Rev. Rul. 75-403

Advice has been requested whether, under the circumstances described below, bonds to be issued by a State will be "industrial development bonds" within the meaning of section 103(c)(2) of the Internal Revenue Code of 1954.

The State conducted a statewide referendum that resulted in the voters approving the issuance of general obligation bonds for the purpose of making loans to nursing homes throughout the State. The loans will be made for the purpose of repairing, reconstructing, and rehabilitating nursing homes in order that such nursing homes will comply with State and Federal safety standards.

The loans will be made through a State nursing home loan agency created by State law. The governing body of the agency consists of nine members, three of whom are appointed by the Governor, with the remaining six members being State officials who attain membership by virtue of holding their State offices.

Each nursing home located in the State will be eligible for a loan from the agency, provided the nursing home qualifies under the State and Federal regulations to accept Medicaid patients. Each nursing home also must demonstrate that it is financially unable to comply with the necessary State and Federal safety standards without assistance from the agency. Approximately 40 percent of the nursing homes in the State are privately owned and operated with a profit motive.

The agency plans to make loans to nursing homes to finance approximately 85 percent of the costs necessary to meet safety standards, but will finance as much as 100 percent of such costs if the circumstances warrant such action. The debt service on a loan will be paid by the nursing home in equal monthly installments commencing two to three months after completion of the financed project. The debt service schedule on the loans will not coincide with the debt service on the bonds proposed to be issued by the State. Although there are no specific requirements as to security for the loans to nursing homes, the agency plans to secure such loans with mortgages on the facilities financed by the loans.

Lending institutions throughout the State will participate in the loan program by lending up to 15 percent of a nursing home's project cost at a market rate of interest. The remaining 85 percent of such project costs will be loaned by the agency at a rate of interest equal to the interest rate on the bonds to be issued by the State. Any nursing home seeking an agency loan will be able to apply through a participating bank. The bank will conduct the closing of the loan, act as a disbursing agent of loan proceeds as the project progresses, receive loan repayments from the nursing home and transmit such repayments to the State, administer a mortgage escrow account for taxes and other charges, review the periodic financial statements of the obligor-nursing home, and cooperate with the agency in curing any default on a loan. The participating bank will be paid a customary fee for performing these services. The security for the bank's participating interest in the loan is to be on a parity with the agency's security for its interest in the loan.

The proposed bonds will be secured by the full faith and credit of the State. The bondholders may look only to the State for payment of bond principal and interest since the nursing home loan repayments, the assets financed by such loans, and any other security on the nursing home loans will not be pledged as security for the payment of the principal of and interest on the proposed bonds.

All of the bond proceeds, loan repayments, and any other receipts and disbursements that are connected with the agency's loan program will be deposited in or paid out of the general funds of the State Treasury. Each year the State will appropriate a sum of money that is sufficient to meet the present year's debt service regardless of the amount of the loan repayments or foreclosure proceeds that will have been received. The agency will maintain bookkeeping accounts solely for the purpose of submitting financial reports to various State officials. The bookkeeping accounts will not be maintained for the purpose of segregating funds for the payment of principal of and interest on the bonds.

Section 103(a)(1) of the Code provides that gross income does not include interest on the obligations of a State, a Territory, or a possession of the United States, or any political subdivision of any of the foregoing, or of the District of Columbia.

Section 103(c)(1) of the Code provides that, except as otherwise provided in section 103(c), any industrial development bond shall be treated as an obligation which is not an obligation described in section 103(a)(1).

Section 103(c)(2) of the Code defines the term "industrial development bond" as any obligation (A) which is issued as part of an issue all or a major portion of the proceeds of which are to be used directly or indirectly in any trade or business carried on by any person who is not an exempt person (as defined in section 103(c)(3)), and (B) the payment of the principal or interest on which (under the terms of such obligation or any underlying arrangement) is, in whole or major part (i) to be secured by any interest in property used or to be used in a trade or business or in payments in respect of such property, or (ii) to be derived from payments in respect of property, or borrowed money, used or to be used in a trade or business.

Since the assets of the nursing homes, the amounts to be received as repayments of loans from the nursing homes, and any payments in respect of the nursing homes will not be pledged as security for payment of the principal of and interest on the bonds, the security interest test contained in section 103(c)(2) of the Code will not be satisfied.

Accordingly, the bonds to be issued by the State will not be "industrial development bonds" within the meaning of section 103(c)(2) of the Code.