Exempt bond 'private use' rules updated.

• Author: Weisner, Philip J.

The IRS has recently issued Rev. Proc. 93-19, setting forth the conditions under which it will rule that management or other service contracts will not result in the "private business use" of bond-financed facilities. Excessive private business use may result in loss of bond tax-exemption; Sec. 501(c)(3) organizations may also be subject to a significant unrelated business income tax liability under Sec. 150(b)(3). As a result, management contracts for bond-financed facilities should be reviewed in light of the conditions outlined in the revenue procedure.

The issue has become more prominent as the Service expands its coordinated examinations of large nonprofits. An IRS official recently indicated that there are 24 exempt bond cases pending in the National Office, most of which have arisen as a result of the coordinated examination program.

Sec. 103(b) provides that interest on private activity bonds, other than "qualified" private activity bonds, is taxable to bondholders. A bond will be considered a private activity bond if more than 10% of bond proceeds is used in a "private business use" and more than 10% of bond principal or interest is secured by property used in a private business use (or the income therefrom). When state or local governments issue bonds on behalf of Sec. 501(c)(3) organizations, allowable private business use falls to 5% of net proceeds and may be further reduced by financed bond issuance costs.

"Private business use" generally means direct or indirect business use of bond proceeds--other than as a member of the general public--by a nongovernmental or non-Sec. 501(c)(3) entity. Use of bond-financed facilities is deemed to be a use of bond proceeds.

Private business use of bond-financed facilities may result from a lease, management contract, incentive payment contract, transfer of ownership or certain output agreements with private parties. In addition, private business use may arise when facilities are used to carry on research for private parties (as might be the case with a university). (See the Conference Report to the Tax Reform Act of 1986 (TRA) at 688-689.)

In Rev. Procs. 82-14 (dealing with management contracts generally) and 82-15 (dealing with hospital-related management contracts), the IRS had issued advance ruling criteria for private business use arising from such arrangements. TRA Section 1301(e) directed the Treasury to issue...