Td 8712

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 141.—Private Activity
Bond; Qualified Bond
T.D. 8712
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
Definition of Private Activity Bonds
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains
final regulations on the definition of
private activity bonds applicable to taxexempt bonds issued by state and local
governments. These final regulations reflect changes to the applicable law that
were made by the Technical and Miscellaneous Revenue Act of 1988. These
regulations affect issuers of tax-exempt
bonds and provide needed guidance for
applying the private activity bond restrictions.
DATES: These regulations are effective
May 16, 1997.
For dates of applicability of these
regulations, see §§ 1.141–15, 1.141–16,
1.148–6(a)(3) and 1.148–6(d)(1)(iii) of
these regulations.
FOR FURTHER INFORMATION CONTACT: Loretta J. Finger or Nancy M.
Lashnits, (202) 622–3980 (not a toll-free
number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations have
been reviewed and approved by the
Office of Management and Budget in
accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control
number 1545–1451. Responses to these
collections of information are mandatory. Pursuant to comments received, the
collections of information have been
amended, but the estimated annual burden per respondent/recordkeeper has not
changed.
An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information
unless the collection of information displays a valid control number.
The estimated average annual burden
hours per respondent/recordkeeper: 3
hours.

Comments concerning the accuracy of
this burden estimate and suggestions for
reducing this burden should be sent to
the Internal Revenue Service, Attn:
IRS Reports Clearance Officer, T:FP,
Washington, DC 20024, and to the Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503.
Books or records relating to collections of information must be retained as
long as their contents may become material in the administration of any internal revenue law. Generally, tax returns
and tax return information are confidential, as required by 26 U.S.C. 6103.

tions are to the Internal Revenue Code
of 1986. On June 8, 1995, the IRS held
a public hearing on the proposed regulations. Written comments responding to
the proposed regulations were received.
On May 31, 1996, final regulations
(FI–72–88) were published in the Federal Register (61 FR 106) to provide
guidance under Code section 1394 to
address the issues relating to enterprise
zone facility bonds. After consideration
of all the comments, certain of the
proposed regulations under Code sections 141, 142, 144, 145, 147, 148, and
150 are adopted as revised by this
Treasury decision. The principal revisions to the proposed regulations are
discussed below.

Background

Explanation of Provisions

Removal of existing regulations for repealed sections

Certain commentators suggested that
the proposed regulations, with certain
modifications, be published again as
proposed regulations. A number of other
commentators suggested that the proposed regulations, with certain modifications, should be promulgated as final
regulations to provide certainty at the
earliest possible time. After considering
these comments, the IRS and Treasury
concluded that state and local government issuers would benefit from the
adoption of the proposed regulations,
with certain modifications made in response to comments, as final regulations.

Prior to the enactment of the Tax
Reduction and Simplification Act of
1977 (Pub. L. 95–30), sections 141
through 144 contained provisions of the
Internal Revenue Code of 1954 relating
to the standard deduction. Sections 141
(‘‘Standard Deduction’’), 142 (‘‘Individuals Not Eligible for Standard Deduction’’), and 144 (‘‘Election of Standard Deduction’’) were repealed by
section 101(d)(1) of that act. Section
143 (‘‘Determination of Marital Status’’)
was redesignated section 7703 by section 1301(j)(2) of the Tax Reform Act of
1986 (Pub. L. 99–514). Therefore, existing regulations §§ 1.141–1, 1.142–1,
1.142–2, 1.144–1, 1.144–2, and 1.144–3
are being removed from the Code of
Federal Regulations (CFR), and regulation § 1.143–1 is being redesignated
§ 1.7703–1.
Proposed Regulations
On December 30, 1994, proposed
regulations (FI–72–88 [1995–1 C.B.
859]) were published in the Federal
Register (59 FR 67658) to provide
guidance under the Internal Revenue
Code of 1986 (Code) in sections 141
(relating to private activity bonds and to
qualified bonds), 142 (relating to
exempt-facility bonds), 145 (relating to
qualified 501(c)(3) bonds), 147 (relating
to other requirements applicable to certain private activity bonds), 148 (relating
to arbitrage), 150 (relating to change of
use), and 1394 (relating to enterprise
zone facility bonds). All subsequent references in this preamble to Code sec-

4

A. Section 1.141–1 Definitions and
rules of general application
Replaced amounts. The proposed
regulations provide that the proceeds
taken into account under the private
activity bond tests include certain replacement proceeds that are reasonably
expected to be available during the
project period.
The final regulations treat replaced
amounts also as arising to the extent
that the issuer reasonably expects that
the term of the issue will be longer than
is reasonably necessary for the governmental purposes of the issue, in the
same manner as replacement proceeds
arise under the arbitrage regulations under Code section 148. Thus, replaced
amounts may arise under the private
activity bond tests if an issuer reasonably expects that there will be available
amounts during the period that the
bonds remain outstanding longer than
necessary for the governmental purposes

of the issue and if those amounts are
used for purposes that are inconsistent
with the private activity bond tests.
B. Section 1.141–2 Private activity bond
tests
1. Clarification of reasonable expectations test. Under the proposed regulations the private activity bond tests
depend on both reasonable expectations
as of the issue date and subsequent
deliberate actions of the issuer.
The final regulations clarify that, in
general, the reasonable expectations test
is met only if the issuer reasonably
expects, as of the issue date, that no
action or event during the entire term of
the bonds will cause either the private
business tests or the private loan financing test to be met. The final regulations
further provide, however, that, if certain
conditions are met, the period of expected compliance needs to extend only
to a mandatory redemption date. This
special rule is intended to accommodate
issuers that reasonably expect that bondfinanced property may be used by nongovernmental persons during the stated
term of the issue, but have not entered
into any arrangement with a nongovernmental person that will use the property
and are unable to predict the timing of
that nongovernmental use. This special
rule does not permit, however, reasonably expected ‘‘recycling’’ of disposition
proceeds because the special rule requires redemption of all nonqualified
bonds.
2. Definition of deliberate action. The
proposed regulations generally provide
that any action within the control of an
issuer is treated as a deliberate action
and that, if the financed property was
designed differently than is reasonably
necessary for the governmental purposes
of the issuer, an action with respect to
that property is treated as deliberate,
even if it is not within the issuer’s
control. Commentators suggested that
deliberate action should be more narrowly defined.
The final regulations make certain
changes that narrow the scope of the
deliberate action rule to minimize administrative burden on state and local
governments. First, the special rule for
property that is ‘‘designed differently’’ is
deleted. The reasonable expectations test
adequately addresses the concerns of
this special rule. Second, the final regulations clarify that an action taken by a
state or local government in response to
a regulatory directive of the federal
government is not a deliberate action.

Finally, the final regulations provide
that, if certain conditions are met, dispositions of personal property in the ordinary course of an established governmental program are not treated as a
deliberate action.
3. Special rule for general obligation
bond programs that finance a large
number of separate purposes. The proposed regulations provide a special exception to the definition of disposition
proceeds that is intended to minimize
the administrative burden of tracing the
use of proceeds of general obligation
bonds that finance a large number of
projects. Commentators suggested that
this exception should be available for
other types of bonds and that fewer
conditions should apply to the exception.
The final regulations provide a similar
rule that is broadly stated as an exception to the rule that a deliberate action
after the issue date can cause an issue to
meet the private activity bond tests. This
exception is intended to provide relief
for ‘‘cash flow’’ general obligation programs, where issuers use the proceeds of
an issue for a large number of projects
and spend proceeds promptly. These
programs merit special treatment in part
because they further the purposes of the
arbitrage rules.
4. When a deliberate action occurs.
The proposed regulations provide that a
deliberate action occurs on the earlier of
the date the parties agree on the consideration for the new use or the date on
which the new use occurs. Commentators suggested that the regulations
should not treat a deliberate action as
occurring before the date on which new
private business use actually commences, in part because it may not be
possible to take a remedial action with
disposition proceeds before the date on
which the disposition proceeds are received.
The final regulations provide in general that a deliberate action occurs on
the date the issuer enters into a binding
contract with a nongovernmental person
for use of the financed property that is
not subject to any material contingencies. In most cases, material conditions
to closing a transaction that results in
private business use will be treated as
material contingencies so that this date
will not occur before the date of receipt
of disposition proceeds.
C. Section 1.141–3 Definition of private
business use
1. Economic benefit as private busi-

5

ness use. Under the proposed regulations, economic benefit to a nongovernmental person may be treated as private
business use, even if the nongovernmental person has no special legal rights to
use the financed property.
Commentators suggested that the private business use test should not be met
unless special legal rights are provided
to a nongovernmental person pursuant to
an arrangement, and that mere economic
benefit is insufficient to give rise to
private business use.
The final regulations largely adopt
these suggestions. The final regulations
provide, however, that, if the financed
property is not available for use by the
general public, a nongovernmental person may be treated as a private business
user of the property based on all of the
facts and circumstances, even if that
nongovernmental person has no special
legal entitlements to use of the property.
2. Ownership. The proposed regulations provide that ownership of property
by a nongovernmental person is private
business use of that property.
Commentators suggested that ownership for this purpose should be defined
to mean ownership for general federal
income tax purposes and that mere
holding of title to property by a nongovernmental person should not necessarily
give rise to private business use. Commentators further suggested that certain
customary financing structures that require a nongovernmental person to be a
nominal owner of financed property
should be accommodated.
The final regulations adopt these suggestions.
3. Discharge of a primary legal obligation. The proposed regulations provide
that the use of bond proceeds to provide
property that discharges a primary and
unconditional legal obligation of a nongovernmental person results in private
business use of that property.
Commentators suggested that this rule
be deleted from the final regulations.
Many commentators indicated that this
rule would interfere with traditional tax
assessment bond financings for governmental projects such as roads and sidewalks. Some commentators also indicated that certain state and local
governments may be required or encouraged under state law to enter into development agreements with private developers that could result in private
business use of governmental projects
under the discharge of a primary legal
obligation rule.

The final regulations adopt this comment by deleting this rule.
4. Management contracts. The proposed regulations provide that management contracts other than qualified management contracts result in private
business use of the managed property.
Commentators suggested that the
qualified management contract rules
should be safe harbors, not substantive
rules, and that a management contract
should give rise to private business use
only if it transfers a proprietary interest
in financed property to a manager that is
a nongovernmental person. Commentators suggested that the permissible contract terms for qualified management
contracts should be further extended and
that limitations on the contract term
based on useful life of the financed
property should be deleted. In addition,
commentators suggested that contracts
for incidental services, such as janitorial
and equipment repair services, should
never give rise to private business use
of financed property.
The final regulations provide more
flexible accommodation for management
contracts that implement cost-saving
‘‘privatization’’ measures for state and
local governments, but continue to reflect the view that Congress intended
that a management contract can give
rise to private business use even if it
does not in substance transfer a
leasehold or ownership interest to a
nongovernmental person for general federal income tax purposes. Thus, the final
regulations do not adopt the rule that a
management contract gives rise to private business use only if it transfers a
proprietary interest to a nongovernmental service provider. The final regulations provide that the determination of
whether a management contract that
does not meet the qualified management
contract safe harbors gives rise to private business use is based on all of the
facts and circumstances. In general, a
management contract gives rise to private business use if the compensation
under the contract is based on net
profits. The final regulations further provide, however, that contracts for services
solely incidental to the primary governmental function or functions of a financed facility do not otherwise give
rise to private business use under the
management contract rules. In addition,
the final regulations clarify the standards
to be applied in determining whether a
management contract is properly characterized as a lease.

A separate revenue procedure establishes safe harbors which expand the
types of management contracts that do
not result in private business use. This
revenue procedure in particular permits
longer term management contracts for
public utility facilities and systems, relaxes certain of the requirements for
permitted compensation arrangements,
and deletes the requirement that the
issuer not control the service provider.
5. Research agreements. The proposed regulations set forth bright line
rules for determining when corporatesponsored research agreements and cooperative research agreements do not
give rise to private business use. These
rules apply only to basic research.
The final regulations provide a facts
and circumstances rule, and a separate
revenue procedure establishes safe harbors for determining when corporatesponsored research agreements and cooperative research agreements do not
give rise to private business use. This
revenue procedure also expands the
definition of basic research, for purposes
of Code section 141, to include any
original investigation for the advancement of scientific knowledge not having
a specific commercial objective.
6. Exception for general public use.
The proposed regulations contain detailed quantitative rules for determining
when use of financed property by a
nongovernmental person is disregarded
because the nongovernmental person is
treated as using the property as a member of the general public. The proposed
regulations also provide that use by a
nongovernmental person of financed
property is not treated as general public
use if the property provides a significant
economic benefit to the nongovernmental person because it is functionally and
integrally related to other property used
by the nongovernmental person.
Commentators suggested that the
quantitative rules for defining general
public use should be deleted, because
they are not sufficiently flexible to accommodate the wide variety of state and
local government financings and because they disproportionately affect
small local governments.
The final regulations largely delete
the quantitative approach in the proposed regulations for general public use.
Instead, the final regulations adopt a
more qualitative test focusing on
whether financed property is intended to
be available and in fact is reasonably
available for use on the same basis by
natural persons not engaged in a trade

