The Internal Revenue Service has determined that some tax-exempt enterprise zone facility bonds issued to finance the construction of a business within a zone will remain tax-exempt even if the facility is sold to another buyer to operate it after its construction.
"We conclude that a sale of the facility to a person who will operate the facility as an enterprise zone business but who will not be the first-time user of the facility in the zone will not cause the bonds to be other than qualified enterprise zone facility bonds," the service stated in its letter.
The agency handed down the decision in a private-letter ruling that was dated Aug. 28, but released last week. It did not identify the facility, bond issue, or the parties involved.
While private-letter rulings are supposed to be applicable only to the issuers that request them, they are believed to provide insights into the IRS' thinking, particularly on tax matters for which little guidance currently exists.
In this particular arrangement, a municipal authority would issue the bonds and loan the proceeds to a developer who would oversee construction of the facility. Once construction was completed, the developer would sell the facility to another buyer who would then operate it as an enterprise zone business.
The issuer sought the IRS' guidance on the matter amid questions surrounding how the so-called first use provision of the tax code for enterprise zone tax benefits applies to tax exemptions for facility bonds, IRS officials said.
The first use provision applies to many enterprise zone tax benefits, including several tied to depreciation, which states that only the first user of a new facility within the zone can receive the benefits, which expire if it is sold to a second taxpayer. The provision exists to encourage the flow of new capital to enterprise zones, rather than simply moving old facilities and equipment to the area.
However, the issuer of the bonds was unsure if this provision meant that if the facility is sold to a second owner after it is constructed, the tax exemption for the bonds - the proceeds of which had been already spent on construction but are still outstanding - would similarly expire.
The IRS determined that the bonds would retain their exemption even if the facility is sold to a new owner. In its rationale, it stated that the total number of owners over the facility's history is irrelevant, because there can only be one "first use" of the facility, and in the case of the bonds, it occurs when the bond proceeds are spent.
The IRS stated in the ruling that if the goal of an enterprise zone is to attract new capital, including bond proceeds spent on construction of the facility, "the sale of the facility does nothing to lessen this accomplishment."
Furthermore, the IRS noted that if the bonds only remained exempt so long as the only qualified user was the one that built or first brought the facility into the zone, "an enterprise zone business that wants to benefit from tax-exempt financing would have to commit to using the property for the entire compliance period."
The agency stated that it can be expected for enterprise zone properties to be sold or leased during the time the bonds are outstanding, and doing so would not endanger the exempt status of the debt, assuming it remains a qualified enterprise zone property after the sale.
But the IRS made clear in its ruling that it is not expressing any other opinion in this private-letter ruling about how the sale of the facility would impact other enterprise zone tax incentives, nor whether the facility would still be considered a qualified zone property after its sale.