The Crystal City, Tex., Public Facilities Corp. has received an adverse tax determination notice from the Internal Revenue Service for $14 million of bonds issued in 2003 for a prison.

The issuer disclosed the IRS notice in a Municipal Securities Rulemaking Board EMMA filing on Friday. Farley Katz, an attorney at Strasburger & Price LLP, said in a letter that the issuer is exploring its options to either settle with the IRS or appeal the notice.

According to the IRS, there are $9.85 million of bonds outstanding that have a tax exposure of about $900,000 through June. The issuer has until July 22 to respond to the IRS adverse notice letter.

The agency initially warned the issuer last August that the bonds’ tax-exempt status was in jeopardy.

The bonds were issued to finance the acquisition of the Crystal City Correctional Center and additional construction to the jail. The issuer acquired the facility from Correctional Properties of Texas Inc., a private company. Bobby Ross Group Inc. managed the property for CPOT, which is a related party. After purchasing the property, the issuer leased the facility to the city, which in turn entered into a management agreement with BRG to continue operating the prison.

The IRS said in a June 21 letter to Katz that it found two issues with the private-business use of the prison. First, the fee arrangement between the issuer and the Bobby Ross Group gives an equity interest in the facility to BRG. The IRS said that allows the city to split profits with BRG, which means that a private business is benefiting from a project financed with tax-exempt funds.

The IRS said the issuer has made an attempt to renegotiate the terms of the revenue-sharing agreement with the facility manager. However, “there is still a net-profits arrangement regardless of how the revenue element is structured,” the letter said.

Second, the prison has too many federal inmates. Federal use, in this case, is not considered the same as public use, the IRS said. From 2008 to 2010, about 90% of inmates were federal prisoners.

In 2009, the prison brought in inmates from Bexar County, when prison facilities there were undergoing renovations., which brought the federal use down to 71%, according to the IRS.

However, the agency is arguing that the initial feasibility study for the prison was flawed, and that “the economics of this facility did not work without substantial federal use,” the IRS said in its letter, which was signed by Carl Scott of the IRS tax-exempt bond group.

Texas-based Jackson Walker LLP was the bond counsel on the deal. Herbert J. Sims & Co. and Municipal Capital Markets Group Inc. were the underwriters.

Katz did not respond to requests for comment on Tuesday.

Crystal City is located half way between San Antonio and the Mexican border. The prison had 464 general population beds in 2003, according to bond documents.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.