6

or business. This approach is more consistent with the requirement in Code
section 141 that any activity carried on
by a person that is not a natural person
is treated as a trade or business activity.
Because the final regulations generally
do not treat mere economic benefit as
private business use, the rules for functionally and integrally related property
are deleted. In light of this narrower
definition of private business use, the
special system improvement rules have
also been deleted. The final regulations
retain the rule in the proposed regulations that use under an arrangement that
conveys priority rights is not use on the
same basis as the general public and
clarifies that an arrangement for longterm use (defined as more than 180
days) is not treated as general public
use. The final regulations provide that
use of financed property by a nongovernmental person that is not general
public use is not necessarily private
business use. Under the approach taken
in the final regulations, the definition of
general public use is significant for
determining when economic benefit
alone can give rise to private business
use and for determining the permitted
terms of short-term arrangements that
are not treated as private business use.
7. Exceptions for short-term arrangements. The proposed regulations provide
that a lease or similar arrangement that
has a term of 1 year or less and that is
not renewed or renewable is generally
disregarded. Commentators suggested
that longer term arrangements should be
disregarded.
The final regulations provide different
exceptions for various short-term contracts. The exceptions for short-term
contracts are based on a hierarchy depending on how broadly contracts with
the same terms are offered to other
users. Under this approach, a contract
that is available to the general public
may have a term up to 180 days; a
contract not treated as general public
use, but offered on the basis of generally applicable or uniformly applied
rates, may have a term of up to 90 days;
and a specially negotiated contract that
provides fair market value compensation
may have a term of up to 30 days. In
each case, the exception applies only if
the property is not financed for a principal purpose of providing that property
for use by the nongovernmental person
entering into the contract. The final
regulations delete the 1-year exception
for non-renewable short-term contracts
because the final regulations adopt a

more flexible rule for measuring private
business use, as discussed below.
8. Exception for temporary use by
developers. The proposed regulations
provide an exception for temporary use
by a developer of an improvement that
carries out an essential governmental
function during an initial development
period not exceeding 3 years.
Commentators suggested that the
3-year limitation on the exception is too
short for many developments and that a
requirement that development proceed
with reasonable speed should suffice.
The final regulations largely adopt
this comment. This approach focuses
more on whether financed property serving an essential governmental function
is transferred to a governmental person
with reasonable speed than on a specific
time frame for development of the property benefited by the improvement.
9. Exceptions for incidental use and
qualified improvements. The final regulations remove certain conditions to exceptions for incidental use and qualified
improvements.
10. Measurement of private business
use. The proposed regulations generally
provide that private business use is
measured on an annual basis, except for
private business use of output facilities.
Commentators suggested that private
business use should be measured on an
average or cumulative basis over the
term of an issue.
The final regulations largely adopt the
suggestion that private business use
should be measured over the term of an
issue. In general, the percentage of
private business use of financed property is determined according to the
average annual private business use of
that property over the measurement period. The measurement period begins on
the later of the issue date of the issue or
the date 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. For
certain bonds that are issued in contemplation of refinancing, such as bond
anticipation notes, the measurement period is based on the final maturity date
of any bond of the refunding issue.
Under an anti-abuse rule, however, if an
issuer extends the term of an issue for a
principal purpose of increasing the permitted amount of private business use,
the Commissioner may determine the
amount of private business use according to the greatest percentage of private
business use in any 1-year period. Fur-

ther, if an issuer reasonably expects on
the issue date that bonds will be redeemed before the final maturity of the
issue because of a deliberate action, the
measurement period ends on the reasonably expected date of redemption. In
addition, for arrangements that result in
ownership of financed property by a
nongovernmental person, the amount of
private business use is the greatest percentage of private business use in any
1-year period.
This approach of looking to the average amount of private business use over
the expected economic life of financed
property is more consistent with the
approach adopted for measuring private
payments and security, which also in
effect looks over the term of an issue.
This approach also provides issuers with
significantly greater flexibility to spread
out de minimis private business use over
the term of an issue.
The final regulations adopt the
measurement-over-the-term rule for private business use, however, only for
purposes of determining whether an issue has no more than the permitted
amount of private business use (that is,
in most cases, the 10 percent threshold).
This general approach reflects the view
that adoption of the measurement-overthe-term rule for purposes other than the
de minimis rules would be unduly complex to administer and could distort the
economic substance.
This general approach also simplifies
the regulations by providing a single
rule for measuring private business use
that applies to both output facilities and
other governmental facilities. The final
regulations reflect the view that all
governmental facilities generally would
benefit from more flexible private business use measurement rules.
11. Determining average use within
an annual period. The proposed regulations generally provide that the average
amount of private business use within a
year is based on the amount of time
financed property is actually used for
private business use as a percentage of
total time for all actual use, provided
that significant differences in fair market
value of different times of use must be
taken into account.
Some commentators suggested that
the average amount of private business
use should be based on a comparison of
time of private business use to time the
financed property is available for use,
not to time it is actually used.
The final regulations continue to determine private business use for certain

7

purposes as a percentage of actual use.
This method more accurately reflects
economic substance. The final regulations also clarify that, in certain cases,
the determination of fair market value of
private business use must take into
account the amount of private payments
for that use.
D. Section 1.141–4 Private security or
payment test
1. Payments not directly made by
private business users. The proposed
regulations provide that payments made
with respect to property used for a
private business use are taken into account under the private payment test,
even if not made by persons that are
private business users of proceeds. Commentators suggested that payments by
persons that are not private business
users should be taken into account only
if they can be imputed to a private
business user of proceeds.
The final regulations retain the general rule in the proposed regulations but
clarify that only payments made for the
period of private business use are taken
into account. The definition of private
business use in the final regulations
narrows the application of this general
rule.
2. Allocation of private payments to
different sources of funding. The proposed regulations provide that a payment from a private business user of
property may be allocated first to repay
any costs of the property paid by the
issuer from a source other than a borrowing (‘‘equity’’). The proposed regulations also provide, however, that, if a
payment is made for property financed
with two or more issues (including
issues that are not tax-exempt), the
payment must be allocated among those
issues according to the relative amount
of proceeds of those issues used to
finance the property. Commentators generally favored the rule permitting allocations first to equity, but suggested that
the same rule should apply to costs
financed with taxable bonds.
The final regulations provide a more
general facts and circumstances test for
the allocation of private payments that
looks to the nexus between the private
payment and both the property financed
and the source of funding. Thus, under
the approach of the final regulations,
allocations of private payments first to
equity before other sources of funding
are generally permitted only to the extent that there is a specific nexus between the payment and a prior expendi-

ture. The final regulations do not adopt
the recommendation that issuers also be
permitted in all cases to allocate private
payments first to repayment of taxable
bonds, but treat the obligation to pay
debt service in future years under the
taxable debt as establishing a nexus to
future private payments. The final regulations retain the rule that allocations of
private payments among issues according to relative amounts of those sources
of funding that are expended on the
property is generally appropriate, but the
final regulations provide issuers with
more flexibility to match these allocations to debt service payments associated with various sources of funding.
3. Allocation of private security
among issues. The proposed regulations
provide that, for bonds other than parity
bonds, property or payments securing
more than one issue must be fully
allocated to each issue under the private
security test. Commentators suggested
that the rule for allocation of private
security among issues should reasonably
reflect foreclosure and default scenarios
under the bond documents. The final
regulations in general adopt this comment.
4. Limitations on private security.
The proposed regulations provide that
any property that is used for a private
business use is taken into account under
the private security test if it secures
payment of debt service on an issue.
The final regulations provide that
only financed property and property that
is provided directly or indirectly by a
nongovernmental person that is treated
as a user of proceeds are taken into
account under the private security test.
5. Exception for generally applicable
taxes. The proposed regulations contain
specific rules for when a special agreement with respect to a generally applicable tax may cause tax payments to be
treated as private payments.
In response to comments, the final
regulations are more flexible for arrangements that reduce the amount of
tax paid and permit a wider range of tax
equivalency payments. The final regulations also clarify that an impermissible
agreement entered into by one taxpayer
does not affect whether payments made
by other taxpayers are treated as generally applicable taxes.
E. Section 1.141–5 Private loan financing test
1. Definition of proceeds for purposes
of the private loan financing test. The
proposed regulations provide that the

private loan financing test is met if
more than the lesser of 5 percent of the
‘‘proceeds’’ or $5 million of ‘‘sale proceeds’’ is used to make or finance loans
to nongovernmental persons. Commentators suggested that the definition of
proceeds for purposes of the test should
be consistent.
The final regulations apply the general private activity bond definition of
‘‘proceeds’’ to both parts of the test.
This approach reflects the view that
investment proceeds that are used to
make or finance loans should be taken
into account in determining whether the
private loan financing test is met.
2. Requirements for the ‘‘tax assessment loan’’ exception. The proposed
regulations provide that a number of
special requirements apply to the exception in Code section 141(c)(2) from the
private loan financing test for loans that
enable the borrower to finance a governmental tax or assessment of general
application for a specific essential governmental function. Commentators suggested that these requirements would
improperly restrict traditional special tax
and assessment tax-exempt financing for
governmental infrastructure in some
states.
In general, special state law restrictions (for example, state constitutional
limitations on issuing general obligation
bonds) should not necessarily foreclose
state and local governments from access
to tax-exempt financing for traditional
governmental infrastructure projects. Accordingly, the final regulations relax the
requirements for the tax assessment
bond exception. The requirement that a
tax or assessment of general application
be proportionate to the benefit to the
taxpayer is deleted. Further, the definition of improvements that serve essential governmental functions is expanded.
Under the new definition, all improvements to utilities and systems that are
owned by a governmental person and
that are available for use by the general
public serve essential governmental
functions for this purpose. In addition,
the final regulations provide that guarantees provided by persons treated as
borrowers in most cases will not cause
taxes or assessments to fail to qualify
for the tax assessment bond exception.
F. Section 1.141–6 Allocation and accounting rules
1. Allocations of proceeds to expenditures. The proposed regulations in
general provide that proceeds must be
allocated to expenditures consistently for

8

private activity bond purposes and
arbitrage purposes. Commentators suggested that, in light of the different
purposes of the private activity bond
rules and the arbitrage rules, this consistency should not be required.
The final regulations continue the
approach of the proposed regulations.
Final regulations are also adopted under
Code section 148 clarifying that allocations of proceeds to expenditures for
both purposes must be made by a
definite time (in no event later than the
date that rebate is, or would be, due).
2. Other allocation rules. The proposed regulations contain detailed rules
in §§ 1.141–1 and 1.141–6 for allocations of proceeds and bonds, including
rules for mixed use facilities and partnerships.
The final regulations reserve these
provisions. The IRS and Treasury are
considering more flexible rules to accommodate public/private partnerships.
G. Section 1.141–7 Special rules for
output contracts
The proposed regulations contain detailed rules in § 1.141–7 for determining the private business use and private
payments resulting from output contracts.
Regulatory changes are dramatically
affecting the electric power industry. In
order to further consider the issues
raised by these changes, the final regulations reserve this section. The final
regulations, however, otherwise apply to
bonds issued to finance output facilities.
H. Section 1.141–8 $15 million limitation for output facilities
Clarification of computation of
nonqualified amount. The proposed
regulations provide guidance on the special $15 million limitation on output
facilities of Code section 141(b)(4). The
final regulations reserve this section.
I. Section 1.141–12 Remedial actions
1. Remedial actions generally. The
proposed regulations provide that an
action that causes the private business
tests or the private loan financing test to
be met is not treated as a deliberate
action if the issuer takes an appropriate
remedial action.
The final regulations clarify that a
remedial action affects only compliance
with the private activity bond rules
relating to use of proceeds and does not
affect compliance with rules relating to
security or payment. This clarification is

important for purposes of determining
the amount of ‘‘nonqualified bonds’’
with respect to which a remedial action
must be taken.
2. Relationship of disposition proceeds and remedial actions. The proposed regulations contain separate rules
for use of proceeds derived from the
disposition of bond-financed property
(‘‘disposition proceeds’’) and remedial
actions. Commentators suggested that
the relationship between the disposition
proceeds rules and the remedial action
rules should be clarified and that, in
particular, additional rules should be
provided indicating when it is appropriate to treat an issue as financing disposition proceeds rather than the transferred
property.
The final regulations take the view
that, if an issuer disposes of bondfinanced property, it is generally appropriate under Code section 141 for the
Commissioner to treat the issue as financing either the transferred property
or the disposition proceeds. This is
because any disposition of bondfinanced property has the potential to
transfer the benefits of tax-exempt financing to the purchaser, and the private
activity bond rules extend to transactions that have significant potential to
transfer these benefits, as well as transactions that actually transfer these benefits. As a matter of administrative convenience, however, the final regulations
in certain cases permit an issuer to
choose to treat an issue as financing
either the transferred property or the
disposition proceeds, provided that certain conditions are met that protect
against abuse. The final regulations accordingly treat the disposition proceeds
rules as conditions to taking certain
remedial actions. For example, in order
for an issue to be eligible for a remedial
action, the disposition proceeds of an
issue must generally be treated as proceeds for purposes of the arbitrage regulations.
3. Conditions to taking a remedial
action. The proposed regulations provide
that an issuer may take a remedial
action to prevent bonds of an issue from
becoming private activity bonds only if
it made certain covenants and certifications on the issue date. Commentators
suggested that these specific requirements should be deleted because they
are unnecessary in light of standard
industry practice to require similar covenants and certifications. The final regulations adopt this comment.

