The Internal Revenue Service has determined in a private-letter ruling that the tax-exempt status of bonds used to finance a portion of a city's multipurpose facility would not be jeopardized by the private payments made in the deal.
In the June 14 ruling, which has not been published, the IRS said the unidentified city could allocate some of the payments to the portion of the facility that is not financed with tax-exempt bonds.
Michael Bailey, a partner with Foley & Lardner who requested the ruling on behalf of a client, said the ruling does not break new ground but provides a greater understanding of existing rules.
"It is one of the few rigorous interpretations of how you allocate private payments," Bailey said yesterday. "This ruling gives some comfort that even if an issuer receives some private payments for a portion of a facility, it doesn't necessarily need to be taken into account as payments for the bond-financed property. You can do these reasonable allocations." He declined to identify the city.
The city that requested the letter ruling planned to build retail space, a multi-tiered parking garage, and a roof deck upon which it expected a private developer to build condos at a later time. Tax-exempt bonds would be used to finance a portion of the parking garage. The construction of the rest of the garage, as well as the retail center and roof deck, would be financed with city funds and proceeds from taxable bonds.
The developer would pay a required initial development fee as well as an annual development fee to the city as a part of the deal. The city would also receive payments from two private corporations. In addition, the developer and the private corporations would lease some of the parking spaces.
The city planned to allocate the private payments and its revenues to the portion of the garage that was not financed with tax-exempt bonds, as well as the retail space. Possible future private payments could also be allocated to the roof deck if condos were built. The parking lease payments were allocated to the tax-exempt portion of the parking garage.
The city asked the IRS if the way it had allocated the private payments would jeopardize the tax-exempt status of its bonds that would finance part of the parking garage.
Under Section 141 of the U.S. Tax Code, private-activity bonds can retain their tax-exempt status if they only fail one, but not both, of the two prongs of the private-activity test. A municipal bond issue is considered taxable if more than 10% of its proceeds are used for private purposes and if more than 10% of the debt service is paid from private sources. Private-activity bond issuers also cannot exceed the private loan financing test that limits loans to non-governmental persons to the lesser of $5 million or 5% of the proceeds of an issue.
The IRS first concluded that the city had appropriately reasoned that the parking garage, roof deck, and retail center were separate and identifiable projects. It then concluded that the private payments were properly allocated to the private portions of the facility.
The letter ruling also found that the rental payment received from the parking leases would exceed the private use test but would not exceed the private-payment test.
The ruling did not address the possible future payments for the roof deck.
Although private-letter rulings cannot be used as a precedent for other transactions, issuers and counsel facing similar circumstances often view them as providing guidance.
Bailey said the recent ruling could be helpful to issuers of any tax-exempt financing that relies on the private payment test, such as certain stadium facilities and tax increment financings.
"There is not a lot of interpretation of the regulations that deal with allocating private payments," Bailey said. "Issuers of bonds that rely on not meeting the payment test would be interested in this ruling."
However, the IRS has provided more detailed information in private-letter rulings on the private business use test, he said.
