[Federal Register Volume 70, Number 242 (Monday, December 19, 2005)]
[Rules and Regulations]
[Pages 75028-75036]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 05-23944]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9234]
RIN 1545-AU98


Obligations of States and Political Subdivisions

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations on the definition of 
private activity bond applicable to tax-exempt bonds issued by State 
and local governments. These regulations affect issuers of tax-exempt 
bonds and provide needed guidance for applying the private activity 
bond restrictions to refunding issues.

DATES: Effective Date: These regulations are effective February 17, 
2006.
    Applicability Date: For dates of applicability, see Sec.  1.141-
15(j) of these regulations.

FOR FURTHER INFORMATION CONTACT: Johanna Som de Cerff, (202) 622-3980 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document amends the Income Tax Regulations (26 CFR part 1) 
under section 141 of the Internal Revenue Code (Code) by providing 
rules on the application of the private activity bond tests to 
refunding issues. This document also amends the Income Tax Regulations 
under sections 145, 149 and 150 by providing rules on certain related 
matters.
    On May 14, 2003, the IRS published in the Federal Register a notice 
of proposed rulemaking (REG-113007-99) (68 FR 25845) (the proposed 
regulations) relating to the matters addressed in this Treasury 
decision. A public hearing on the proposed regulations was scheduled 
for September 9, 2003. However, the public hearing was cancelled 
because no requests to speak were received. Written comments on the 
proposed regulations were received. After consideration of all the 
written comments, the proposed regulations are adopted as revised by 
this Treasury decision (the final regulations). The revisions are 
discussed below.

Explanation of Provisions

A. Introduction

    In general, under section 103, gross income does not include the 
interest on any State or local bond. However, this exclusion does not 
apply to private activity bonds (other than certain qualified bonds). 
Section 141(a) defines a private activity bond as any bond issued as 
part of an issue that meets either (1) the private business use test in 
section 141(b)(1) and the private security or payment test in section 
141(b)(2) (the private business tests) or (2) the private loan 
financing test in section 141(c) (the private business tests and the 
private loan financing test are referred to collectively as the 
``private activity bond tests'').
    The private business use test is met if more than 10 percent of the 
proceeds of an issue are to be used for any private business use. 
Section 141(b)(6) defines private business use as use directly or 
indirectly in a trade or business that is carried on by any person 
other than a governmental unit.
    The private security or payment test is met if the payment of the 
principal of, or the interest on, more than 10 percent of the proceeds 
of an issue is directly or indirectly (1) secured by an interest in 
property used or to be used for a private business use, (2) secured by 
an interest in payments in respect of such property, or (3) to be 
derived from payments,

[[Page 75029]]

whether or not to the issuer, in respect of property, or borrowed 
money, used or to be used for a private business use.
    The private loan financing test is satisfied if more than the 
lesser of $5 million or 5 percent of the proceeds of an issue are to be 
used to make or finance loans to persons other than governmental units.
    On January 16, 1997, final regulations (TD 8712) relating to the 
definition of private activity bonds and related rules under sections 
103, 141, 142, 144, 145, 147, 148, and 150 were published in the 
Federal Register (62 FR 2275) (the 1997 regulations). Under the 1997 
regulations, the amount of private business use of property financed by 
an issue is equal to the average percentage of private business use of 
that property during a defined measurement period. The measurement 
period begins on the later of the issue date of the issue or the date 
that the property is placed in service and ends on the earlier of the 
last date of the reasonably expected economic life of the property or 
the latest maturity date of any bond of the issue financing the 
property (determined without regard to any optional redemption dates). 
In general, under the 1997 regulations, the amount of private security 
or private payments is determined by comparing the present value of the 
private security or private payments to the present value of the debt 
service to be paid over the term of the issue, using the bond yield as 
the discount rate. The 1997 regulations reserve Sec.  1.141-13 for 
rules regarding the application of the private business tests and the 
private loan financing test to refunding issues.