4. Maturity limitations and remedial
actions. The proposed regulations provide that an issuer cannot take advantage of certain favorable rules involving
disposition proceeds if the weighted average maturity of an issue is greater
than 120 percent of the economic life of
the financed property. Commentators
suggested that use of this 120 percent
maturity limitation as a condition to
favorable treatment in taking remedial
actions is burdensome for issuers of
governmental bonds.
The final regulations provide that an
issue is eligible for the remedial action
rules only if the term of the issue is not
longer than is reasonably necessary for
the governmental purposes of the issue.
To determine whether the term of an
issue is unreasonably long, the final
regulations adopt the same standard that
is used for purposes of determining
whether replacement proceeds arise because the term of an issue is unreasonably long under § 1.148–1(c)(4). This
standard provides that the 120 percent
maturity limitation is a safe harbor,
rather than a requirement in all cases.
5. Special rules for identifying disposition proceeds. Under the proposed
regulations, many of the rules for remedial actions depend on identification of
disposition proceeds. The final regulations clarify how disposition proceeds
are to be allocated to an issue when the
transferred property has been financed
with different sources of funding. In
general, the final regulations provide
that disposition proceeds should be allocated first to the outstanding bonds that
financed the property (both tax-exempt
and taxable) in proportion to the outstanding principal amounts of those outstanding bonds. Only amounts in excess
of these outstanding principal amounts
may be allocated to other sources of
funding, such as equity of an issuer or
bonds that are no longer outstanding.
6. Redemption and defeasance as remedial actions. The proposed regulations
generally provide that redemption and
defeasance of nonqualified bonds are
permitted remedial actions. In cases
where the disposition is exclusively for
cash, only the disposition proceeds need
to be used to redeem or defease bonds;
in other cases, the entire amount of
nonqualified bonds is required to be
redeemed or defeased. The proposed
regulations also provide, however, that
defeasance of bonds to a date that is
more than six months from the date of a
deliberate action is permitted only if the
possibility of a disposition was remote

9

as of the issue date of the bonds.
Commentators suggested that this special limitation should be deleted because
the remoteness standard is vague and
would require governmental issuers to
use special call provisions that would
substantially increase borrowing costs.
The final regulations delete the ‘‘remote possibility’’ limitation on use of
defeasance as a remedial action. Instead,
the final regulations permit defeasance
as a remedial action only if the first call
date of the nonqualified bonds is not
greater than 10 1/2 years from the issue
date. This limitation presents an administrable standard that will not unduly
interfere with customary financing practices of state and local governments,
while at the same time preventing improper use of defeasance as a remedial
action for bonds that cannot be called
for an extended period of time.
7. Alternative qualifying use of a facility as a remedial action. The proposed
regulations provide that alternative
qualifying use of a bond-financed facility is a permitted remedial action if the
facility is used in a manner that meets
the requirements for any type of qualified private activity bonds and the bonds
are treated as reissued as of the date of
the deliberate action for purposes of the
tax-exempt bond rules concerning use of
bond-financed property. Commentators
suggested that for purposes of determining whether bonds that are treated as
reissued as of the date of the deliberate
action satisfy all of the applicable requirements for qualified bonds, the rules
contained in Code section 146 relating
to volume cap and the rules contained in
Code sections 55 and 57 should not
apply. Commentators also suggested that
the regulations should clarify whether
any limitations are placed on an issuer’s
use of disposition proceeds when it
chooses to use this remedial action.
The final regulations provide that, in
order to qualify for this remedial action,
an issuer must deposit any disposition
proceeds that it receives into a yieldrestricted escrow to pay the nonqualified
bonds. This requirement is different than
the defeasance remedial action, because
an issuer is permitted to leave bonds
outstanding until maturity (rather than
the first call date) and is not subject to
the special 10 1/2-year call protection
limitation on the defeasance remedial
action. Also, if an issuer chooses to use
this rule, it may receive compensation in
installments and use any payments received either to pay debt service or to
deposit into a yield-restricted escrow to

pay debt service. This requirement is
appropriate because it establishes the
necessary nexus between the new user
and the nonqualified bonds. In effect,
the new user is treated, as far as is
reasonably practicable, as if it were the
conduit borrower of the bond proceeds.
The final regulations also clarify that,
for purposes of determining whether
nonqualified bonds that are deemed to
be reissued meet all of the requirements
for qualified private activity bonds, the
law in effect on the date of the deliberate action applies. The final regulations
do not adopt the suggestion that the
rules contained in Code section 146
relating to volume cap and the rules
contained in Code sections 55 and 57
should not apply. The IRS and Treasury
are issuing a revenue procedure (discussed in paragraph 10 below) to address the change in status of bonds from
governmental bonds to qualified private
activity bonds and the application of the
alternative minimum tax provisions. The
final regulations provide that the rules
contained in Code section 147(d) relating to the acquisition of existing property do not apply to this remedial action.
8. Nonqualified bonds. The proposed
regulations permit an issuer to take a
remedial action with respect to a portion
of the bonds of an issue, rather than the
entire issue. In general, the proposed
regulations require that these ‘‘nonqualified bonds’’ be a pro rata portion
(among the maturities) of the outstanding bonds of an issue. Commentators
suggested that issuers should have
greater flexibility to allocate uses of
proceeds to bonds when a deliberate
action occurs.
The final regulations permit an issuer
to redeem or defease bonds with longer
maturities than the nonqualified bonds
in a remedial action, but in general
continue to require that nonqualified
bonds be identified on a pro rata basis.
Issuers have significant flexibility to
allocate bonds of an issue to separate
purposes on or before the issue date
under § 1.150–1(c)(3).
Under the final regulations, the percentage of outstanding bonds that are
nonqualified bonds is equal to the highest percentage of private business use in
any 1-year period commencing with the
deliberate action.
9. Effect of deliberate actions and
remedial actions on bonds that have
been advance refunded. The proposed
regulations do not specifically address
how deliberate actions and remedial actions affect bonds that have been ad-

vance refunded. Commentators suggested that a deliberate action should
not affect the status of an advance
refunded bond under Code section 141.
The final regulations provide that a
remedial action taken with respect to
advance refunding bonds proportionately
‘‘cures’’ the bonds that have been advance refunded.
10. Remedial payment revenue procedure. The preamble to the proposed
regulations indicates that the IRS and
Treasury are considering issuance of a
revenue procedure pursuant to which an
issuer may request a closing agreement
with respect to outstanding bonds. Under the closing agreement, the issuer
would make a payment to the IRS to
prevent the interest on bonds from being
includible in gross income of bondholders as a result of a deliberate action that
results in satisfaction of the private
activity bond test. In general, the payment would be based on the difference
between applicable federal rates for taxable and tax-exempt obligations. The
preamble to the proposed regulations
indicates that this revenue procedure is
being considered in lieu of permitting
defeasance as a remedial action. Commentators generally favored the publication of such a revenue procedure but
suggested that it should apply in addition to defeasance as a remedial action.
Commentators also suggested that an
issuer should be permitted to make a
payment to the IRS in those cases where
the bonds were issued as governmental
bonds, the interest on which was not
treated as an item of tax preference for
purposes of the alternative minimum tax
provisions, but the bonds become qualified private activity bonds, the interest
on which is treated as an item of tax
preference for purposes of the alternative minimum tax provisions as a consequence of a remedial action taken by the
issuer.
The IRS and Treasury are issuing a
revenue procedure in addition to permitting defeasance as a remedial action.
Under this revenue procedure the
amount of the remedial payment is
based on a factor that roughly approximates revenue loss to the United States
rather than the difference between taxable and tax-exempt applicable federal
rates. While this approach may in many
cases require greater remedial payments
than under the approach described in the
proposed regulations, the fluctuation in
the difference between taxable and taxexempt applicable federal rates would
result in inconsistent treatment of issu-

10

ers. Further, a more rigorous standard
for determining the remedial payment is
appropriate because the revenue procedure is adopted in addition to all of the
remedial actions set forth in the final
regulations.
In response to comments, this revenue
procedure also provides that an issuer
may make a payment to prevent the
application of the alternative minimum
tax provisions to interest payable on
bonds that were issued as governmental
bonds but, as a consequence of a remedial action taken by an issuer, are
qualified private activity bonds. This
approach recognizes the difficulty state
and local government issuers may have
in notifying bondholders of this change
in status.
J. Section 1.141–13 Refunding issues
The final regulations reserve on the
treatment of refunding bonds under
Code section 141.
K. Section 1.141–14 Anti-abuse rules
Application of the rule to override
specific tracing. The proposed regulations provide that if an issuer enters into
a transaction or series of transactions
with a principal purpose of transferring
to nongovernmental persons (other than
as members of the general public) significant benefits of tax-exempt financing
in a manner that is inconsistent with the
purposes of Code section 141, the Commissioner may take any action to reflect
the substance of the transaction or transactions.
The final regulations adopt this rule
and add examples to clarify that it may
be invoked in appropriate cases to override specific tracing of the use of proceeds.
L. Section 1.145–1 Special rules for
qualified 501(c)(3) bonds
1. Application of private activity
bond rules to Code section 145(a). The
proposed regulations provide that the
regulations under Code section 141 interpreting the private activity bond tests
apply for purposes of Code section
145(a)(2).
The final regulations in general continue this approach but also provide that
certain provisions under Code section
141, which are intended to apply only to
governmental programs, do not apply to
qualified 501(c)(3) bonds. The final
regulations also clarify that regulations
under Code section 141 apply in the
same manner to the ownership test of

Code section 145(a)(1) and to the modified private activity bond test of Code
section 145(a)(2).
2. Application of deliberate action
and remedial action rules to other provisions of Code section 145. The proposed
regulations provide that the deliberate
action rules of § 1.141–2 and the remedial action rules of § 1.141–12 generally apply to Code section 145.
The final regulations do not apply to
Code sections 145(b), (c), or (d). The
$150 million limitation on bonds other
than hospital bonds of Code sections
145(b) and (c) involves a number of
special considerations, which the IRS
and Treasury believe would be more
appropriate to consider in a project
comprehensively interpreting the operation of the special volume cap rules.
Similarly, the restrictions on bonds used
to provide residential rental housing for
family units of Code section 145(d)
involve a number of special considerations, which the IRS and Treasury
believe would be more appropriate to
consider in a project comprehensively
interpreting the special rules for bonds
financing residential rental housing.
M. Special rules for other qualified
bonds
1. General standard for compliance.
The proposed regulations provide that
the requirements for qualified bonds
(other than qualified 501(c)(3) bonds)
generally must be actually met throughout the term of an issue. Commentators
suggested that this rule should be deleted because the compliance standard
for each type of qualified bond should
be separately considered. Other commentators suggested that the compliance
standard applicable to governmental
bonds, looking to reasonable expectations and deliberate actions, is generally
appropriate for qualified bonds.
The final regulations do not address
the general compliance standard for
qualified bonds (other than qualified
501(c)(3) bonds). The IRS and Treasury
believe that further consideration should
be given to whether special rules apply
to different types of qualified bonds.
Accordingly, the final regulations address only whether remedial actions may
be taken to prevent certain types of
qualified bonds from failing to meet
requirements relating to use of proceeds.
Thus, no implication is intended that the
measurement-over-the-term rule for private business use under Code sections
141 and 145 applies in any manner to
other qualified bonds.

2. Remedial actions for change in
use. The proposed regulations in general
provide that, if an action results in
nonqualified use of proceeds, the remedial actions that apply to governmental
bonds also apply to qualified bonds. The
permitted remedial actions include redemption and defeasance of bonds and
alternative qualifying use of a facility.
The final regulations address only
whether remedial actions may be taken
for exempt facility bonds under Code
section 142 and qualified small issue
bonds under Code section 144(a) and
with respect to certain provisions of
147. The final regulations continue to
provide that redemption and defeasance
are permitted remedial actions for these
types of issues, under rules that are
similar to the remedial action rules that
apply to governmental bonds. The requirements for these types of qualified
bonds focus on the use of a particular
facility for a particular qualifying use,
and, unlike governmental bonds and
qualified 501(c)(3) bonds, do not generally focus on the status of the borrower.
For this reason, the final regulations
generally do not permit an issuer of
exempt facility bonds or qualified small
issue bonds to take a remedial action
based on use of disposition proceeds.
Accordingly, the final regulations clarify
that the amount of bonds required to be
redeemed or defeased under a remedial
action is not limited to the amount of
disposition proceeds. For administrative
convenience, however, the final regulations permit the use of disposition proceeds from the sale of personal property
that is incidental to a qualifying facility
to replace the personal property that is
sold. The final regulations do not permit
alternative qualifying use of a facility as
a remedial action for exempt facility
bonds or qualified small issue bonds.
3. Remedial actions for failure to
spend proceeds. The proposed regulations provide that a remedial action may
be taken to correct a failure to spend
proceeds as required under Code sections 142 and 144. This rule replaces
Rev. Proc. 79–5, 1979–1 C.B. 485, and
Rev. Proc. 81–22, 1981–1 C.B. 692,
which provide guidance on how the
requirement in the predecessor to Code
section 142 that substantially all of the
proceeds be spent for a qualifying purpose is met when excess bond proceeds
remain on hand after acquisition or
construction has been completed.
The final regulations clarify that the
requirements for remedial action in the
case of failure to spend proceeds for a

