The Internal Revenue Service has ruled that a nonprofit health care system cannot use tax-exempt bonds to pay off the debt of a for-profit subsidiary that financed the development of a wellness and fitness facility, even though the facility was donated to another nonprofit organization.

The agency reached its conclusion in a private-letter ruling published this week that did not identify any of the parties involved.

The IRS said the bonds would not be tax-exempt because the for-profit still holds the debt, even though the debt was guaranteed by the nonprofit health system while the wellness facility was donated to another nonprofit that signed an agreement to use the facility in a manner that would comply with the requirements for tax-exempt, 501(c)(3) bonds.

“I see this fact situation as unique and the ruling as having very little application to our day-to-day practice,” said Dave Caprera, of counsel at Kutak Rock LLP in Denver.

“I think it’s a pretty unusual situation,” said Perry Israel, who has his own law firm in Sacramento, Calif.

It is unusual for an issuer or borrower requesting a letter ruling to allow the IRS to publish the ruling if it goes against them.

The IRS always cautions that such rulings are limited to the facts and circumstances of the underlying case and should not be applied to other transactions, but bond lawyers sometimes refer to them when there is little other relevant guidance available.

According to the facts of the case outlined by the IRS, the for-profit subsidiary of the health system obtained a line of credit to acquire and construct a wellness and fitness facility.

The for-profit’s line of credit was secured by a guarantee from the health care system, which wholly owned the for-profit subsidiary through a for-profit holding company.

The subsidiary expected to use the revenues from the wellness and fitness facility to pay off the debt.

The facility was placed in service. A year later, the for-profit subsidiary refinanced its line of credit.

The debt was not secured by a lien against the facility.

However, the facility failed to make money and operated at a loss.

The subsidiary donated the wellness facility to another nonprofit subject to an agreement that allowed the health system to have naming rights; to let its patients use the facility; and affiliates to lease or use certain portions of the facility; to own the facility if the other nonprofit stopped using it for exempt purposes.

The nonprofit that acquired the wellness facility did not assume the subsidiary’s debt.

In its ruling, the IRS said that the “subsidiary continues to be the debtor on the debt, and both the health system and holding company continue to guarantee the debt.”

The IRS said that the “subsidiary, being neither a governmental person nor a 501(c)(3) organization, cannot avail itself of a loan of the proceeds of qualified 501(c)(3) bonds,” which would be tax-exempt.

“Similarly, the holding company cannot avail itself of a loan of the proceeds of qualified 501(c)(3) bonds,” the agency said.

“Accordingly, to reflect the substance of the transaction, the proceeds of the proposed bonds would be allocable to the expenditure of repaying the debt, but, not, however, properly allocable to the facility,” it said.

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