B. Application of Private Activity Bond Tests to Refunding Issues

    1. In general. The proposed regulations provide that, in general, a 
refunding issue and a prior issue are tested separately under section 
141. Thus, the determination of whether a refunding issue consists of 
private activity bonds generally does not depend on whether the prior 
issue consists of private activity bonds.
    Commentators supported this separate testing principle. The final 
regulations retain this approach.
    2. Allocation of proceeds. The proposed regulations provide that, 
in applying the private business tests and the private loan financing 
test to a refunding issue, the proceeds of the refunding issue are 
allocated to the same purpose investments (including any private loan 
under section 141(c)) and expenditures as the proceeds of the prior 
issue.
    Comments were not received on this allocation provision. The final 
regulations retain this rule.
    3. Measurement of private business use. The proposed regulations 
generally provide that the amount of private business use of a 
refunding issue is determined based on the separate measurement period 
for the refunding issue under Sec.  1.141-3(g) (for example, without 
regard to any private business use that occurred before the issue date 
of the refunding issue). Thus, for instance, if an issuer refunds a 
taxable bond or an exempt facility bond, any private business use of 
the refinanced facilities before the issue date of the refunding issue 
is disregarded in applying the private business use test to the 
refunding issue.
    In the case of a refunding issue that refunds a prior issue of 
governmental bonds, however, the amount of private business use is 
generally determined based on a combined measurement period. For 
purposes of the proposed regulations, a governmental bond is any bond 
that, when issued, purported to be either a governmental bond, as 
defined in Sec.  1.150-1(b), or a qualified 501(c)(3) bond, as defined 
in section 145(a). The combined measurement period is the period that 
begins on the first day of the measurement period (as defined in Sec.  
1.141-3(g)) for the prior issue (or the first issue of governmental 
bonds in the case of a series of refundings of governmental bonds) and 
ends on the last day of the measurement period for the refunding issue.
    As an alternative to the combined measurement period approach, the 
proposed regulations permit issuers to measure private business use 
based on the separate measurement period of the refunding issue, but 
only if the prior issue of governmental bonds does not meet the private 
business use test during a shortened measurement period. The shortened 
measurement period begins on the first day of the measurement period of 
the prior issue (or the first issue of governmental bonds in the case 
of a series of refundings of governmental bonds) and ends on the issue 
date of the refunding issue. Whether a prior issue meets the private 
business use test during the shortened measurement period is determined 
based on the actual use of proceeds, without regard to the reasonable 
expectations test of Sec.  1.141-2(d).
    Commentators suggested that the proposed regulations be modified 
with respect to governmental bonds: (1) To delete the shortened 
measurement period concept; (2) to provide, absent any evidence to the 
contrary, and subject to general anti-abuse rules, a presumption that 
an issuer did not exceed the ten percent private business use limit; 
and (3) to specify that the amount of private business use of the 
refunding issue is the amount of private business use during either the 
separate measurement period for the refunding issue or the combined 
measurement period.
    These commentators suggested that a separate measurement period 
approach would not allow an issuer to increase the amount of private 
business use without jeopardizing the tax exemption of the prior issue, 
and thus an issuer generally should be permitted to measure private 
business use of a refunding issue using a separate measurement period. 
Nevertheless, these commentators suggested that the regulations include 
a general anti-abuse rule. They noted, for example, that a separate 
measurement period approach could permit an issuer to have an 
additional ten percent of private business use in connection with a 
refunding issue after the period of limitations for the prior bonds has 
run. These commentators suggested that, in such a situation, it would 
be fair to consider the refunding issue to be an abuse if the issuer is 
deliberately trying to exploit the private business use limit.
    The final regulations retain the basic approach of the proposed 
regulations to measuring private business use. The final regulations do 
not adopt the suggestions to delete the shortened measurement period 
concept and to provide that private business use may be measured during 
either a separate or combined measurement period. These suggestions are 
not adopted because they could result in more private business use than 
otherwise would be permitted after the expiration of the period of 
limitations for the prior issue.
    The final regulations do not adopt the suggestion to create a 
presumption that the private business use limit was not exceeded with 
respect to prior bonds. It is not clear such a presumption is warranted 
in all cases.
    The final regulations also do not adopt the suggestion to add an 
anti-abuse rule. The IRS and Treasury Department have concluded that 
the bright-line rule in the proposed regulations for determining when 
issuers must apply a combined measurement period and when issuers may 
apply either a combined measurement period or a separate measurement 
period is an appropriate methodology for measuring the private business 
use of a refunding issue and provides more administrative certainty 
than would be provided by an anti-abuse rule.

[[Page 75030]]

    Commentators expressed concern regarding an issuer's ability to 
establish the amount of private business use during a combined 
measurement period if the period begins a significant amount of time 
before the refunding bonds are issued. They noted that, in some cases, 
the refunded bonds may have been issued as many as twenty years or more 
before the refunding bonds are issued. These commentators stated that 
document retention policies vary by issuer and retaining or locating 
the necessary information over such long periods of time may be 
difficult.
    The final regulations apply prospectively and only to refunding 
bonds that are subject to the 1997 regulations. In general, under Sec.  
1.141-15, the 1997 regulations apply to refunding bonds only if, among 
other requirements, (1) the refunded bonds were originally issued on or 
after May 16, 1997, (2) the weighted average maturity of the refunding 
bonds is longer than the weighted average maturity of the refunded 
bonds, or (3) the issuer chooses to apply the 1997 regulations to the 
refunding bonds. Thus, the final regulations will not apply to any 
refunding of bonds originally issued before May 16, 1997, unless the 
issuer extends the weighted average maturity of the prior bonds or 
otherwise chooses to have the 1997 regulations apply to the refunding 
bonds (or an earlier issue of bonds).
    In addition, to address commentators' concerns, the final 
regulations provide transitional relief for refundings of bonds 
originally issued before May 16, 1997 (the effective date of the 1997 
regulations). Specifically, the final regulations provide that, if the 
prior issue (or, in the case of a series of refundings of governmental 
bonds, the first issue of governmental bonds in the series) was issued 
before May 16, 1997, then the issuer, at its option, may treat the 
combined measurement period as beginning on the date (the transition 
date) that is the earlier of (1) December 19, 2005 or (2) the first 
date on which the prior issue (or an earlier issue in the case of a 
series of refundings of governmental bonds) became subject to the 1997 
regulations. This transitional relief, which was not contained in the 
proposed regulations, has been added to the final regulations in 
response to concerns expressed by commentators regarding an issuer's 
ability to establish the amount of private business use during a 
combined measurement period if the period begins a significant amount 
of time before the refunding bonds are issued.
    Some commentators requested guidance on how the private business 
tests apply to the shortened and combined measurement periods for 
refundings of bonds originally issued before the effective date of the 
Tax Reform Act of 1986, 100 Stat. 2085 (the 1986 Act), if the refunding 
does not qualify for transitional relief under the 1986 Act or prior 
law. Specifically, commentators requested guidance on whether (1) the 
ten-percent private business use limitation under the 1986 Act or (2) 
the applicable private business use limitation under prior law (for 
example, the 25-percent limitation under the Internal Revenue Code of 
1954) applies in the case of a non-transitioned refunding of a bond 
issued under law in effect prior to the 1986 Act. The final regulations 
clarify in an example that the 1986 Act limitations apply to the 
shortened and combined measurement periods. The issuer, however, may 
treat these periods as beginning on the transition date described 
above.
    4. Measurement of private security and private payments. Under the 
proposed regulations, if the amount of private business use is 
determined based on the separate measurement period for the refunding 
issue, then the amount of private security and private payments 
allocable to the refunding issue is determined under Sec.  1.141-4 by 
treating the refunding issue as a separate issue. On the other hand, if 
the amount of private business use is determined based on a combined 
measurement period, then the amount of private security and private 
payments allocable to the refunding issue is determined under Sec.  
1.141-4 by treating the refunding issue and all earlier issues taken 
into account in determining the combined measurement period as a 
combined issue. The proposed regulations contain specific rules for 
determining the present value of the debt service on, and the private 
security and private payments allocable to, a combined issue.
    Commentators requested clarification regarding how the private 
security or payment test applies under the combined issue methodology 
in the case of a refunding of only a portion of the original principal 
amount of a prior issue. The final regulations clarify that, in these 
circumstances, (1) the refunded portion of the prior issue is treated 
as a separate issue and (2) any private security or private payments 
with respect to the prior issue are allocated ratably between the 
combined issue and the unrefunded portion of the prior issue in a 
consistent manner based on relative debt service.
    The proposed regulations also permit an issuer to use the yield on 
a prior issue of governmental bonds to determine the present value of 
private security or private payments under arrangements that were not 
entered into in contemplation of the refunding issue. For this purpose, 
any arrangement that was entered into more than one year before the 
issue date of the refunding issue will be treated as not entered into 
in contemplation of the refunding issue.
    Comments were not received on this special rule for arrangements 
not entered into in contemplation of the refunding issue. The final 
regulations retain this provision.
    5. Multipurpose issue allocations. Section 1.148-9(h) permits an 
issuer to use a reasonable, consistently applied allocation method to 
treat the portion of a multipurpose issue allocable to a separate 
purpose as a separate issue for certain of the arbitrage provisions of 
section 148. Section 1.141-13(d) of the proposed regulations allows an 
issuer to apply Sec.  1.148-9(h) to a multipurpose issue for certain 
purposes under section 141. An allocation will not be reasonable for 
this purpose if it achieves more favorable results under section 141 
than could be achieved with actual separate issues. In addition, 
allocations under the proposed regulations and Sec.  1.148-9(h) must be 
consistent for purposes of sections 141 and 148. The proposed 
regulations do not permit allocations for purposes of section 141(c)(1) 
(relating to the private loan financing test) or section 141(d)(1) 
(relating to certain restrictions on acquiring nongovernmental output 
property).
    Commentators supported the multipurpose allocation provisions in 
the proposed regulations. The final regulations retain those 
provisions. Commentators also requested clarification that an 
allocation under Sec.  1.141-13(d) may be made at any time. The final 
regulations provide that an allocation under Sec.  1.141-13(d) may be 
made at any time, but once made may not be changed. The final 
regulations also provide that the issue to be allocated and each of the 
separate issues under the allocation must consist of one or more tax-
exempt bonds. Thus, an allocation of a multipurpose issue into two or 
more separate issues is not permitted under Sec.  1.141-13(d) if, at 
the time of the allocation, the issue to be allocated or any of the 
separate issues under the allocation consists of taxable private 
activity bonds.
    6. Application of reasonable expectations test to certain refunding 
bonds. Section 1.141-2(d) provides that an issue consists of private 
activity bonds if the issuer (1) reasonably expects, as of the issue 
date, that the