11

qualifying purpose are comparable to
the requirements for remedial action in
the case of change in use of a qualifying
facility. Accordingly, the final regulations require that nonqualified bonds
must be redeemed at their first call date,
regardless of the amount of call premium that is required to be paid, and
that defeasance is permitted only if the
first call date is no later than 10 1/2
years after the issue date.
4. Refundings of qualified bonds. The
final regulations reserve on the treatment of refundings of qualified bonds.
N. Section 1.150–4 Statutory change of
use rules for qualified private activity
bonds
The proposed regulations provide that
the change of use provisions of Code
section 150(b) apply even if an issuer
takes a remedial action that enables an
issue of qualified private activity bonds
to continue to meet use of proceeds
requirements. Commentators suggested
that a remedial action that preserves the
tax-exempt status of a qualified private
activity bond should also prevent application of the interest deduction denial
and imputed unrelated business income
provisions of Code section 150(b).
The final regulations more specifically address the effect of each type of
remedial action on the application of the
Code section 150(b) consequences. In
general, defeasance of bonds does not
prevent application of Code section
150(b). If other remedial actions are
taken promptly after the date of the
remedial action, however, Code section
150(b) does not apply.
O. Effective dates
The final regulations generally apply
to bonds issued after May 16, 1997. To
promote compliance, the final regulations generally permit elective, retroactive application of the regulations in
whole, but not in part, to outstanding
issues. In addition, the final regulations
permit elective, retroactive application to
outstanding issues of any of the following sections of the regulations: § 1.141–
12 (the remedial action rules); § 1.141–
3(b)(4) (the management contract rules);
and § 1.141–3(b)(6) (the research agreement rules).
Effect on Other Documents
In part because the existing industrial
development bond regulations under
§ 1.103–7 may continue to apply to
refunding bonds issued after the effec-

tive date of the private activity bond
regulations, § 1.103–7 is not being removed from the Code of Federal Regulations.
For bonds to which the final regulations apply, the following publications
are obsolete:
Notice 87–69, 1987–2 C.B. 378.
Notice 89–9, 1989–1 C.B. 630.
For actions that occur on or after May
16, 1997, the following publications are
obsolete:
Rev. Proc. 93–17, 1993–1 C.B. 507.
Rev. Proc. 81–22, 1981–1 C.B. 692.
Rev. Proc. 79–5, 1979–1 C.B. 485.
Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has 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 notice of proposed rulemaking
preceding the regulations was issued
prior to March 29, 1996, the Regulatory
Flexibility Act (5 U.S.C. chapter 6) does
not apply. Pursuant to section 7805(f) of
the Internal Revenue Code, the notice of
proposed rulemaking preceding these
regulations was submitted to the Chief
Counsel for Advocacy of the Small
Business Administration for comment on
its impact on small business.
Drafting Information
The principal authors of these regulations are Michael G. Bailey, Loretta J.
Finger, and Nancy M. Lashnits, Office
of Assistant Chief Counsel (Financial
Institutions and Products), and Linda B.
Schakel of the Office of Tax Legislative
Counsel. However, other personnel from
the IRS and Treasury Department participated in their development.
*

*

*

*

*

Adoption of Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 602
are amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation
for part 1 is amended by adding an
entry in numerical order to read as
follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.148–6 also issued under 26
U.S.C. 148(f), (g), and (i). * * *
Section 1.150–4 also issued under 26
U.S.C. 150(c)(5). * * *

Par. 2. The center heading immediately preceding § 1.141–1 is revised to
read as follows:
TAX EXEMPTION REQUIREMENTS
FOR STATE AND LOCAL BONDS
Par. 3. Section 1.141–1 is revised.
§ 1.143–1 [Redesignated as § 1.7703–
1]
Par. 4. Section 1.143–1 is redesignated as § 1.7703–1.
§ 1.144–3 [Removed]
Par. 5. Section 1.144–3 is removed.
Par. 6. Sections 1.141–0 and 1.141–2
through 1.141–16 are added.
The revised and added sections read
as follows:
§ 1.141–0 Table of contents.
This section lists the captioned paragraphs contained in §§ 1.141–1 through
1.141–16.
§ 1.141–1 Definitions and rules of general application.
(a)
(b)
(c)
(d)

In general.
Certain general definitions.
Elections.
Related parties.

§ 1.141–2 Private activity bond tests.
(a) Overview.
(b) Scope.
(c) General definition of private activity bond.
(d) Reasonable expectations and deliberate actions.
(1) In general.
(2) Reasonable expectations test.
(3) Deliberate action defined.
(4) Special rule for dispositions of
personal property in the ordinary course
of an established governmental program.
(5) Special rule for general obligation
bond programs that finance a large
number of separate purposes.
(e) When a deliberate action occurs.
(f) Certain remedial actions.
(g) Examples.
§ 1.141–3 Definition of private business use.
(a) General rule.
(1) In general.
(2) Indirect use.
(3) Aggregation of private business
use.
(b) Types of private business use arrangements.
(1) In general.
(2) Ownership.

12

(3) Leases.
(4) Management contracts.
(5) Output contracts.
(6) Research agreements.
(7) Other actual or beneficial use.
(c) Exception for general public use.
(1) In general.
(2) Use on the same basis.
(3) Long-term arrangements not
treated as general public use.
(4) Relation to other use.
(d) Other exceptions.
(1) Agents.
(2) Use incidental to financing arrangements.
(3) Exceptions for arrangements other
than arrangements resulting in ownership of financed property by a nongovernmental person.
(4) Temporary use by developers.
(5) Incidental use.
(6) Qualified improvements.
(e) Special rule for tax assessment
bonds.
(f) Examples.
(g) Measurement of private business
use.
(1) In general.
(2) Measurement period.
(3) Determining average percentage
of private business use.
(4) Determining the average amount
of private business use for a 1-year
period.
(5) Common areas.
(6) Allocation of neutral costs.
(7) Commencement of measurement
of private business use.
(8) Examples.
§ 1.141–4 Private security or payment
test.
(a) General rule.
(1) Private security or payment.
(2) Aggregation of private payments
and security.
(3) Underlying arrangement.
(b) Measurement of private payments
and security.
(1) Scope.
(2) Present value measurement.
(c) Private payments.
(1) In general.
(2) Payments taken into account.
(3) Allocation of payments.
(d) Private security.
(1) In general.
(2) Security taken into account.
(3) Pledge of unexpended proceeds.
(4) Secured by any interest in property or payments.
(5) Payments in respect of property.

(6) Allocation of security among issues.
(e) Generally applicable taxes.
(1) General rule.
(2) Definition of generally applicable
taxes.
(3) Special charges.
(4) Manner of determination and collection.
(5) Payments in lieu of taxes.
(f) Certain waste remediation bonds.
(1) Scope.
(2) Persons that are not private users.
(3) Persons that are private users.
(g) Examples.
§ 1.141–5 Private loan financing test.
(a) In general.
(b) Measurement of test.
(c) Definition of private loan.
(1) In general.
(2) Application only to purpose investments.
(3) Grants.
(4) Hazardous waste remediation
bonds.
(d) Tax assessment loan exception.
(1) General rule.
(2) Tax assessment loan defined.
(3) Mandatory tax or other assessment.
(4) Specific essential governmental
function.
(5) Equal basis requirement.
(6) Coordination with private business tests.
(e) Examples.
§ 1.141–6 Allocation and accounting
rules.
(a) Allocation of proceeds to expenditures.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common areas. [Reserved]
(e) Allocation of proceeds to bonds.
[Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
§ 1.141–7
contracts.

Special rules for output

[Reserved]
§ 1.141–8 $15 million limitation for
output facilities.
[Reserved]

§ 1.141–9 Unrelated or disproportionate use test.
(a) General rules.
(1) Description of test.
(2) Application of unrelated or disproportionate use test.
(b) Unrelated use.
(1) In general.
(2) Use for the same purpose as
government use.
(c) Disproportionate use.
(1) Definition of disproportionate use.
(2) Aggregation of related uses.
(3) Allocation rule.
(d) Maximum use taken into account.
(e) Examples.
§ 1.141–10
cap.

Coordination with volume

[Reserved]
§ 1.141–11 Acquisition of nongovernmental output property.
[Reserved]
§ 1.141–12 Remedial actions.
(a) Conditions to taking remedial action.
(1) Reasonable expectations test met.
(2) Maturity not unreasonably long.
(3) Fair market value consideration.
(4) Disposition proceeds treated as
gross proceeds for arbitrage purposes.
(5) Proceeds expended on a governmental purpose.
(b) Effect of a remedial action.
(1) In general.
(2) Effect on bonds that have been
advance refunded.
(c) Disposition proceeds.
(1) Definition.
(2) Allocating disposition proceeds to
an issue.
(3) Allocating disposition proceeds to
different sources of funding.
(d) Redemption or defeasance of
nonqualified bonds.
(1) In general.
(2) Special rule for dispositions for
cash.
(3) Notice of defeasance.
(4) Special limitation.
(5) Defeasance escrow defined.
(e) Alternative use of disposition proceeds.
(1) In general.
(2) Special rule for use by 501(c)(3)
organizations.
(f) Alternative use of facility.
(g) Rules for deemed reissuance.
(h) Authority of Commissioner to
provide for additional remedial actions.

13

(i) Effect of remedial action on continuing compliance.
(j) Nonqualified bonds.
(1) Amount of nonqualified bonds.
(2) Allocation of nonqualified bonds.
(k) Examples.
§ 1.141–13 Refunding issues.
[Reserved]
§ 1.141–14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of transactions.
(b) Examples.
§ 1.141–15 Effective dates.
(a) Scope.
(b) Effective dates.
(c) Refunding bonds.
(d) Permissive application of regulations.
(e) Permissive retroactive application
of certain sections.
§ 1.141–16 Effective dates for qualified
private activity bond provisions.
(a) Scope.
(b) Effective dates.
(c) Permissive application.
§ 1.141–1 Definitions and rules of general application.
(a) In general. For purposes of
§§ 1.141–0 through 1.141–16, the following definitions and rules apply: the
definitions in this section, the definitions
in § 1.150–1, the definition of placed in
service under § 1.150–2(c), the definition of grant under § 1.148–6(d)(4)(iii),
the definition of reasonably required
reserve or replacement fund in § 1.148–
2(f), and the following definitions under
§ 1.148–1: bond year, commingled
fund, fixed yield issue, higher yielding
investments, investment, investment proceeds, issue price, issuer, nonpurpose
investment, purpose investment, qualified guarantee, qualified hedge, reasonable expectations or reasonableness, rebate amount, replacement proceeds, sale
proceeds, variable yield issue, and yield.
(b) Certain general definitions. Common areas means portions of a facility
that are equally available to all users of
a facility on the same basis for uses that
are incidental to the primary use of the
facility. For example, hallways and elevators generally are treated as common
areas if they are used by the different
lessees of a facility in connection with
the primary use of that facility.

Consistently applied means applied
uniformly to account for proceeds and
other amounts.
Deliberate action is defined in
§ 1.141–2(d)(3).
Discrete portion means a portion of a
facility that consists of any separate and
discrete portion of a facility to which
use is limited, other than common areas.
A floor of a building and a portion of a
building separated by walls, partitions,
or other physical barriers are examples
of a discrete portion.
Disposition is defined in § 1.141–
12(c)(1).
Disposition proceeds is defined in
§ 1.141–12(c)(1).
Essential governmental function is defined in § 1.141–5(d)(4)(ii).
Financed means constructed, reconstructed, or acquired with proceeds of an
issue.
Governmental bond means a bond
issued as part of an issue no portion of
which consists of private activity bonds.
Governmental person means a state or
local governmental unit as defined in
§ 1.103–1 or any instrumentality
thereof. It does not include the United
States or any agency or instrumentality
thereof.
Hazardous waste remediation bonds
is defined in § 1.141–4(f)(1).
Measurement period is defined in
§ 1.141–3(g)(2).
Nongovernmental person means a
person other than a governmental person.
Output facility means electric and gas
generation, transmission, distribution,
and related facilities, and water collection, storage, and distribution facilities.
Private business tests means the private business use test and the private
security or payment test of section
141(b).
Proceeds means the sale proceeds of
an issue (other than those sale proceeds
used to retire bonds of the issue that are
not deposited in a reasonably required
reserve or replacement fund). Proceeds
also include any investment proceeds
from investments that accrue during the
project period (net of rebate amounts
attributable to the project period). Disposition proceeds of an issue are treated
as proceeds to the extent provided in
§ 1.141–12. The Commissioner may
treat any replaced amounts as proceeds.
Project period means the period beginning on the issue date and ending on
the date that the project is placed in
service. In the case of a multipurpose
issue, the issuer may elect to treat the

project period for the entire issue as
ending on either the expiration of the
temporary period described in § 1.148–
2(e)(2) or the end of the fifth bond year
after the issue date.
Public utility property means public
utility property as defined in section
168(i)(10).
Qualified bond means a qualified
bond as defined in section 141(e).
Renewal option means a provision
under which either party has a legally
enforceable right to renew the contract.
Thus, for example, a provision under
which a contract is automatically renewed for 1-year periods absent cancellation by either party is not a renewal
option (even if it is expected to be
renewed).
Replaced amounts means replacement
proceeds other than amounts that are
treated as replacement proceeds solely
because they are sinking funds or
pledged funds.
Weighted average maturity is determined under section 147(b).
Weighted average reasonably expected economic life is determined under section 147(b). The reasonably expected economic life of property may be
determined by reference to the class life
of the property under section 168.
(c) Elections. Elections must be made
in writing on or before the issue date
and retained as part of the bond documents, and, once made, may not be
revoked without the permission of the
Commissioner.
(d) Related parties. Except as otherwise provided, all related parties are
treated as one person and any reference
to ‘‘person’’ includes any related party.
§ 1.141–2 Private activity bond tests.
(a) Overview. Interest on a private
activity bond is not excludable from
gross income under section 103(a) unless the bond is a qualified bond. The
purpose of the private activity bond tests
of section 141 is to limit the volume of
tax-exempt bonds that finance the activities of nongovernmental persons, without regard to whether a financing actually transfers benefits of tax-exempt
financing to a nongovernmental person.
The private activity bond tests serve to
identify arrangements that have the potential to transfer the benefits of taxexempt financing, as well as arrangements that actually transfer these
benefits. The regulations under section
141 may not be applied in a manner that
is inconsistent with these purposes.

