IRS Provides Rules on Nonqualified Use of Exempt Bond Proceeds

Rev. Proc. 93-17

SECTION 1. PURPOSE

This revenue procedure sets forth conditions under which changes in the use of proceeds of an issue of State or local bonds will not result in those bonds being treated as violating certain requirements of sections 141 through 150 of the Internal Revenue Code of 1986 (the "Code").

SEC. 2. BACKGROUND

Under section 103(a) of the Code, gross income does not include interest on any issue of State or local bonds if the applicable requirements of sections 141 through 150 are satisfied. These requirements include ones relating to the use of proceeds of an issue. Under some circumstances, it is appropriate to permit certain remedial actions to prevent a change of use of proceeds of an issue from a qualified use to a nonqualified use from being treated as violating certain requirements of sections 141 through 150 of the Code.

Corresponding provisions of the Internal Revenue Code of 1954 (the "1954 Code") set forth requirements for the exclusion from gross income of the interest on an issue of State or local bonds. For purposes of this revenue procedure, any reference to a Code provision includes a reference to the corresponding provision, if any, under the 1954 Code.

SEC. 3. SCOPE

This revenue procedure applies to any change of use resulting in a change from a qualified to a nonqualified use. This revenue procedure has no effect on the application of the change of use provisions set forth in sections 150(b) and (c) of the Code.

SEC. 4. OPERATING RULES

01. DEFINITIONS.

(1) CHANCE OF USE means a change in the use of proceeds of an issue of State or local bands from the use for which those proceeds were used or expected to be used as of the date of issue to a different use.

(2) FACILITY means both (a) capital expenditures (as defined in section 1.150-1(h) of the Income Tax Regulations) for all, or a readily identifiable portion of, a building, structure, asset, or other similar property, and (b) other costs directly related to those capital expenditures that do not, in total, exceed 10 percent of those related capital expenditures.

(3) GOVERNMENTAL BONDS means an issue of State or local bonds if, as of the date of issue, either (a) the interest on the issue is excluded from gross income under section 103(a) of the Code and none of the bonds are private activity bonds under section 141(a) of the Code, or (b) the interest on the issue is excluded from gross income under section 103(a) of the 1954 Code and none of the bonds are industrial development bonds under section 103(b) of the 1954 Code or private loan bonds under section 103(o) of the 1954 Code.

(4) NONQUALIFIED BONDS means, for purposes of this revenue procedure, the portion of the outstanding bonds of an issue of State or local bonds that is properly allocable to proceeds with respect to which there occurs a change of use that results in a change from a qualified use to a nonqualified use of the issue. This portion of bonds must have an issue price that bears the same relationship to the aggregate issue price of the issue as the portion of the sale proceeds used for the facility for which the change of use occurs bears to the aggregate sale proceeds of the issue. Appropriate adjustments must be made to properly allocate pre-issuance accrued interest and original issue discount or premium. In determining the portion, allocations must be done in a reasonable, consistently applied manner. Ratable allocations are generally presumed to be reasonable.

(5) NONQUALIFIED USE means any use of proceeds of an issue of State or local bonds, including use of any facility financed with those proceeds, in a manner that fails to satisfy the applicable requirements for tax exempt bonds under sections 141 (except subsection (b)(2)), 142 (except subsection (d)), 144 (except subsections (a)(4) and (a)(10)), 145 (except subsection (b)), 147(b)(5), 147(c), 147(d), 147(e), and 147(f).

(6) QUALIFIED USE means any use of the proceeds of an issue of State or local bonds, including the use of any facility financed with those proceeds, in a manner that satisfies all the applicable requirements for tax exempt bonds under sections 103 and 141 through 150 of the Code.

(7) Section 501(c)(3) BONDS means bonds of an issue of State or local bonds that, as of the date of issue, are qualified 501(c)(3) bonds under section 145 and the interest on which is excluded from gross income under section 103(a).

02. SAFE HARBOR. If the following requirements are satisfied, a change of use of proceeds of an issue of State or local bonds that results in change from a qualified use to a nonqualified use will not be treated as causing the interest on the bonds to fail to be excluded from gross income under section 103(a) of the Code because of a failure to meet the requirements of the sections of the Code set forth in section 4.01(5):

(1) REASONABLE EXPECTATIONS. As of the date of issue, the issuer and all conduit borrowers reasonably expected to use the proceeds of the issue for a qualified use for the entire term of the issue.

(2) ACTUAL USE FOR A SUBSTANTIAL PERIOD OF TIME. The proceeds of the issue were used for a qualified use for at least 5 years after the later of the date of issue or the date on which the facility with respect to which the change of use occurred was placed in service (within the meaning of section 1.103-8(a)(5) of the regulations).

