The Internal Revenue Service has ruled that an investor-owned utility can demolish bond-financed pollution control facilities without jeopardizing the tax-exempt status of the bonds or its interest deductions related to the debt.

Demolition of the facilities would mean they would no longer be used except as scrap materials for recycling, which would have zero value, net of decommissioning costs, the IRS said in a private-letter ruling released last week. The letter ruling did not identify the parties or bonds.

Bond lawyers said the ruling is consistent with earlier IRS rulings and may have limited impact for the market because it revolves around bonds that were subject to the tax law that existed before the Tax Reform Act of 1986.

Before that act, tax-exempt private-activity bonds called “exempt facility” bonds could be issued to finance pollution-control projects. The reform act stopped such bond issues, but grandfathered certain bonds issued for projects that were in the works before the law was enacted. The act also allowed the grandfathered bonds to be current refunded under certain circumstances. In current refundings, the proceeds from refunding bonds are used to retire outstanding bonds that are eligible for early redemption.

In this case, the bonds were sold under the grandfathering provisions of the Tax Reform Act, according to the IRS. The bonds were issued by a state authority, which lent the proceeds to an investor-owned utility to finance the construction of pollution control facilities. The bonds were then current refunded.

Two years later, the utility was sued over violations of federal and state environmental laws. The utility entered into a consent decree to settle the lawsuit, under which it agreed to upgrade the pollution-control facilities to continue operating beyond a certain date. However, on that date, the plant’s fuel supply contract terminated.

The utility tried selling the plant, but this proved unsuccessful, the IRS said. It then decided to decommission and demolish the plant, including the pollution-control facilities. But it wanted assurance that the agency would not consider the demolition to be a change-in-use of the facilities, which could jeopardize the tax-exempt status of the bonds or its interest deductions.

The utility told the IRS that after demolition the plant would not be of any use except to provide scrap materials and that, net of decommissioning costs, the scrap value would be “less than zero.”

In its letter ruling, the IRS wrote: “The consent decree provides that the project facilities, without specific action on the part of [the] issuer or borrower, could no longer function in the manner expected when the bonds were issued. Demolition of the project facilities precludes any further use of [them] by causing them to change from what is currently an unexpected non-functional use to no use at all except potentially as scrap materials for recycling” that has no net value.

“This ruling is very similar to a 2009 ruling … and both are consistent with earlier rulings that have held that mere discontinued use of tax-exempt bond-financed facilities does not impair the continued exclusion of interest on the bonds from gross income,” said Thomas Vander Molen, a lawyer at Dorsey & Whitney LLP in Minneapolis. “I do not believe any of the earlier rulings addressed the section 150(b)(4) interest deduction question, however.”

“This is not the first ruling where non-use is not change-in-use,” said David Caprera, a lawyer with Kutak Rock LLP in Denver. “It is unusual in that it relates back to the 1986 [Tax Reform Act] transition rules. As such, it has little value for the bond community.”

The IRS cautioned that the letter ruling is only directed at the taxpayer that requested it. But bond lawyers sometimes look at letter rulings for guidance, particularly in areas where little guidance has been provided.

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