14

(b) Scope. Sections 1.141–0 through
1.141–16 apply generally for purposes
of the private activity bond limitations
under section 141.
(c) General definition of private activity bond. Under section 141, bonds
are private activity bonds if they meet
either the private business use test and
private security or payment test of section 141(b) or the private loan financing
test of section 141(c). The private business use and private security or payment
tests are described in §§ 1.141–3 and
1.141–4. The private loan financing test
is described in § 1.141–5.
(d) Reasonable expectations and deliberate actions—(1) In general. An
issue is an issue of private activity
bonds if the issuer reasonably expects,
as of the issue date, that the issue will
meet either the private business tests or
the private loan financing test. An issue
is also an issue of private activity bonds
if the issuer 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 met.
(2) Reasonable expectations test—(i)
In general. In general, the reasonable
expectations test must take into account
reasonable expectations about events
and actions over the entire stated term
of an issue.
(ii) Special rule for issues with mandatory redemption provisions. An action
that is reasonably expected, as of the
issue date, to occur after the issue date
and to cause either the private business
tests or the private loan financing test to
be met may be disregarded for purposes
of those tests if—
(A) The issuer reasonably expects, as
of the issue date, that the financed
property will be used for a governmental purpose for a substantial period before the action;
(B) The issuer is required to redeem
all nonqualifying bonds (regardless of
the amount of disposition proceeds actually received) within 6 months of the
date of the action;
(C) The issuer does not enter into
any arrangement with a nongovernmental person, as of the issue date, with
respect to that specific action; and
(D) The mandatory redemption of
bonds meets all of the conditions for
remedial action under § 1.141–12(a).
(3) Deliberate action defined—(i) In
general. Except as otherwise provided in
this paragraph (d)(3), a deliberate action
is any action taken by the issuer that is
within its control. An intent to violate

the requirements of section 141 is not
necessary for an action to be deliberate.
(ii) Safe harbor exceptions. An action
is not treated as a deliberate action if—
(A) It would be treated as an involuntary or compulsory conversion under
section 1033; or
(B) It is taken in response to a regulatory directive made by the federal
government.
(4) Special rule for dispositions of
personal property in the ordinary course
of an established governmental program—(i) In general. Dispositions of
personal property in the ordinary course
of an established governmental program
are not treated as deliberate actions if—
(A) The weighted average maturity of
the bonds financing that personal property is not greater than 120 percent of
the reasonably expected actual use of
that property for governmental purposes;
(B) The issuer reasonably expects on
the issue date that the fair market value
of that property on the date of disposition will be not greater than 25 percent
of its cost; and
(C) The property is no longer suitable
for its governmental purposes on the
date of disposition.
(ii) Reasonable expectations test. The
reasonable expectation that a disposition
described in paragraph (d)(4)(i) of this
section may occur in the ordinary course
while the bonds are outstanding will not
cause the issue to meet the private
activity bond tests if the issuer is required to deposit amounts received from
the disposition in a commingled fund
with substantial tax or other governmental revenues and the issuer reasonably
expects to spend the amounts on governmental programs within 6 months
from the date of commingling.
(iii) Separate issue treatment. An issuer may treat the bonds properly allocable to the personal property eligible
for this exception as a separate issue
under § 1.150–1(c)(3).
(5) Special rule for general obligation bond programs that finance a large
number of separate purposes. 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 if all of the
requirements of paragraphs (d)(5)(i)
through (vii) of this section are met.
(i) The issue is an issue of general
obligation bonds of a general purpose
governmental unit that finances at least
25 separate purposes (as defined in

§ 1.150–1(c)(3)) and does not predominantly finance fewer than 4 separate
purposes.
(ii) The issuer has adopted a fund
method of accounting for its general
governmental purposes that makes tracing the bond proceeds to specific expenditures unreasonably burdensome.
(iii) The issuer reasonably expects on
the issue date to allocate all of the net
proceeds of the issue to capital expenditures within 6 months of the issue date
and adopts reasonable procedures to
verify that net proceeds are in fact so
expended. A program to randomly spot
check that 10 percent of the net proceeds were so expended generally is a
reasonable verification procedure for
this purpose.
(iv) The issuer reasonably expects on
the issue date to expend all of the net
proceeds of the issue before expending
proceeds of a subsequent issue of similar general obligation bonds.
(v) The issuer reasonably expects on
the issue date that it will not make any
loans to nongovernmental persons with
the proceeds of the issue.
(vi) The issuer reasonably expects on
the issue date that the capital expenditures that it could make during the
6-month period beginning on the issue
date with the net proceeds of the issue
that would not meet the private business
tests are not less than 125 percent of the
capital expenditures to be financed with
the net proceeds of the issue.
(vii) The issuer reasonably expects on
the issue date that the weighted average
maturity of the issue is not greater than
120 percent of the weighted average
reasonably expected economic life of
the capital expenditures financed with
the issue. To determine reasonably expected economic life for this purpose an
issuer may use reasonable estimates
based on the type of expenditures made
from a fund.
(e) When a deliberate action occurs.
A deliberate action occurs on the date
the issuer enters into a binding contract
with a nongovernmental person for use
of the financed property that is not
subject to any material contingencies.
(f) Certain remedial actions. See
§ 1.141–12 for certain remedial actions
that prevent a deliberate action with
respect to property financed by an issue
from causing that issue to meet the
private business use test or the private
loan financing test.
(g) Examples. The following examples illustrate the application of this
section:

15

Example 1. Involuntary action. City B issues
bonds to finance the purchase of land. On the
issue date, B reasonably expects that it will be the
sole user of the land for the entire term of the
bonds. Subsequently, the federal government acquires the land in a condemnation action. B sets
aside the condemnation proceeds to pay debt
service on the bonds but does not redeem them on
their first call date. The bonds are not private
activity bonds because B has not taken a deliberate action after the issue date. See, however,
§ 1.141–14(b), Example 2.
Example 2. Reasonable expectations test—
involuntary action. The facts are the same as in
Example 1, except that, on the issue date, B
reasonably expects that the federal government
will acquire the land in a condemnation action
during the term of the bonds. On the issue date,
the present value of the amount that B reasonably
expects to receive from the federal government is
greater than 10 percent of the present value of the
debt service on the bonds. The terms of the bonds
do not require that the bonds be redeemed within
6 months of the acquisition by the federal government. The bonds are private activity bonds because the issuer expects as of the issue date that
the private business tests will be met.
Example 3. Reasonable expectations test—
mandatory redemption. City C issues bonds to
rehabilitate an existing hospital that it currently
owns. On the issue date of the bonds, C reasonably expects that the hospital will be used for a
governmental purpose for a substantial period. On
the issue date, C also plans to construct a new
hospital, but the placed in service date of that new
hospital is uncertain. C reasonably expects that,
when the new hospital is placed in service, it will
sell or lease the rehabilitated hospital to a private
hospital corporation. The bond documents require
that the bonds must be redeemed within 6 months
of the sale or lease of the rehabilitated hospital
(regardless of the amount actually received from
the sale). The bonds meet the reasonable expectations requirement of the private activity bond tests
if the mandatory redemption of bonds meets all of
the conditions for a remedial action under
§ 1.141–12(a).
Example 4. Dispositions in the ordinary course
of an established governmental program. City D
issues bonds with a weighted average maturity of
6 years for the acquisition of police cars. D
reasonably expects on the issue date that the
police cars will be used solely by its police
department, except that, in the ordinary course of
its police operations, D sells its police cars to a
taxicab corporation after 5 years of use because
they are no longer suitable for police use. Further,
D reasonably expects that the value of the police
cars when they are no longer suitable for police
use will be no more than 25 percent of cost. D
subsequently sells 20 percent of the police cars
after only 3 years of actual use. At that time, D
deposits the proceeds from the sale of the police
cars in a commingled fund with substantial tax
revenues and reasonably expects to spend the
proceeds on governmental programs within 6
months of the date of deposit. D does not trace the
actual use of these commingled amounts. The sale
of the police cars does not cause the private
activity bond tests to be met because the requirements of paragraph (d)(4) of this section are met.

§ 1.141–3 Definition of private business use.
(a) General rule—(1) In general. The
private business use test relates to the

use of the proceeds of an issue. The 10
percent private business use test of
section 141(b)(1) is met if more than 10
percent of the proceeds of an issue is
used in a trade or business of a nongovernmental person. For this purpose, the
use of financed property is treated as the
direct use of proceeds. Any activity
carried on by a person other than a
natural person is treated as a trade or
business. Unless the context or a provision clearly requires otherwise, this section also applies to the private business
use test under sections 141(b)(3) (unrelated or disproportionate use), 141(b)(4)
($15 million limitation for certain output
facilities), and 141(b)(5) (the coordination with the volume cap where the
nonqualified amount exceeds $15 million).
(2) Indirect use. In determining
whether an issue meets the private business use test, it is necessary to look to
both the indirect and direct uses of
proceeds. For example, a facility is
treated as being used for a private
business use if it is leased to a nongovernmental person and subleased to a
governmental person or if it is leased to
a governmental person and then subleased to a nongovernmental person,
provided that in each case the nongovernmental person’s use is in a trade or
business. Similarly, the issuer’s use of
the proceeds to engage in a series of
financing transactions for property to be
used by nongovernmental persons in
their trades or businesses may cause the
private business use test to be met. In
addition, proceeds are treated as used in
the trade or business of a nongovernmental person if a nongovernmental person, as a result of a single transaction or
a series of related transactions, uses
property acquired with the proceeds of
an issue.
(3) Aggregation of private business
use. The use of proceeds by all nongovernmental persons is aggregated to determine whether the private business use
test is met.
(b) Types of private business use arrangements—(1) In general. Both actual
and beneficial use by a nongovernmental person may be treated as private
business use. In most cases, the private
business use test is met only if a
nongovernmental person has special legal entitlements to use the financed
property under an arrangement with the
issuer. In general, a nongovernmental
person is treated as a private business
user of proceeds and financed property
as a result of ownership; actual or

beneficial use of property pursuant to a
lease, or a management or incentive
payment contract; or certain other arrangements such as a take or pay or
other output-type contract.
(2) Ownership. Except as provided in
paragraph (d)(1) or (d)(2) of this section, ownership by a nongovernmental
person of financed property is private
business use of that property. For this
purpose, ownership refers to ownership
for federal income tax purposes.
(3) Leases. Except as provided in
paragraph (d) of this section, the lease
of financed property to a nongovernmental person is private business use of
that property. For this purpose, any
arrangement that is properly characterized as a lease for federal income tax
purposes is treated as a lease. In determining whether a management contract
is properly characterized as a lease, it is
necessary to consider all of the facts and
circumstances, including the following
factors—
(i) The degree of control over the
property that is exercised by a nongovernmental person; and
(ii) Whether a nongovernmental person bears risk of loss of the financed
property.
(4) Management contracts—(i) Facts
and circumstances test. Except as provided in paragraph (d) of this section, a
management contract (within the meaning of paragraph (b)(4)(ii) of this section) with respect to financed property
may result in private business use of
that property, based on all of the facts
and circumstances. A management contract with respect to financed property
generally results in private business use
of that property if the contract provides
for compensation for services rendered
with compensation based, in whole or in
part, on a share of net profits from the
operation of the facility.
(ii) Management contract defined.
For purposes of this section, a management contract is a management, service,
or incentive payment contract between a
governmental person and a service provider under which the service provider
provides services involving all, a portion
of, or any function of, a facility. For
example, a contract for the provision of
management services for an entire hospital, a contract for management services for a specific department of a
hospital, and an incentive payment contract for physician services to patients of
a hospital are each treated as a management contract.

16

(iii) Arrangements generally not
treated as management contracts. The
arrangements described in paragraphs
(b)(4)(iii)(A) through (D) of this section
generally are not treated as management
contracts that give rise to private business use.
(A) Contracts for services that are
solely incidental to the primary governmental function or functions of a financed facility (for example, contracts
for janitorial, office equipment repair,
hospital billing, or similar services).
(B) The mere granting of admitting
privileges by a hospital to a doctor, even
if those privileges are conditioned on
the provision of de minimis services, if
those privileges are available to all
qualified physicians in the area, consistent with the size and nature of its
facilities.
(C) A contract to provide for the
operation of a facility or system of
facilities that consists predominantly of
public utility property, if the only compensation is the reimbursement of actual
and direct expenses of the service provider and reasonable administrative
overhead expenses of the service provider.
(D) A contract to provide for services, if the only compensation is the
reimbursement of the service provider
for actual and direct expenses paid by
the service provider to unrelated parties.
(iv) Management contracts that are
properly treated as other types of private business use. A management contract with respect to financed property
results in private business use of that
property if the service provider is
treated as the lessee or owner of financed property for federal income tax
purposes, unless an exception under
paragraph (d) of this section applies to
the arrangement.
(5) Output contracts. See § 1.141–7
for special rules for contracts for the
purchase of output of output facilities.
(6) Research agreements—(i) Facts
and circumstances test. Except as provided in paragraph (d) of this section, an
agreement by a nongovernmental person
to sponsor research performed by a
governmental person may result in private business use of the property used
for the research, based on all of the
facts and circumstances.
(ii) Research agreements that are
properly treated as other types of private business use. A research agreement
with respect to financed property results
in private business use of that property
if the sponsor is treated as the lessee or