[[Page 75031]]

issue will meet either the private business tests or the private loan 
financing test, or (2) takes a deliberate action, subsequent to the 
issue date, that causes the conditions of either the private business 
tests or the private loan financing test to be satisfied. Section 
1.141-2(d)(3) provides, in general, that a deliberate action is any 
action taken by the issuer that is within its control.
    The proposed regulations provide that an action that would 
otherwise cause a refunding issue to satisfy the private business tests 
or the private loan financing test is not taken into account under the 
reasonable expectations test of Sec.  1.141-2(d) if (1) the action is 
not a deliberate action within the meaning of Sec.  1.141-2(d)(3), and 
(2) the weighted average maturity of the refunding bonds is not greater 
than the remaining weighted average maturity of the prior bonds.
    Commentators suggested that the limitation on the weighted average 
maturity of the refunding bonds to the remaining weighted average 
maturity of the prior bonds could penalize issuers for issuing shorter-
term obligations initially, or provide an incentive to issue longer-
term obligations initially. These commentators requested that the 
weighted average maturity of the refunding bonds be limited only to 120 
percent of the weighted average reasonably expected economic life of 
the property financed by the prior bonds. The final regulations amend 
this provision to provide that the weighted average maturity of the 
refunding bonds may not exceed the weighted average reasonably expected 
economic life of the property financed by the prior bonds.
    Commentators also requested that an example illustrating this 
provision be added to the regulations. The final regulations add such 
an example.
    7. Refundings of certain general obligation bonds. Section 1.141-
2(d)(5) provides that the determination of whether bonds of an issue 
are private activity bonds may be based solely on the issuer's 
reasonable expectations as of the issue date (and not on whether there 
are any subsequent deliberate actions) if, among other requirements, 
the issue is an issue of general obligation bonds of a general purpose 
governmental unit that finances at least 25 separate purposes.
    Commentators suggested that a refunding issue should not consist of 
private activity bonds if the prior issue meets the requirements of 
Sec.  1.141-2(d)(5). The final regulations adopt this comment.

C. Treatment of Issuance Costs Financed by Prior Issue of Qualified 
501(c)(3) Bonds

    Under the 1997 regulations, the use of proceeds of an issue of 
qualified 501(c)(3) bonds to pay issuance costs of the issue is treated 
as a private business use. The proposed regulations provide that, 
solely for purposes of applying the private business use test to a 
refunding issue, the use of proceeds of the prior issue (or any earlier 
issue in a series of refundings) to pay issuance costs of the prior 
issue (or the earlier issue) is treated as a government use.
    Comments were not received on this provision. The final regulations 
retain this rule.

