WASHINGTON — The Internal Revenue Service’s tentative decision that the Village Center Community Development District in Florida is not a political subdivision could have far-reaching effects on special purpose districts set up for municipal bond issues nationwide.

In a recent two-page letter sent to the IRS Oct. 16, the National Association of Bond Lawyers warned that the agency’s position on the definition of a “political subdivision” could seriously undermine the municipal bond market.

At issue is whether at least $364 million of bonds the Florida CDD issued between 1998 and 2003 qualifies for tax-exempt status. In total, the Village CDD issued $426.2 million of bonds between 1993 and 2004.

The Villages is an active adult retirement community consisting of approximately 21,458 acres spanning across the counties of Lake, Sumpter and Marion counties. When it’s fully developed it is expected to include approximately 55,761 residences and approximately 106,000 residents, according to recent bond documents.

But the bonds could be stripped of their tax-exempt status if the IRS’ office of chief counsel ultimately decides the CDD is not a political subdivision under Section 103 of the Internal Revenue Code. As of now, the IRS has “tentatively” concluded the Village Center CDD is not a political subdivision because there was only one person on the governing board at the time bonds were issued.

The IRS is working on a technical advice memorandum or TAM for its final ruling.

NABL urged the IRS to “follow existing authority on this issue and not consider the number of landowners in a special district as being relevant to the specific question of whether a special district is a political subdivision.”

Both former NABL president Kristen Franceschi, a partner at DLA Piper LLP in Baltimore, and current president Scott Lilienthal, partner with Hogan Lovells LLP, warned that the IRS should not be changing long-standing law through TAMs.

“You shouldn’t create law through rulings,” Franceschi said. “If you want this to be a requirement, you need to change it prospectively and get people to comment. You can’t just do this.”

“There are unspecified amounts of deals out there that could be impacted. It’s not fair to change the rules in the middle of the game,” she added.

Questioning whether an issuer is a political subdivision based on how many landowners there are or how many persons are voting for the controlling board of the issuer appears to be a new focus of the IRS.

Franceschi said at this point bond lawyers can’t fully assess the impact of such a requirement because they don’t keep track of how many landowners there are for such districts “because it hasn’t been a relevant consideration.”

If the IRS applies this TAM to other audits, borrowing costs presumably could rise to some extent for special purpose district borrowers, said Charles Sandmel, an investment advisory representative who manages individual portfolios withFirst Affirmative Financial Network.

In its letter, NABL said that special districts are an important tool for financing public infrastructure improvements and by their nature will often involve one or a small number of property owners initially.

Lilienthal echoed Franceschi and said if the IRS is interested in reexamining the definition of political subdivision it ought to do so in the regular rulemaking process so as not to risk any uncertainty.

There could be uncertainty for bond counsel working on new transactions in terms of exactly what the IRS’ position is on these districts, Lilienthal said. While a TAM is not a binding precedent, it does indicate the IRS’ legal position.

“Our concern is the possibility that it could be applied more broadly in other audits,” Lilienthal said. “It’s not clear how broad of a scope the IRS might apply this analysis.”

Currently, billionaire H. Gary Morse, 75, is the landowner of the Villages Center CDD. Since 1992, Morse has raised at least $1.16 billion through 41 tax-exempt bond and note offerings in 11 special taxing districts, according to Bloomberg. He plans to issue more bonds to help finance an additional 11,000 homes, according to bond documents on the Municipal Rulemaking Securities Board’s EMMA system. His spokesperson, Gary Lester, could not be reached for comment.

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