owner of financed property for federal
income tax purposes, unless an exception under paragraph (d) of this section
applies to the arrangement.
(7) Other actual or beneficial use—
(i) In general. Any other arrangement
that conveys special legal entitlements
for beneficial use of bond proceeds or
of financed property that are comparable
to special legal entitlements described in
paragraphs (b)(2), (3), (4), (5), or (6) of
this section results in private business
use. For example, an arrangement that
conveys priority rights to the use or
capacity of a facility generally results in
private business use.
(ii) Special rule for facilities not used
by the general public. In the case of
financed property that is not available
for use by the general public (within the
meaning of paragraph (c) of this section), private business use may be established solely on the basis of a special
economic benefit to one or more nongovernmental persons, even if those
nongovernmental persons have no special legal entitlements to use of the
property. In determining whether special
economic benefit gives rise to private
business use it is necessary to consider
all of the facts and circumstances, including one or more of the following
factors—
(A) Whether the financed property is
functionally related or physically proximate to property used in the trade or
business of a nongovernmental person;
(B) Whether only a small number of
nongovernmental persons receive the
special economic benefit; and
(C) Whether the cost of the financed
property is treated as depreciable by any
nongovernmental person.
(c) Exception for general public
use—(1) In general. Use as a member
of the general public (general public
use) is not private business use. Use of
financed property by nongovernmental
persons in their trades or businesses is
treated as general public use only if the
property is intended to be available and
in fact is reasonably available for use on
the same basis by natural persons not
engaged in a trade or business.
(2) Use on the same basis. In general, use under an arrangement that
conveys priority rights or other preferential benefits is not use on the same basis
as the general public. Arrangements providing for use that is available to the
general public at no charge or on the
basis of rates that are generally applicable and uniformly applied do not
convey priority rights or other preferen-

tial benefits. For this purpose, rates may
be treated as generally applicable and
uniformly applied even if—
(i) Different rates apply to different
classes of users, such as volume purchasers, if the differences in rates are
customary and reasonable; or
(ii) A specially negotiated rate arrangement is entered into, but only if
the user is prohibited by federal law
from paying the generally applicable
rates, and the rates established are as
comparable as reasonably possible to the
generally applicable rates.
(3) Long-term arrangements not
treated as general public use. An arrangement is not treated as general
public use if the term of the use under
the arrangement, including all renewal
options, is greater than 180 days. For
this purpose, a right of first refusal to
renew use under the arrangement is not
treated as a renewal option if—
(i) The compensation for the use under the arrangement is redetermined at
generally applicable, fair market value
rates that are in effect at the time of
renewal; and
(ii) The use of the financed property
under the same or similar arrangements
is predominantly by natural persons who
are not engaged in a trade or business.
(4) Relation to other use. Use of
financed property by the general public
does not prevent the proceeds from
being used for a private business use
because of other use under this section.
(d) Other exceptions—(1) Agents.
Use of proceeds by nongovernmental
persons solely in their capacity as agents
of a governmental person is not private
business use. For example, use by a
nongovernmental person that issues obligations on behalf of a governmental
person is not private business use to the
extent the nongovernmental person’s use
of proceeds is in its capacity as an agent
of the governmental person.
(2) Use incidental to financing arrangements. Use by a nongovernmental
person that is solely incidental to a
financing arrangement is not private
business use. A use is solely incidental
to a financing arrangement only if the
nongovernmental person has no substantial rights to use bond proceeds or
financed property other than as an agent
of the bondholders. For example, a
nongovernmental person that acts solely
as an owner of title in a sale and
leaseback financing transaction with a
city generally is not a private business
user of the property leased to the city,
provided that the nongovernmental per-

17

son has assigned all of its rights to use
the leased facility to the trustee for the
bondholders upon default by the city.
Similarly, bond trustees, servicers, and
guarantors are generally not treated as
private business users.
(3) Exceptions for arrangements
other than arrangements resulting in
ownership of financed property by a
nongovernmental person—(i) Arrangements not available for use on the same
basis by natural persons not engaged in
a trade or business. Use by a nongovernmental person pursuant to an arrangement, other than an arrangement
resulting in ownership of financed property by a nongovernmental person, is
not private business use if—
(A) The term of the use under the
arrangement, including all renewal options, is not longer than 90 days;
(B) The arrangement would be
treated as general public use, except that
it is not available for use on the same
basis by natural persons not engaged in
a trade or business because generally
applicable and uniformly applied rates
are not reasonably available to natural
persons not engaged in a trade or business; and
(C) The property is not financed for a
principal purpose of providing that property for use by that nongovernmental
person.
(ii) Negotiated arm’s-length arrangements. Use by a nongovernmental person pursuant to an arrangement, other
than an arrangement resulting in ownership of financed property by a nongovernmental person, is not private business
use if—
(A) The term of the use under the
arrangement, including all renewal options, is not longer than 30 days;
(B) The arrangement is a negotiated
arm’s-length arrangement, and compensation under the arrangement is at fair
market value; and
(C) The property is not financed for a
principal purpose of providing that property for use by that nongovernmental
person.
(4) Temporary use by developers. Use
during an initial development period by
a developer of an improvement that
carries out an essential governmental
function is not private business use if
the issuer and the developer reasonably
expect on the issue date to proceed with
all reasonable speed to develop the
improvement and property benefited by
that improvement and to transfer the
improvement to a governmental person,
and if the improvement is in fact trans-

ferred to a governmental person
promptly after the property benefited by
the improvement is developed.
(5) Incidental use—(i) General rule.
Incidental uses of a financed facility are
disregarded, to the extent that those uses
do not exceed 2.5 percent of the proceeds of the issue used to finance the
facility. A use of a facility by a nongovernmental person is incidental if—
(A) Except for vending machines,
pay telephones, kiosks, and similar uses,
the use does not involve the transfer to
the nongovernmental person of possession and control of space that is separated from other areas of the facility by
walls, partitions, or other physical barriers, such as a night gate affixed to a
structural component of a building (a
nonpossessory use);
(B) The nonpossessory use is not
functionally related to any other use of
the facility by the same person (other
than a different nonpossessory use); and
(C) All nonpossessory uses of the
facility do not, in the aggregate, involve
the use of more than 2.5 percent of the
facility.
(ii) Illustrations. Incidental uses may
include pay telephones, vending machines, advertising displays, and use for
television cameras, but incidental uses
may not include output purchases.
(6) Qualified improvements. Proceeds
that provide a governmentally owned
improvement to a governmentally
owned building (including its structural
components and land functionally related and subordinate to the building)
are not used for a private business use
if—
(i) The building was placed in service
more than 1 year before the construction
or acquisition of the improvement is
begun;
(ii) The improvement is not an enlargement of the building or an improvement of interior space occupied
exclusively for any private business use;
(iii) No portion of the improved
building or any payments in respect of
the improved building are taken into
account under section 141(b)(2)(A) (the
private security test); and
(iv) No more than 15 percent of the
improved building is used for a private
business use.
(e) Special rule for tax assessment
bonds. In the case of a tax assessment
bond that satisfies the requirements of
§ 1.141–5(d), the loan (or deemed loan)
of the proceeds to the borrower paying
the assessment is disregarded in determining whether the private business use

test is met. However, the use of the loan
proceeds is not disregarded in determining whether the private business use test
is met.
(f) Examples. The following examples illustrate the application of paragraphs (a) through (e) of this section. In
each example, assume that the arrangements described are the only arrangements with nongovernmental persons for
use of the financed property.
Example 1. Nongovernmental ownership. State
A issues 20-year bonds to purchase land and equip
and construct a factory. A then enters into an
arrangement with Corporation X to sell the factory
to X on an installment basis while the bonds are
outstanding. The issue meets the private business
use test because a nongovernmental person owns
the financed facility. See also § 1.141–2 (relating
to the private activity bond tests), and § 1.141–5
(relating to the private loan financing test).
Example 2. Lease to a nongovernmental person.
(i) The facts are the same as in Example 1, except
that A enters into an arrangement with X to lease
the factory to X for 3 years rather than to sell it to
X. The lease payments will be made annually and
will be based on the tax-exempt interest rate on
the bonds. The issue meets the private business
use test because a nongovernmental person leases
the financed facility. See also § 1.141–14 (relating
to anti-abuse rules).
(ii) The facts are the same as in Example 2(i),
except that the annual payments made by X will
equal fair rental value of the facility and exceed
the amount necessary to pay debt service on the
bonds for the 3 years of the lease. The issue meets
the private business use test because a nongovernmental person leases the financed facility and the
test does not require that the benefits of taxexempt financing be passed through to the nongovernmental person.
Example 3. Management contract in substance
a lease. City L issues 30-year bonds to finance the
construction of a city hospital. L enters into a
15-year contract with M, a nongovernmental person that operates a health maintenance organization relating to the treatment of M’s members at
L’s hospital. The contract provides for reasonable
fixed compensation to M for services rendered
with no compensation based, in whole or in part,
on a share of net profits from the operation of the
hospital. However, the contract also provides that
30 percent of the capacity of the hospital will be
exclusively available to M’s members and M will
bear the risk of loss of that portion of the capacity
of the hospital so that, under all of the facts and
circumstances, the contract is properly characterized as a lease for federal income tax purposes.
The issue meets the private business use test
because a nongovernmental person leases the
financed facility.
Example 4. Ownership of title in substance a
leasehold interest. Nonprofit corporation R issues
bonds on behalf of City P to finance the construction of a hospital. R will own legal title to the
hospital. In addition, R will operate the hospital,
but R is not treated as an agent of P in its capacity
as operator of the hospital. P has certain rights to
the hospital that establish that it is properly treated
as the owner of the property for federal income
tax purposes. P does not have rights, however, to
directly control operation of the hospital while R
owns legal title to it and operates it. The issue
meets the private business use test because the
arrangement provides a nongovernmental person

18

an interest in the financed facility that is comparable to a leasehold interest. See paragraphs (a)(2)
and (b)(7)(i) of this section.
Example 5. Rights to control use of property
treated as private business use—parking lot. Corporation C and City D enter into a plan to finance
the construction of a parking lot adjacent to C’s
factory. Pursuant to the plan, C conveys the site
for the parking lot to D for a nominal amount,
subject to a covenant running with the land that
the property be used only for a parking lot. In
addition, D agrees that C will have the right to
approve rates charged by D for use of the parking
lot. D issues bonds to finance construction of the
parking lot on the site. The parking lot will be
available for use by the general public on the basis
of rates that are generally applicable and uniformly applied. The issue meets the private business use test because a nongovernmental person
has special legal entitlements for beneficial use of
the financed facility that are comparable to an
ownership interest. See paragraph (b)(7)(i) of this
section.
Example 6. Other actual or beneficial use—
hydroelectric enhancements. J, a political subdivision, owns and operates a hydroelectric generation
plant and related facilities. Pursuant to a take or
pay contract, J sells 15 percent of the output of
the plant to Corporation K, an investor-owned
utility. K is treated as a private business user of
the plant. Under the license issued to J for
operation of the plant, J is required by federal
regulations to construct and operate various facilities for the preservation of fish and for public
recreation. J issues its obligations to finance the
fish preservation and public recreation facilities. K
has no special legal entitlements for beneficial use
of the financed facilities. The fish preservation
facilities are functionally related to the operation
of the plant. The recreation facilities are available
to natural persons on a short-term basis according
to generally applicable and uniformly applied
rates. Under paragraph (c) of this section, the
recreation facilities are treated as used by the
general public. Under paragraph (b)(7) of this
section, K’s use is not treated as private business
use of the recreation facilities because K has no
special legal entitlements for beneficial use of the
recreation facilities. The fish preservation facilities
are not of a type reasonably available for use on
the same basis by natural persons not engaged in a
trade or business. Under all of the facts and
circumstances (including the functional relationship of the fish preservation facilities to property
used in K’s trade or business) under paragraph
(b)(7)(ii) of this section, K derives a special
economic benefit from the fish preservation facilities. Therefore, K’s private business use may be
established solely on the basis of that special
economic benefit, and K’s use of the fish preservation facilities is treated as private business use.
Example 7. Other actual or beneficial use—
pollution control facilities. City B issues obligations to finance construction of a specialized
pollution control facility on land that it owns
adjacent to a factory owned by Corporation N. B
will own and operate the pollution control facility,
and N will have no special legal entitlements to
use the facility. B, however, reasonably expects
that N will be the only user of the facility. The
facility will not be reasonably available for use on
the same basis by natural persons not engaged in a
trade or business. Under paragraph (b)(7)(ii) of
this section, because under all of the facts and
circumstances the facility is functionally related
and is physically proximate to property used in
N’s trade or business, N derives a special economic benefit from the facility. Therefore, N’s

private business use may be established solely on
the basis of that special economic benefit, and N’s
use is treated as private business use of the
facility. See paragraph (b)(7)(ii) of this section.
Example 8. General public use—airport runway.
(i) City I issues bonds and uses all of the proceeds
to finance construction of a runway at a new
city-owned airport. The runway will be available
for take-off and landing by any operator of an
aircraft desiring to use the airport, including
general aviation operators who are natural persons
not engaged in a trade or business. It is reasonably
expected that most of the actual use of the runway
will be by private air carriers (both charter airlines
and commercial airlines) in connection with their
use of the airport terminals leased by those
carriers. These leases for the use of terminal space
provide no priority rights or other preferential
benefits to the air carriers for use of the runway.
Moreover, under the leases the lease payments are
determined without taking into account the revenues generated by runway landing fees (that is,
the lease payments are not determined on a
‘‘residual’’ basis). Although the lessee air carriers
receive a special economic benefit from the use of
the runway, this economic benefit is not sufficient
to cause the air carriers to be private business
users, because the runway is available for general
public use. The issue does not meet the private
business use test. See paragraphs (b)(7)(ii) and (c)
of this section.
(ii) The facts are the same as in Example 8(i),
except that the runway will be available for use
only by private air carriers. The use by these
private air carriers is not general public use,
because the runway is not reasonably available for
use on the same basis by natural persons not
engaged in a trade or business. Depending on all
of the facts and circumstances, including whether
there are only a small number of lessee private air
carriers, the issue may meet the private business
use test solely because the private air carriers
receive a special economic benefit from the runway. See paragraph (b)(7)(ii) of this section.
(iii) The facts are the same as in Example 8(i),
except that the lease payments under the leases
with the private air carriers are determined on a
residual basis by taking into account the net
revenues generated by runway landing fees. These
leases cause the private business use test to be met
with respect to the runway because they are
arrangements that convey special legal entitlements to the financed facility to nongovernmental
persons. See paragraph (b)(7)(i) of this section.
Example 9. General public use—airport parking
garage. City S issues bonds and uses all of the
proceeds to finance construction of a city-owned
parking garage at the city-owned airport. S reasonably expects that more than 10 percent of the
actual use of the parking garage will be by
employees of private air carriers (both charter
airlines and commercial airlines) in connection
with their use of the airport terminals leased by
those carriers. The air carriers’ use of the parking
garage, however, will be on the same basis as
passengers and other members of the general
public using the airport. The leases for the use of
the terminal space provide no priority rights to the
air carriers for use of the parking garage, and the
lease payments are determined without taking into
account the revenues generated by the parking
garage. Although the lessee air carriers receive a
special economic benefit from the use of the
parking garage, this economic benefit is not
sufficient to cause the air carriers to be private
business users, because the parking garage is
available for general public use. The issue does