D. Limitation on Advance Refundings of Private Activity Bonds

    Under section 149(d)(2), interest on a bond is not excluded from 
gross income if any portion of the issue of which the bond is a part is 
issued to advance refund a private activity bond (other than a 
qualified 501(c)(3) bond). The proposed regulations provide that, for 
purposes of section 149(d)(2), the term private activity bond includes 
a qualified bond described in section 141(e) (other than a qualified 
501(c)(3) bond), regardless of whether the refunding issue consists of 
private activity bonds under the proposed regulations. The proposed 
regulations also provide that, for purposes of section 149(d)(2), the 
term private activity bond does not include a taxable bond. Section 
1.150-1(b) defines taxable bond as any obligation the interest on which 
is not excludable from gross income under section 103.
    Commentators recommended that the regulations be modified to permit 
a tax-exempt private activity bond to be advance refunded by a 
governmental bond if the nongovernmental entity's participation in the 
financing has been terminated and the only beneficiary of the financing 
is the governmental unit. Based on the plain language of section 
149(d)(2) and the policies underlying that Code provision, the final 
regulations do not adopt this comment.

Effective Date

    The final regulations apply to bonds that are (1) sold on or after 
February 17, 2006 and (2) subject to the 1997 regulations.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because the 
regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply.

Drafting Information

    The principal authors of these regulations are Johanna Som de Cerff 
and Laura W. Lederman, Office of Chief Counsel (Tax-exempt and 
Government Entities), Internal Revenue Service and Stephen J. Watson, 
Office of Tax Legislative Counsel, Department of the Treasury. However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read, in 
part, as follows:

    Authority: 26 U.S.C. 7805 * * *

0
Par. 2. Section 1.141-0 is amended by adding entries to the table in 
numerical order for Sec. Sec.  1.141-13 and 1.141-15(j) to read as 
follows:


Sec.  1.141-0  Table of contents.

* * * * *


Sec.  1.141-13  Refunding issues.

    (a) In general.
    (b) Application of private business use test and private loan 
financing test.
    (1) Allocation of proceeds.
    (2) Determination of amount of private business use.
    (c) Application of private security or payment test.
    (1) Separate issue treatment.
    (2) Combined issue treatment.
    (3) Special rule for arrangements not entered into in 
contemplation of the refunding issue.
    (d) Multipurpose issue allocations.
    (1) In general.
    (2) Exceptions.
    (e) Application of reasonable expectations test to certain 
refunding bonds.
    (f) Special rule for refundings of certain general obligation 
bonds.
    (g) Examples.
* * * * *


Sec.  1.141-15  Effective dates.

* * * * *
    (j) Effective dates for certain regulations relating to 
refundings.
* * * * *

[[Page 75032]]


0
Par. 3. In Sec.  1.141-1, paragraph (b) is amended by revising the 
definition of governmental bond to read as follows:


Sec.  1.141-1  Definitions and rules of general application.

* * * * *
    (b) * * *
    Governmental bond has the same meaning as in Sec.  1.150-1(b), 
except that, for purposes of Sec.  1.141-13, governmental bond is 
defined in Sec.  1.141-13(b)(2)(iv).
* * * * *
0
Par. 4. Section 1.141-13 is added to read as follows:


Sec.  1.141-13  Refunding issues.

    (a) In general. Except as provided in this section, a refunding 
issue and a prior issue are tested separately under section 141. Thus, 
the determination of whether a refunding issue consists of private 
activity bonds generally does not depend on whether the prior issue 
consists of private activity bonds.
    (b) Application of private business use test and private loan 
financing test--(1) Allocation of proceeds. In applying the private 
business use test and the private loan financing test to a refunding 
issue, the proceeds of the refunding issue are allocated to the same 
expenditures and purpose investments as the proceeds of the prior 
issue.
    (2) Determination of amount of private business use--(i) In 
general. Except as provided in paragraph (b)(2)(ii) of this section, 
the amount of private business use of a refunding issue is determined 
under Sec.  1.141-3(g), based on the measurement period for that issue 
(for example, without regard to any private business use that occurred 
prior to the issue date of the refunding issue).
    (ii) Refundings of governmental bonds. In applying the private 
business use test to a refunding issue that refunds a prior issue of 
governmental bonds, the amount of private business use of the refunding 
issue is the amount of private business use--
    (A) During the combined measurement period; or
    (B) At the option of the issuer, during the period described in 
paragraph (b)(2)(i) of this section, but only if, without regard to the 
reasonable expectations test of Sec.  1.141-2(d), the prior issue does 
not satisfy the private business use test, based on a measurement 
period that begins on the first day of the combined measurement period 
and ends on the issue date of the refunding issue.
    (iii) Combined measurement period--(A) In general. Except as 
provided in paragraph (b)(2)(iii)(B) of this section, the combined 
measurement period is the period that begins on the first day of the 
measurement period (as defined in Sec.  1.141-3(g)) for the prior issue 
(or, in the case of a series of refundings of governmental bonds, the 
first issue of governmental bonds in the series) and ends on the last 
day of the measurement period for the refunding issue.
    (B) Transition rule for refundings of bonds originally issued 
before May 16, 1997. If the prior issue (or, in the case of a series of 
refundings of governmental bonds, the first issue of governmental bonds 
in the series) was issued before May 16, 1997, then the issuer, at its 
option, may treat the combined measurement period as beginning on the 
date (the transition date) that is the earlier of December 19, 2005 or 
the first date on which the prior issue (or an earlier issue in the 
case of a series of refundings of governmental bonds) became subject to 
the 1997 regulations (as defined in Sec.  1.141-15(b)). If the issuer 
treats the combined measurement period as beginning on the transition 
date in accordance with this paragraph (b)(2)(iii)(B), then paragraph 
(c)(2) of this section shall be applied by treating the transition date 
as the issue date of the earliest issue, by treating the bonds as 
reissued on the transition date at an issue price equal to the value of 
the bonds (as determined under Sec.  1.148-4(e)) on that date, and by 
disregarding any private security or private payments before the 
transition date.
    (iv) Governmental bond. For purposes of this section, the term 
governmental bond means any bond that, when issued, purported to be a 
governmental bond, as defined in Sec.  1.150-1(b), or a qualified 
501(c)(3) bond, as defined in section 145(a).
    (v) Special rule for refundings of qualified 501(c)(3) bonds with 
governmental bonds. For purposes of applying this paragraph (b)(2) to a 
refunding issue that refunds a qualified 501(c)(3) bond, any use of the 
property refinanced by the refunding issue before the issue date of the 
refunding issue by a 501(c)(3) organization with respect to its 
activities that do not constitute an unrelated trade or business under 
section 513(a) is treated as government use.
    (c) Application of private security or payment test--(1) Separate 
issue treatment. If the amount of private business use of a refunding 
issue is determined based on the measurement period for that issue in 
accordance with paragraph (b)(2)(i) or (b)(2)(ii)(B) of this section, 
then the amount of private security and private payments allocable to 
the refunding issue is determined under Sec.  1.141-4 by treating the 
refunding issue as a separate issue.
    (2) Combined issue treatment. If the amount of private business use 
of a refunding issue is determined based on the combined measurement 
period for that issue in accordance with paragraph (b)(2)(ii)(A) of 
this section, then the amount of private security and private payments 
allocable to the refunding issue is determined under Sec.  1.141-4 by 
treating the refunding issue and all earlier issues taken into account 
in determining the combined measurement period as a combined issue. For 
this purpose, the present value of the private security and private 
payments is compared to the present value of the debt service on the 
combined issue (other than debt service paid with proceeds of any 
refunding bond). Present values are computed as of the issue date of 
the earliest issue taken into account in determining the combined 
measurement period (the earliest issue). Except as provided in 
paragraph (c)(3) of this section, present values are determined by 
using the yield on the combined issue as the discount rate. The yield 
on the combined issue is determined by taking into account payments on 
the refunding issue and all earlier issues taken into account in 
determining the combined measurement period (other than payments made 
with proceeds of any refunding bond), and based on the issue price of 
the earliest issue. In the case of a refunding of only a portion of the 
original principal amount of a prior issue, the refunded portion of the 
prior issue is treated as a separate issue and any private security or 
private payments with respect to the prior issue are allocated ratably 
between the combined issue and the unrefunded portion of the prior 
issue in a consistent manner based on relative debt service. See 
paragraph (b)(2)(iii)(B) of this section for special rules relating to 
certain refundings of governmental bonds originally issued before May 
16, 1997.
    (3) Special rule for arrangements not entered into in contemplation 
of the refunding issue. In applying the private security or payment 
test to a refunding issue that refunds a prior issue of governmental 
bonds, the issuer may use the yield on the prior issue to determine the 
present value of private security and private payments under 
arrangements that were not entered into in contemplation of the 
refunding issue. For this purpose, any arrangement that was entered 
into more than 1 year before the issue date of the refunding issue is 
treated as not entered into in contemplation of the refunding issue.