(3) ARM'S-LENGTH TRANSACTION. Any agreements between the new user and the original owner, any lessee, or any other user are bona fide and arm's-length, and the new user pays consideration equal to the fair market value of its use of the facility.

(4) NO ABUSE. No circumstances are present that indicate an attempt to avoid directly or indirectly the requirements of sections 103 and 141 to 150 of the Code or the conditions of this revenue procedure.

(5) REMEDIAL ACTION. The issuer takes remedial action that satisfies the provisions of section 4.02(5)(a), 4.02(5)(b), or 4.02(5)(c)

(a) REDEMPTION OF BONDS. The nonqualified bonds are redeemed at the earliest call date after the change of use. If the bonds are not redeemable within 90 days of the change of use, an irrevocable escrow is established within that period and used to redeem the bonds at their earliest call date. The escrow is not invested in higher yielding investments within the meaning of section 148 of the Code. The escrow is established in an amount that, together with investment earnings, is sufficient to pay all principal, interest, and call premium on the nonqualified bonds from the date the escrow is established to, and including, the earliest call date. The escrow is not invested in any investment under which the obligor is a user of the proceeds of the nonqualified bonds or any related party to that user.

(b) ALTERNATIVE USE OF DISPOSITION PROCEEDS OF A FACILITY THAT IS FINANCED BY GOVERNMENTAL BONDS OR SECTION 501(c)(3) BONDS. This section 4.02(5)(b) applies only to an issue of governmental bonds or section 501(c)(3) bonds. Upon a change of use that arises from a sale, exchange, or other disposition of a facility financed by such an issue, the disposition proceeds are used in an alternative manner that would have resulted in qualified use of those disposition proceeds and other proceeds of the issue (excluding the proceeds of the nonqualified bonds) in the aggregate. This determination of qualified use is made as of the date of original issuance of the issue after giving effect to the cure provision under section 4.03. The disposition proceeds must be allocated to expenditures for the alternative use within one year after the change of use. Except to the extent provided in section 4.04, the amount of disposition proceeds used for an alternative use in this manner must at least equal (but need not exceed) the proceeds of the issue allocable to the nonqualified bonds. Any disposition proceeds allocable to the nonqualified bonds that are not used for this alternative use must be used to redeem a pro rata portion of the nonqualified bonds in the manner provided under section 4.02(5)(a). In addition, except to the extent provided in section 4.04, if the amount of disposition proceeds is less than the proceeds of the issue allocable to the nonqualified bonds, funds other than proceeds of tax-exempt bonds must be used to redeem a pro rata portion of the nonqualified bonds in a manner that satisfies section 4.02(5)(a).

(c) ALTERNATIVE USE OF A FACILITY THAT IS FINANCED BY GOVERNMENTAL BONDS OR SECTION 501(c)(3) BONDS. This section 4.02(5)(c) applies only to an issue of governmental bonds or section 501(c)(3) bonds. Upon a change of use with respect to a facility financed by such an issue, that facility is used in an alternative manner that would have resulted in qualified use of that facility and other facilities financed with the proceeds of the issue in the aggregate. This determination of qualified use is made as of the date of original issuance of the issue after giving effect to the cure provision under section 4.03.

03. CURE PERIOD TO SATISFY ADDITIONAL REQUIREMENTS. For purposes of sections 4.02(5)(b) and 4.02(5)(c), the issuer has 90 days from the date of the change of use to satisfy the requirements applicable to governmental bonds or section 501(c)(3) bonds. A new or amended Form 8038 or 8038-G need not be filed. For example, an issuer has 90 days after the disposition to satisfy the public approval requirement under section 147(f) of the Code.

04. SMALL TRANSACTION EXCEPTION FOR DISPOSITIONS AT A LOSS. If a change of use from a qualified use to a nonqualified use arises from a sale, exchange, or other disposition of a facility at a loss and the disposition proceeds are less than $5,000,000, the amount of bonds required to be redeemed to satisfy section 4.02(5)(a) and the amount of disposition proceeds required to be applied to an alternative qualified use to satisfy section 4.02(5)(b) are each reduced to an amount equal to those disposition proceeds.

SEC. 5. EFFECT ON OTHER DOCUMENTS

Rev. Rul. 77-416, 1977-2 C.B. 34, is revoked. Under section 7805(b) of the Code, the revocation will not be applied with retroactive effect to changes of use occurring before March 8, 1993.

SEC. 6. ADVANCE RULINGS

The Service will consider requests for rulings in the case of changes of use in which the safe harbors provided in section 4 are not satisfied.

SEC. 7. EFFECTIVE DATE

This revenue procedure is effective for any change of use of a bond-financed facility that occurs after March 8, 1993.

DRAFTING INFORMATION

The principal author of this revenue ruling is Nancy M. Lashnits of the Office of Assistant Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling contact Ms. Nancy M. Lashnits at (202) 622-3980 (not a toll-free number).