the right to use bond-financed facilities and the right to receive income paid for the use of the bond-financed amenities," the IRS said.

Bond lawyers said the IRS not considering members of the development to be the general public raises questions, since the community is large.

The IRS also said the bonds meet the private security or payment test.

The amenity fees, which were the main source of payments on the bonds, are private payments, because they were made to use facilities that are used in the trade or business of private party. Also, the district's gross revenues, which mainly consist of amenities fees, were security for the bonds.

Kim Betterton, a partner at Ballard Spahr in Baltimore, said that a lot of lawyers would, at least in some respects, interpret the PAB rules differently from the way the IRS did in the notice. She said there really needs to be guidance relating to special districts, since they finance a lot of infrastructure in some states, such as Florida, Colorado and California.

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