[[Page 75033]]

    (d) Multipurpose issue allocations--(1) In general. For purposes of 
section 141, unless the context clearly requires otherwise, Sec.  
1.148-9(h) applies to allocations of multipurpose issues (as defined in 
Sec.  1.148-1(b)), including allocations involving the refunding 
purposes of the issue. An allocation under this paragraph (d) may be 
made at any time, but once made may not be changed. An allocation is 
not reasonable under this paragraph (d) if it achieves more favorable 
results under section 141 than could be achieved with actual separate 
issues. The issue to be allocated and each of the separate issues under 
the allocation must consist of one or more tax-exempt bonds. 
Allocations made under this paragraph (d) and Sec.  1.148-9(h) must be 
consistent for purposes of section 141 and section 148.
    (2) Exceptions. This paragraph (d) does not apply for purposes of 
sections 141(c)(1) and 141(d)(1).
    (e) Application of reasonable expectations test to certain 
refunding bonds. An action that would otherwise cause a refunding issue 
to satisfy the private business tests or the private loan financing 
test is not taken into account under the reasonable expectations test 
of Sec.  1.141-2(d) if--
    (1) The action is not a deliberate action within the meaning of 
Sec.  1.141-2(d)(3); and
    (2) The weighted average maturity of the refunding bonds is not 
greater than the weighted average reasonably expected economic life of 
the property financed by the prior bonds.
    (f) Special rule for refundings of certain general obligation 
bonds. Notwithstanding any other provision of this section, a refunding 
issue does not consist of private activity bonds if--
    (1) The prior issue meets the requirements of Sec.  1.141-2(d)(5) 
(relating to certain general obligation bond programs that finance a 
large number of separate purposes); or
    (2) The refunded portion of the prior issue is part of a series of 
refundings of all or a portion of an issue that meets the requirements 
of Sec.  1.141-2(d)(5).
    (g) Examples. The following examples illustrate the application of 
this section:

    Example 1. Measuring private business use.  In 2002, Authority A 
issues tax-exempt bonds that mature in 2032 to acquire an office 
building. The measurement period for the 2002 bonds under Sec.  
1.141-3(g) is 30 years. At the time A acquires the building, it 
enters into a 10-year lease with a nongovernmental person under 
which the nongovernmental person will use 5 percent of the building 
in its trade or business during each year of the lease term. In 
2007, A issues bonds to refund the 2002 bonds. The 2007 bonds mature 
on the same date as the 2002 bonds and have a measurement period of 
25 years under Sec.  1.141-3(g). Under paragraph (b)(2)(ii)(A) of 
this section, the amount of private business use of the proceeds of 
the 2007 bonds is 1.67 percent, which equals the amount of private 
business use during the combined measurement period (5 percent of 
\1/3\ of the 30-year combined measurement period). In addition, the 
2002 bonds do not satisfy the private business use test, based on a 
measurement period beginning on the first day of the measurement 
period for the 2002 bonds and ending on the issue date of the 2007 
bonds, because only 5 percent of the proceeds of the 2002 bonds are 
used for a private business use during that period. Thus, under 
paragraph (b)(2)(ii)(B) of this section, A may treat the amount of 
private business use of the 2007 bonds as 1 percent (5 percent of 
\1/5\ of the 25-year measurement period for the 2007 bonds). The 
2007 bonds do not satisfy the private business use test.
    Example 2. Combined issue yield computation. (i) On January 1, 
2000, County B issues 20-year bonds to finance the acquisition of a 
municipal auditorium. The 2000 bonds have a yield of 7.7500 percent, 
compounded annually, and an issue price and par amount of $100 
million. The debt service payments on the 2000 bonds are as follows:

------------------------------------------------------------------------
                         Date                             Debt service
------------------------------------------------------------------------
1/1/01...............................................         $9,996,470
1/1/02...............................................          9,996,470
1/1/03...............................................          9,996,470
1/1/04...............................................          9,996,470
1/1/05...............................................          9,996,470
1/1/06...............................................          9,996,470
1/1/07...............................................          9,996,470
1/1/08...............................................          9,996,470
1/1/09...............................................          9,996,470
1/1/10...............................................          9,996,470
1/1/11...............................................          9,996,470
1/1/12...............................................          9,996,470
1/1/13...............................................          9,996,470
1/1/14...............................................          9,996,470
1/1/15...............................................          9,996,470
1/1/16...............................................          9,996,470
1/1/17...............................................          9,996,470
1/1/18...............................................          9,996,470
1/1/19...............................................          9,996,470
1/1/20...............................................          9,996,470
                                                      ------------------
                                                             199,929,400
------------------------------------------------------------------------

    (ii) On January 1, 2005, B issues 15-year bonds to refund all of 
the outstanding 2000 bonds maturing after January 1, 2005 (in the 
aggregate principal amount of $86,500,000). The 2005 bonds have a 
yield of 6.0000 percent, compounded annually, and an issue price and 
par amount of $89,500,000. The debt service payments on the 2005 
bonds are as follows:

------------------------------------------------------------------------
                         Date                             Debt service
------------------------------------------------------------------------
1/1/06...............................................         $9,215,167
1/1/07...............................................          9,215,167
1/1/08...............................................          9,215,167
1/1/09...............................................          9,215,167
1/1/10...............................................          9,215,167
1/1/11...............................................          9,215,167
1/1/12...............................................          9,215,167
1/1/13...............................................          9,215,167
1/1/14...............................................          9,215,167
1/1/15...............................................          9,215,167
1/1/16...............................................          9,215,167
1/1/17...............................................          9,215,167
1/1/18...............................................          9,215,167
1/1/19...............................................          9,215,167
1/1/20...............................................          9,215,167
                                                      ------------------
                                                             138,227,511
------------------------------------------------------------------------

    (iii) In accordance with Sec.  1.141-15(h), B chooses to apply 
Sec.  1.141-13 (together with the other provisions set forth in 
Sec.  1.141-15(h)), to the 2005 bonds. For purposes of determining 
the amount of private security and private payments with respect to 
the 2005 bonds, the 2005 bonds and the refunded portion of the 2000 
bonds are treated as a combined issue under paragraph (c)(2) of this 
section. The yield on the combined issue is determined in accordance 
with Sec. Sec.  1.148-4, 1.141-4(b)(2)(iii) and 1.141-13(c)(2). 
Under this methodology, the yield on the combined issue is 7.1062 
percent per year compounded annually, illustrated as follows:

----------------------------------------------------------------------------------------------------------------
                                             Previous debt
                                              service on
                   Date                        refunded     Refunding debt      Total debt      Present value on
                                              portion of        service          service             1/1/00
                                              prior issue
----------------------------------------------------------------------------------------------------------------
1/1/00....................................  ..............  ..............  .................   ($86,500,000.00)
1/1/01....................................       6,689,793  ..............          6,689,793       6,245,945.33
1/1/02....................................       6,689,793  ..............          6,689,793       5,831,545.62
1/1/03....................................       6,689,793  ..............          6,689,793       5,444,640.09
1/1/04....................................       6,689,793  ..............          6,689,793       5,083,404.58
1/1/05....................................       6,689,793  ..............          6,689,793       4,746,135.95
1/1/06....................................  ..............       9,215,167          9,215,167       6,104,023.84
1/1/07....................................  ..............       9,215,167          9,215,167       5,699,040.20
1/1/08....................................  ..............       9,215,167          9,215,167       5,320,926.00
1/1/09....................................  ..............       9,215,167          9,215,167       4,967,898.55

[[Page 75034]]

 
1/1/10....................................  ..............       9,215,167          9,215,167       4,638,293.40
1/1/11....................................  ..............       9,215,167          9,215,167       4,330,556.57
1/1/12....................................  ..............       9,215,167          9,215,167       4,043,237.15
1/1/13....................................  ..............       9,215,167          9,215,167       3,774,980.51
1/1/14....................................  ..............       9,215,167          9,215,167       3,524,521.90
1/1/15....................................  ..............       9,215,167          9,215,167       3,290,680.46
1/1/16....................................  ..............       9,215,167          9,215,167       3,072,353.70
1/1/17....................................  ..............       9,215,167          9,215,167       2,868,512.26
1/1/18....................................  ..............       9,215,167          9,215,167       2,678,195.09
1/1/19....................................  ..............       9,215,167          9,215,167       2,500,504.89
1/1/20....................................  ..............       9,215,167          9,215,167       2,334,603.90
                                           -----------------
                                                33,448,965     138,227,511    171,676,4760.00               0.00
----------------------------------------------------------------------------------------------------------------

    Example 3. Determination of private payments allocable to 
combined issue. The facts are the same as in Example 2. In addition, 
on January 1, 2001, B enters into a contract with a nongovernmental 
person for the use of the auditorium. The contract results in a 
private payment in the amount of $500,000 on each January 1 
beginning on January 1, 2001, and ending on January 1, 2020. Under 
paragraph (c)(2) of this section, the amount of the private payments 
allocable to the combined issue is determined by treating the 
refunded portion of the 2000 bonds ($86,500,000 principal amount) as 
a separate issue, and by allocating the total private payments 
ratably between the combined issue and the unrefunded portion of the 
2000 bonds ($13,500,000 principal amount) based on relative debt 
service, as follows:

----------------------------------------------------------------------------------------------------------------
                                                                                         Percentage   Amount of
                                                            Debt                         of private    private
                                             Private     service on   Debt service on     payments     payments
                   Date                      payments    unrefunded    combined issue    allocable    allocable
                                                         portion of                     to combined  to combined
                                                        prior issue                        issue        issue
----------------------------------------------------------------------------------------------------------------
1/1/01...................................     $500,000   $3,306,677         $6,689,793        66.92     $334,608
1/1/02...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/03...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/04...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/05...................................      500,000    3,306,677          6,689,793        66.92      334,608
1/1/06...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/07...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/08...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/09...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/10...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/11...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/12...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/13...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/14...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/15...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/16...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/17...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/18...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/19...................................      500,000  ...........          9,215,167       100.00      500,000
1/1/20...................................      500,000  ...........          9,215,167       100.00      500,000
                                          --------------
                                           $10,000,000  $16,533,385       $171,676,476  ...........   $9,173,039
----------------------------------------------------------------------------------------------------------------

    Example 4. Refunding taxable bonds and qualified bonds. (i) In 
1999, City C issues taxable bonds to finance the construction of a 
facility for the furnishing of water. The bonds are secured by 
revenues from the facility. The facility is managed pursuant to a 
management contract with a nongovernmental person that gives rise to 
private business use. In 2007, C terminates the management contract 
and takes over the operation of the facility. In 2009, C issues 
bonds to refund the 1999 bonds. On the issue date of the 2009 bonds, 
C reasonably expects that the facility will not be used for a 
private business use during the term of the 2009 bonds. In addition, 
during the term of the 2009 bonds, the facility is not used for a 
private business use. Under paragraph (b)(2)(i) of this section, the 
2009 bonds do not satisfy the private business use test because the 
amount of private business use is based on the measurement period 
for those bonds and therefore does not take into account any private 
business use that occurred pursuant to the management contract.
    (ii) The facts are the same as in paragraph (i) of this Example 
4, except that the 1999 bonds are issued as exempt facility bonds 
under section 142(a)(4). The 2009 bonds do not satisfy the private 
business use test.
    Example 5. Multipurpose issue. In 2001, State D issues bonds to 
finance the construction of two office buildings, Building 1 and 
Building 2. D expends an equal amount of the proceeds on each 
building. D enters into arrangements that result in 8 percent of 
Building 1 and 12 percent of Building 2 being used for a private 
business use during the measurement period under Sec.  1.141-3(g). 
These arrangements result in a total of 10 percent of the proceeds 
of the 2001 bonds being used for a private business use. In 2006, D 
purports to allocate, under paragraph (d) of this section, an equal 
amount of the outstanding 2001 bonds to Building 1 and Building 2. D 
also enters into another private business use arrangement with 
respect to Building 1 that results in an additional 2

[[Page 75035]]

percent (and a total of 10 percent) of Building 1 being used for a 
private business use during the measurement period. An allocation is 
not reasonable under paragraph (d) of this section if it achieves 
more favorable results under section 141 than could be achieved with 
actual separate issues. D's allocation is unreasonable because, if 
permitted, it would result in more than 10 percent of the proceeds 
of the 2001 bonds being used for a private business use.
    Example 6. Non-deliberate action. In 1998, City E issues bonds 
to finance the purchase of land and construction of a building (the 
prior bonds). On the issue date of the prior bonds, E reasonably 
expects that it will be the sole user of the financed property for 
the entire term of the bonds. In 2003, the federal government 
acquires the financed property in a condemnation action. In 2006, E 
issues bonds to refund the prior bonds (the refunding bonds). The 
weighted average maturity of the refunding bonds is not greater than 
the reasonably expected economic life of the financed property. In 
general, under Sec.  1.141-2(d) and this section, reasonable 
expectations must be separately tested on the issue date of a 
refunding issue. Under paragraph (e) of this section, however, the 
condemnation action is not taken into account in applying the 
reasonable expectations test to the refunding bonds because the 
condemnation action is not a deliberate action within the meaning of 
Sec.  1.141-2(d)(3) and the weighted average maturity of the 
refunding bonds is not greater than the weighted average reasonably 
expected economic life of the property financed by the prior bonds. 
Thus, the condemnation action does not cause the refunding bonds to 
be private activity bonds.
    Example 7. Non-transitioned refunding of bonds subject to 1954 
Code.
    In 1985, County F issues bonds to finance a court house. The 
1985 bonds are subject to the provisions of the Internal Revenue 
Code of 1954. In 2006, F issues bonds to refund all of the 
outstanding 1985 bonds. The weighted average maturity of the 2006 
bonds is longer than the remaining weighted average maturity of the 
1985 bonds. In addition, the 2006 bonds do not satisfy any 
transitional rule for refundings in the Tax Reform Act of 1986, 100 
Stat. 2085 (1986). Section 141 and this section apply to determine 
whether the 2006 bonds are private activity bonds including whether, 
for purposes of Sec.  1.141-13(b)(2)(ii)(B), the 1985 bonds satisfy 
the private business use test based on a measurement period that 
begins on the first day of the combined measurement period for the 
2006 bonds and ends on the issue date of the 2006 bonds.

0
Par. 5. Section 1.141-15 is amended by revising paragraphs (b)(1), (c), 
(d) and (h) and adding paragraph (j) to read as follows:


Sec.  1.141-15  Effective dates.