not meet the private business use test. See paragraphs (b)(7)(ii) and (c) of this section.
Example 10. Long-term arrangements not
treated as general public use—insurance fund.
Authority T deposits all of the proceeds of its
bonds in its insurance fund and invests all of those
proceeds in tax-exempt bonds. The insurance fund
provides insurance to a large number of businesses
and natural persons not engaged in a trade or
business. Each participant receives insurance for a
term of 1 year. The use by the participants, other
than participants that are natural persons not
engaged in a trade or business, is treated as
private business use of the proceeds of the bonds
because the participants have special legal entitlements to the use of bond proceeds, even though
the contractual rights are not necessarily properly
characterized as ownership, leasehold, or similar
interests listed in paragraph (b) of this section.
Use of the bond proceeds is not treated as general
public use because the term of the insurance is
greater than 180 days. See paragraphs (b)(7)(i) and
(c)(3) of this section.
Example 11. General public use—port road.
Highway Authority W uses all of the proceeds of
its bonds to construct a 25-mile road to connect an
industrial port owned by Corporation Y with
existing roads owned and operated by W. Other
than the port, the nearest residential or commercial
development to the new road is 12 miles away.
There is no reasonable expectation that development will occur in the area surrounding the new
road. W and Y enter into no arrangement (either
by contract or ordinance) that conveys special
legal entitlements to Y for the use of the road. Use
of the road will be available without restriction to
all users, including natural persons who are not
engaged in a trade or business. The issue does not
meet the private business use test because the road
is treated as used only by the general public.
Example 12. General public use of governmentally owned hotel. State Q issues bonds to purchase land and construct a hotel for use by the
general public (that is, tourists, visitors, and
business travelers). The bond documents provide
that Q will own and operate the project for the
term of the bonds. Q will not enter into a lease or
license with any user for use of rooms for a period
longer than 180 days (although users may actually
use rooms for consecutive periods in excess of
180 days). Use of the hotel by hotel guests who
are travelling in connection with trades or businesses of nongovernmental persons is not a private
business use of the hotel by these persons because
the hotel is intended to be available and in fact is
reasonably available for use on the same basis by
natural persons not engaged in a trade or business.
See paragraph (c)(1) of this section.
Example 13. General public use with rights of
first refusal. Authority V uses all of the proceeds
of its bonds to construct a parking garage. At least
90 percent of the spaces in the garage will be
available to the general public on a monthly
first-come, first-served basis. V reasonably expects
that the spaces will be predominantly leased to
natural persons not engaged in a trade or business
who have priority rights to renew their spaces at
then current fair market value rates. More than 10
percent of the spaces will be leased to nongovernmental persons acting in a trade or business. These
leases are not treated as arrangements with a term
of use greater than 180 days. The rights to renew
are not treated as renewal options because the
compensation for the spaces is redetermined at
generally applicable, fair market value rates that
will be in effect at the time of renewal and the use
of the spaces under similar arrangements is predominantly by natural persons who are not en-

19

gaged in a trade or business. The issue does not
meet the private business use test because at least
90 percent of the use of the parking garage is
general public use. See paragraph (c)(3) of this
section.
Example 14. General public use with a specially
negotiated rate agreement with agency of United
States. G, a sewage collection and treatment
district, operates facilities that were financed with
its bonds. F, an agency of the United States, has a
base located within G. Approximately 20 percent
of G’s facilities are used to treat sewage produced
by F under a specially negotiated rate agreement.
Under the specially negotiated rate agreement, G
uses its best efforts to charge F as closely as
possible the same amount for its use of G’s
services as its other customers pay for the same
amount of services, although those other customers pay for services based on standard district
charges and tax levies. F is prohibited by federal
law from paying for the services based on those
standard district charges and tax levies. The use of
G’s facilities by F is on the same basis as the
general public. See paragraph (c)(2)(ii) of this
section.
Example 15. Arrangements not available for use
by natural persons not engaged in a trade or
business—federal use of prisons. Authority E uses
all of the proceeds of its bonds to construct a
prison. E contracts with federal agency F to house
federal prisoners on a space-available, first-come,
first-served basis, pursuant to which F will be
charged approximately the same amount for each
prisoner as other persons that enter into similar
transfer agreements. It is reasonably expected that
other persons will enter into similar agreements.
The term of the use under the contract is not
longer than 90 days, and F has no right to renew,
although E reasonably expects to renew the contract indefinitely. The prison is not financed for a
principal purpose of providing the prison for use
by F. It is reasonably expected that during the
term of the bonds, more than 10 percent of the
prisoners at the prison will be federal prisoners.
F’s use of the facility is not general public use
because this type of use (leasing space for prisoners) is not available for use on the same basis by
natural persons not engaged in a trade or business.
The issue does not meet the private business use
test, however, because the leases satisfy the exception of paragraph (d)(3)(i) of this section.
Example 16. Negotiated arm’s-length arrangements—auditorium reserved in advance. (i) City Z
issues obligations to finance the construction of a
municipal auditorium that it will own and operate.
The use of the auditorium will be open to anyone
who wishes to use it for a short period of time on
a rate-scale basis. Z reasonably expects that the
auditorium will be used by schools, church groups,
sororities, and numerous commercial organizations. Corporation H, a nongovernmental person,
enters into an arm’s-length arrangement with Z to
use the auditorium for 1 week for each year for a
10-year period (a total of 70 days), pursuant to
which H will be charged a specific price reflecting
fair market value. On the date the contract is
entered into, Z has not established generally
applicable rates for future years. Even though the
auditorium is not financed for a principal purpose
of providing use of the auditorium to H, H is not
treated as using the auditorium as a member of the
general public because its use is not on the same
basis as the general public. Because the term of
H’s use of the auditorium is longer than 30 days,
the arrangement does not meet the exception under
paragraph (d)(3)(ii) of this section.

(ii) The facts are the same as in Example 16(i),
except that H will enter into an arm’s-length
arrangement with Z to use the auditorium for 1
week for each year for a 4-year period (a total of
28 days), pursuant to which H will be charged a
specific price reflecting fair market value. H is not
treated as a private business user of the auditorium
because its contract satisfies the exception of
paragraph (d)(3)(ii) of this section for negotiated
arm’s-length arrangements.

(g) Measurement of private business
use—(1) In general. In general, the
private business use of proceeds is allocated to property under § 1.141–6. The
amount of private business use of that
property is determined according to the
average percentage of private business
use of that property during the measurement period.
(2) Measurement period—(i) General
rule. Except as provided in this paragraph (g)(2), the measurement period of
property financed by an issue begins on
the later of the issue date of that issue
or the date 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, the period of
reasonably expected economic life of
the property for this purpose is based on
reasonable expectations as of the issue
date.
(ii) Special rule for refundings of
short-term obligations. For an issue of
short-term obligations that the issuer
reasonably expects to refund with a
long-term financing (such as bond anticipation notes), the measurement period is based on the latest maturity date
of any bond of the last refunding issue
with respect to the financed property
(determined without regard to any optional redemption dates).
(iii) Special rule for reasonably expected mandatory redemptions. If an
issuer reasonably expects on the issue
date that an action will occur during the
term of the bonds to cause either the
private business tests or the private loan
financing test to be met and is required
to redeem bonds to meet the reasonable
expectations test of § 1.141–2(d)(2), the
measurement period ends on the reasonably expected redemption date.
(iv) Special rule for ownership by a
nongovernmental person. The amount of
private business use resulting from ownership by a nongovernmental person is
the greatest percentage of private business use in any 1-year period.

(v) Anti-abuse rule. If an issuer establishes the term of an issue for a
period that is longer than is reasonably
necessary for the governmental purposes
of the issue for a principal purpose of
increasing the permitted amount of private business use, the Commissioner
may determine the amount of private
business use according to the greatest
percentage of private business use in
any 1-year period.
(3) Determining average percentage
of private business use. The average
percentage of private business use is the
average of the percentages of private
business use during the 1-year periods
within the measurement period. Appropriate adjustments must be made for
beginning and ending periods of less
than 1 year.
(4) Determining the average amount
of private business use for a 1-year
period—(i) In general. The percentage
of private business use of property for
any 1-year period is the average private
business use during that year. This average is determined by comparing the
amount of private business use during
the year to the total amount of private
business use and use that is not private
business use (government use) during
that year. Paragraphs (g)(4)(ii) through
(v) of this section apply to determine
the average amount of private business
use for a 1-year period.
(ii) Uses at different times. For a
facility in which actual government use
and private business use occur at different times (for example, different days),
the average amount of private business
use generally is based on the amount of
time that the facility is used for private
business use as a percentage of the total
time for all actual use. In determining
the total amount of actual use, periods
during which the facility is not in use
are disregarded.
(iii) Simultaneous use. In general, for
a facility in which government use and
private business use occur simultaneously, the entire facility is treated as
having private business use. For example, a governmentally owned facility
that is leased or managed by a nongovernmental person in a manner that results in private business use is treated as
entirely used for a private business use.
If, however, there is also private business use and actual government use on
the same basis, the average amount of
private business use may be determined
on a reasonable basis that properly reflects the proportionate benefit to be
derived by the various users of the

20

facility (for example, reasonably expected fair market value of use). For
example, the average amount of private
business use of a garage with unassigned spaces that is used for government use and private business use is
generally based on the number of spaces
used for private business use as a percentage of the total number of spaces.
(iv) Discrete portion. For purposes of
this paragraph (g), measurement of the
use of proceeds allocated to a discrete
portion of a facility is determined by
treating that discrete portion as a separate facility.
(v) Relationship to fair market value.
For purposes of paragraphs (g)(4)(ii)
through (iv) of this section, if private
business use is reasonably expected as
of the issue date to have a significantly
greater fair market value than government use, the average amount of private
business use must be determined according to the relative reasonably expected
fair market values of use rather than
another measure, such as average time
of use. This determination of relative
fair market value may be made as of the
date the property is acquired or placed
in service if making this determination
as of the issue date is not reasonably
possible (for example, if the financed
property is not identified on the issue
date). In general, the relative reasonably
expected fair market value for a period
must be determined by taking into account the amount of reasonably expected payments for private business use
for the period in a manner that properly
reflects the proportionate benefit to be
derived from the private business use.
(5) Common areas. The amount of
private business use of common areas
within a facility is based on a reasonable method that properly reflects the
proportionate benefit to be derived by
the users of the facility. For example, in
general, a method that is based on the
average amount of private business use
of the remainder of the entire facility
reflects proportionate benefit.
(6) Allocation of neutral costs. Proceeds that are used to pay costs of
issuance, invested in a reserve or replacement fund, or paid as fees for a
qualified guarantee or a qualified hedge
must be allocated ratably among the
other purposes for which the proceeds
are used.
(7) Commencement of measurement
of private business use. Generally, private business use commences on the
first date on which there is a right to
actual use by the nongovernmental per-

son. However, if an issuer enters into an
arrangement for private business use a
substantial period before the right to
actual private business use commences
and the arrangement transfers ownership
or is an arrangement for other long-term
use (such as a lease for a significant
portion of the remaining economic life
of financed property), private business
use commences on the date the arrangement is entered into, even if the right to
actual use commences after the measurement period. For this purpose, 10
percent of the measurement period is
generally treated as a substantial period.
(8) Examples. The following examples illustrate the application of this
paragraph (g):
Example 1. Research facility. University U, a
state owned and operated university, owns and
operates a research facility. U proposes to finance
general improvements to the facility with the
proceeds of an issue of bonds. U enters into
sponsored research agreements with nongovernmental persons that result in private business use
because the sponsors will own title to any patents
resulting from the research. The governmental
research conducted by U and the research U
conducts for the sponsors take place simultaneously in all laboratories within the research
facility. All laboratory equipment is available
continuously for use by workers who perform both
types of research. Because it is not possible to
predict which research projects will be successful,
it is not reasonably practicable to estimate the
relative revenues expected to result from the
governmental and nongovernmental research. U
contributed 90 percent of the cost of the facility
and the nongovernmental persons contributed 10
percent of the cost. Under this section, the nongovernmental persons are using the facility for a
private business use on the same basis as the
government use of the facility. The portions of the
costs contributed by the various users of the
facility provide a reasonable basis that properly
reflects the proportionate benefit to be derived by
the users of the facility. The nongovernmental
persons are treated as using 10 percent of the
proceeds of the issue.
Example 2. Stadium. (i) City L issues bonds and
uses all of the proceeds to construct a stadium. L
enters into a long-term contract with a professional
sports team T under which T will use the stadium
20 times during each year. These uses will occur
on nights and weekends. L reasonably expects that
the stadium will be used more than 180 other
times each year, none of which will give rise to
private business use. This expectation is based on
a feasibility study and historical use of the old
stadium that is being replaced by the new stadium.
There is no significant difference in the value of
T’s uses when compared to the other uses of the
stadium, taking into account the payments that T
is reasonably expected to make for its use.
Assuming no other private business use, the issue
does not meet the private business use test because
not more than 10 percent of the use of the facility
is for a private business use.
(ii) The facts are the same as in Example 2(i),
except that L reasonably expects that the stadium
will be used not more than 60 other times each
year, none of which will give rise to private
business use. The issue meets the private business

use test because 25 percent of the proceeds are
used for a private business use.
Example 3. Airport terminal areas treated as
common areas. City N issues bonds to finance the
construction of an airport terminal. Eighty percent
of the leasable space of the terminal will be leased
to private air carriers. The remaining 20 percent of
the leasable space will be used for the term of the
bonds by N for its administrative purposes. The
common areas of the terminal, including waiting
areas, lobbies, and hallways are treated as 80
percent used by the air carriers for purposes of the
private business use test.