* * * * *
    (b) Effective dates--(1) In general. Except as otherwise provided 
in this section, Sec. Sec.  1.141-0 through 1.141-6(a), 1.141-9 through 
1.141-12, 1.141-14, 1.145-1 through 1.145-2(c), and the definition of 
bond documents contained in Sec.  1.150-1(b) (the 1997 regulations) 
apply to bonds issued on or after May 16, 1997, that are subject to 
section 1301 of the Tax Reform Act of 1986 (100 Stat. 2602).
* * * * *
    (c) Refunding bonds. Except as otherwise provided in this section, 
the 1997 regulations (defined in paragraph (b)(1) of this section) do 
not apply to any bonds issued on or after May 16, 1997, to refund a 
bond to which those regulations do not apply unless--
    (1) The refunding bonds are subject to section 1301 of the Tax 
Reform Act of 1986 (100 Stat. 2602); and
    (2)(i) The weighted average maturity of the refunding bonds is 
longer than--
    (A) The weighted average maturity of the refunded bonds; or
    (B) In the case of a short-term obligation that the issuer 
reasonably expects to refund with a long-term financing (such as a bond 
anticipation note), 120 percent of the weighted average reasonably 
expected economic life of the facilities financed; or
    (ii) A principal purpose for the issuance of the refunding bonds is 
to make one or more new conduit loans.
    (d) Permissive application of regulations. Except as provided in 
paragraph (e) of this section, the 1997 regulations (defined in 
paragraph (b)(1) of this section) may be applied in whole, but not in 
part, to actions taken before February 23, 1998, with respect to--
    (1) Bonds that are outstanding on May 16, 1997, and subject to 
section 141; or
    (2) Refunding bonds issued on or after May 16, 1997, that are 
subject to 141.
* * * * *
    (h) Permissive retroactive application. Except as provided in 
paragraphs (d), (e) or (i) of this section, Sec. Sec.  1.141-1 through 
1.141-6(a), 1.141-7 through 1.141-14, 1.145-1 through 1.145-2, 
1.149(d)-1(g), 1.150-1(a)(3), the definition of bond documents 
contained in Sec.  1.150-1(b) and Sec.  1.150-1(c)(3)(ii) may be 
applied by issuers in whole, but not in part, to--
    (1) Outstanding bonds that are sold before February 17, 2006, and 
subject to section 141; or
    (2) Refunding bonds that are sold on or after February 17, 2006, 
and subject to section 141.
* * * * *
    (j) Effective dates for certain regulations relating to refundings. 
Except as otherwise provided in this section, Sec. Sec.  1.141-13, 
1.145-2(d), 1.149(d)-1(g), 1.150-1(a)(3) and 1.150-1(c)(3)(ii) apply to 
bonds that are sold on or after February 17, 2006 and that are subject 
to the 1997 regulations.
0
Par. 6. Section 1.145-0 is amended by adding an entry to the table in 
numerical order for Sec.  1.145-2(d) to read as follows:


Sec.  1.145-0  Table of contents.

* * * * *


Sec.  1.145-2  Application of private activity bond regulations.

* * * * *
    (d) Issuance costs financed by prior issue.

0
Par. 7. In Sec.  1.145-2, paragraph (d) is added to read as follows:


Sec.  1.145-2  Application of private activity bond regulations.

* * * * *
    (d) Issuance costs financed by prior issue. Solely for purposes of 
applying the private business use test to a refunding issue under Sec.  
1.141-13, the use of proceeds of the prior issue (or any earlier issue 
in a series of refundings) to pay issuance costs of the prior issue (or 
the earlier issue) is treated as a government use.
0
Par. 8. Section 1.149(d)-1 is amended by revising paragraph (g) and 
adding paragraph (h) to read as follows:


Sec.  1.149(d)-1  Limitations on advance refundings.

* * * * *
    (g) Limitation on advance refundings of private activity bonds. 
Under section 149(d)(2) and this section, interest on a bond is not 
excluded from gross income if any portion of the issue of which the 
bond is a part is issued to advance refund a private activity bond 
(other than a qualified 501(c)(3) bond). For this purpose, the term 
private activity bond--
    (1) Includes a qualified bond described in section 141(e) (other 
than a qualified 501(c)(3) bond), regardless of whether the refunding 
issue consists of private activity bonds under Sec.  1.141-13; and
    (2) Does not include a taxable bond.
    (h) Effective dates--(1) In general. Except as provided in this 
paragraph (h), this section applies to bonds issued after June 30, 
1993, to which Sec. Sec.  1.148-1 through 1.148-11 apply, including 
conduit loans that are treated as issued after June 30, 1993, under 
paragraph (b)(4) of this section. In addition, this section applies to 
any issue to which the election described in Sec.  1.148-11(b)(1) is 
made.
    (2) Special effective date for paragraph (b)(3). Paragraph (b)(3) 
of this

[[Page 75036]]

section applies to any advance refunding issue issued after May 28, 
1991.
    (3) Special effective date for paragraph (f)(3). Paragraph (f)(3) 
of this section applies to bonds sold on or after July 8, 1997 and to 
any issue to which the election described in Sec.  1.148-11(b)(1) is 
made. See Sec.  1.148-11A(i) for rules relating to certain bonds sold 
before July 8, 1997.
    (4) Special effective date for paragraph (g). See Sec.  1.141-15 
for the applicability date of paragraph (g) of this section.
0
Par 9. Section 1.150-1 is amended by revising paragraphs (a)(3) and 
(c)(3)(ii) to read as follows:


Sec.  1.150-1  Definitions.

    (a) * * *
    (3) Exceptions to general effective date. See Sec.  1.141-15 for 
the applicability date of the definition of bond documents contained in 
paragraph (b) of this section and the effective date of paragraph 
(c)(3)(ii) of this section.
* * * * *
    (c) * * *
    (3) * * *
    (ii) Exceptions. This paragraph (c)(3) does not apply for purposes 
of sections 141, 144(a), 148, 149(d) and 149(g).
* * * * *

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
    Approved: November 23, 2005.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury.
[FR Doc. 05-23944 Filed 12-16-05; 8:45 am]
BILLING CODE 4830-01-P