§ 1.141–4 Private security or payment
test.
(a) General rule—(1) Private security
or payment. The private security or
payment test relates to the nature of the
security for, and the source of, the
payment of debt service on an issue.
The private payment portion of the test
takes into account the payment of the
debt service on the issue that is directly
or indirectly to be derived from payments (whether or not to the issuer or
any related party) in respect of property,
or borrowed money, used or to be used
for a private business use. The private
security portion of the test takes into
account the payment of the debt service
on the issue that is directly or indirectly
secured by any interest in property used
or to be used for a private business use
or payments in respect of property used
or to be used for a private business use.
For additional rules for output facilities,
see § 1.141–7.
(2) Aggregation of private payments
and security. For purposes of the private
security or payment test, payments taken
into account as private payments and
payments or property taken into account
as private security are aggregated. However, the same payments are not taken
into account as both private security and
private payments.
(3) Underlying arrangement. The security for, and payment of debt service
on, an issue is determined from both the
terms of the bond documents and on the
basis of any underlying arrangement. An
underlying arrangement may result from
separate agreements between the parties
or may be determined on the basis of all
of the facts and circumstances surrounding the issuance of the bonds. For
example, if the payment of debt service
on an issue is secured by both a pledge
of the full faith and credit of a state or
local governmental unit and any interest
in property used or to be used in a
private business use, the issue meets the
private security or payment test.
(b) Measurement of private payments
and security—(1) Scope. This paragraph

21

(b) contains rules that apply to both
private security and private payments.
(2) Present value measurement—(i)
Use of present value. In determining
whether an issue meets the private security or payment test, the present value of
the payments or property taken into
account is compared to the present value
of the debt service to be paid over the
term of the issue.
(ii) Debt service—(A) Debt service
paid from proceeds. Debt service does
not include any amount paid or to be
paid from sale proceeds or investment
proceeds. For example, debt service
does not include payments of capitalized
interest funded with proceeds.
(B) Adjustments to debt service. Debt
service is adjusted to take into account
payments and receipts that adjust the
yield on an issue for purposes of section
148(f). For example, debt service includes fees paid for qualified guarantees
under § 1.148–4(f) and is adjusted to
take into account payments and receipts
on qualified hedges under § 1.148–4(h).
(iii) Computation of present value—
(A) In general. Present values are determined by using the yield on the issue as
the discount rate and by discounting all
amounts to the issue date. See, however,
§ 1.141–13 for special rules for refunding bonds.
(B) Fixed yield issues. For a fixed
yield issue, yield is determined on the
issue date and is not adjusted to take
into account subsequent events.
(C) Variable yield issues. The yield
on a variable yield issue is determined
over the term of the issue. To determine
the reasonably expected yield as of any
date, the issuer may assume that the
future interest rate on a variable yield
bond will be the then-current interest
rate on the bonds determined under the
formula prescribed in the bond documents. A deliberate action requires a
recomputation of the yield on the variable yield issue to determine the present
value of payments under that arrangement. In that case, the issuer must use
the yield determined as of the date of
the deliberate action for purposes of
determining the present value of payments under the arrangement causing
the deliberate action. See paragraph (g)
of this section, Example 3.
(iv) Application to private security.
For purposes of determining the present
value of debt service that is secured by
property, the property is valued at fair
market value as of the first date on
which the property secures bonds of the
issue.

(c) Private payments—(1) In general.
This paragraph (c) contains rules that
apply to private payments.
(2) Payments taken into account—(i)
Payments for use—(A) In general. Both
direct and indirect payments made by
any nongovernmental person that is
treated as using proceeds of the issue
are taken into account as private payments to the extent allocable to the
proceeds used by that person. Payments
are taken into account as private payments only to the extent that they are
made for the period of time that proceeds are used for a private business
use. Payments for a use of proceeds
include payments (whether or not to the
issuer) in respect of property financed
(directly or indirectly) with those proceeds, even if not made by a private
business user. Payments are not made in
respect of financed property if those
payments are directly allocable to other
property being directly used by the
person making the payment and those
payments represent fair market value
compensation for that other use. See
paragraph (g) of this section, Example 4
and Example 5. See also paragraph
(c)(3) of this section for rules relating to
allocation of payments to the source or
sources of funding of property.
(B) Payments not to exceed use. Payments with respect to proceeds that are
used for a private business use are not
taken into account to the extent that the
present value of those payments exceeds
the present value of debt service on
those proceeds. Payments need not be
directly derived from a private business
user, however, to be taken into account.
Thus, if 7 percent of the proceeds of an
issue is used by a person over the
measurement period, payments with respect to the property financed with those
proceeds are taken into account as private payments only to the extent that the
present value of those payments does
not exceed the present value of 7 percent of the debt service on the issue.
(C) Payments for operating expenses.
Payments by a person for a use of
proceeds do not include the portion of
any payment that is properly allocable
to the payment of ordinary and necessary expenses (as defined under section
162) directly attributable to the operation and maintenance of the financed
property used by that person. For this
purpose, general overhead and administrative expenses are not directly attributable to those operations and maintenance. For example, if an issuer receives
$5,000 rent during the year for use of

space in a financed facility and during
the year pays $500 for ordinary and
necessary expenses properly allocable to
the operation and maintenance of that
space and $400 for general overhead
and general administrative expenses
properly allocable to that space, $500 of
the $5,000 received would not be considered a payment for the use of the
proceeds allocable to that space (regardless of the manner in which that $500 is
actually used).
(ii) Refinanced debt service. Payments of debt service on an issue to be
made from proceeds of a refunding
issue are taken into account as private
payments in the same proportion that
the present value of the payments taken
into account as private payments for the
refunding issue bears to the present
value of the debt service to be paid on
the refunding issue. For example, if all
the debt service on a note is paid with
proceeds of a refunding issue, the note
meets the private security or payment
test if (and to the same extent that) the
refunding issue meets the private security or payment test. This paragraph
(c)(2)(ii) does not apply to payments
that arise from deliberate actions that
occur more than 3 years after the retirement of the prior issue that are not
reasonably expected on the issue date of
the refunding issue. For purposes of this
paragraph (c)(2)(ii), whether an issue is
a refunding issue is determined without
regard to § 1.150–1(d)(2)(i) (relating to
certain payments of interest).
(3) Allocation of payments—(i) In
general. Private payments for the use of
property are allocated to the source or
different sources of funding of property.
The allocation to the source or different
sources of funding is based on all of the
facts and circumstances, including
whether an allocation is consistent with
the purposes of section 141. In general,
a private payment for the use of property is allocated to a source of funding
based upon the nexus between the payment and both the financed property and
the source of funding. For this purpose,
different sources of funding may include
different tax-exempt issues, taxable issues, and amounts that are not derived
from a borrowing, such as revenues of
an issuer (equity).
(ii) Payments for use of discrete
property. Payments for the use of a
discrete facility (or a discrete portion of
a facility) are allocated to the source or
different sources of funding of that
discrete property.

22

(iii) Allocations among two or more
sources of funding. In general, except as
provided in paragraphs (c)(3)(iv) and (v)
of this section, if a payment is made for
the use of property financed with two or
more sources of funding (for example,
equity and a tax-exempt issue), that
payment must be allocated to those
sources of funding in a manner that
reasonably corresponds to the relative
amounts of those sources of funding that
are expended on that property. If an
issuer has not retained records of
amounts expended on the property (for
example, records of costs of a building
that was built 30 years before the allocation), an issuer may use reasonable
estimates of those expenditures. For this
purpose, costs of issuance and other
similar neutral costs are allocated ratably among expenditures in the same
manner as in § 1.141–3(g)(6). A payment for the use of property may be
allocated to two or more issues that
finance property according to the relative amounts of debt service (both paid
and accrued) on the issues during the
annual period for which the payment is
made, if that allocation reasonably reflects the economic substance of the
arrangement. In general, allocations of
payments according to relative debt service reasonably reflect the economic
substance of the arrangement if the
maturity of the bonds reasonably corresponds to the reasonably expected economic life of the property and debt
service payments on the bonds are approximately level from year to year.
(iv) Payments made under an arrangement entered into in connection
with issuance of bonds. A private payment for the use of property made under
an arrangement that is entered into in
connection with the issuance of the
issue that finances that property generally is allocated to that issue. Whether
an arrangement is entered into in connection with the issuance of an issue is
determined on the basis of all of the
facts and circumstances. An arrangement
is ordinarily treated as entered into in
connection with the issuance of an issue
if—
(A) The issuer enters into the arrangement during the 3-year period beginning 18 months before the issue date;
and
(B) The amount of payments reflects
all or a portion of debt service on the
issue.
(v) Allocations to equity. A private
payment for the use of property may be

allocated to equity before payments are
allocated to an issue only if—
(A) Not later than 60 days after the
date of the expenditure of those
amounts, the issuer adopts an official
intent (in a manner comparable to
§ 1.150–2(e)) indicating that the issuer
reasonably expects to be repaid for the
expenditure from a specific arrangement; and
(B) The private payment is made not
later than 18 months after the later of
the date the expenditure is made or the
date the project is placed in service.
(d) Private security—(1) In general.
This paragraph (d) contains rules that
relate to private security.
(2) Security taken into account. The
property that is the security for, or the
source of, the payment of debt service
on an issue need not be property financed with proceeds. For example, unimproved land or investment securities
used, directly or indirectly, in a private
business use that secures an issue provides private security. Private security
(other than financed property and private payments) for an issue is taken into
account under section 141(b), however,
only to the extent it is provided, directly
or indirectly, by a user of proceeds of
the issue.
(3) Pledge of unexpended proceeds.
Proceeds qualifying for an initial temporary period under § 1.148–2(e)(2) or (3)
or deposited in a reasonably required
reserve or replacement fund (as defined
in § 1.148–2(f)(2)(i)) are not taken into
account under this paragraph (d) before
the date on which those amounts are
either expended or loaned by the issuer
to an unrelated party.
(4) Secured by any interest in property or payments. Property used or to be
used for a private business use and
payments in respect of that property are
treated as private security if any interest
in that property or payments secures the
payment of debt service on the bonds.
For this purpose, the phrase any interest
in is to be interpreted broadly and
includes, for example, any right, claim,
title, or legal share in property or payments.
(5) Payments in respect of property.
The payments taken into account as
private security are payments in respect
of property used or to be used for a
private business use. Except as otherwise provided in this paragraph (d)(5)
and paragraph (d)(6) of this section, the
rules in paragraphs (c)(2)(i)(A) and (B)
and (c)(2)(ii) of this section apply to
determine the amount of payments

treated as payments in respect of property used or to be used for a private
business use. Thus, payments made by
members of the general public for use
of a facility used for a private business
use (for example, a facility that is the
subject of a management contract that
results in private business use) are taken
into account as private security to the
extent that they are made for the period
of time that property is used by a
private business user.
(6) Allocation of security among issues. In general, property or payments
from the disposition of that property that
are taken into account as private security are allocated to each issue secured
by the property or payments on a reasonable basis that takes into account
bondholders’ rights to the payments or
property upon default.
(e) Generally applicable taxes—(1)
General rule. For purposes of the private security or payment test, generally
applicable taxes are not taken into account (that is, are not payments from a
nongovernmental person and are not
payments in respect of property used for
a private business use).
(2) Definition of generally applicable
taxes. A generally applicable tax is an
enforced contribution exacted pursuant
to legislative authority in the exercise of
the taxing power that is imposed and
collected for the purpose of raising
revenue to be used for governmental
purposes. A generally applicable tax
must have a uniform tax rate that is
applied to all persons of the same
classification in the appropriate jurisdiction and a generally applicable manner
of determination and collection.
(3) Special charges. A payment for a
special privilege granted or service rendered is not a generally applicable tax.
Special assessments paid by property
owners benefiting from financed improvements are not generally applicable
taxes. For example, a tax or a payment
in lieu of tax that is limited to the
property or persons benefited by an
improvement is not a generally applicable tax.
(4) Manner of determination and collection—(i) In general. A tax does not
have a generally applicable manner of
determination and collection to the extent that one or more taxpayers make
any impermissible agreements relating
to payment of those taxes. An impermissible agreement relating to the payment
of a tax is taken into account whether or
not it is reasonably expected to result in
any payments that would not otherwise

23

have been made. For example, if an
issuer uses proceeds to make a grant to
a taxpayer to improve property, agreements that impose reasonable conditions
on the use of the grant do not cause a
tax on that property to fail to be a
generally applicable tax. If an agreement
by a taxpayer causes the tax imposed on
that taxpayer not to be treated as a
generally applicable tax, the entire tax
paid by that taxpayer is treated as a
special charge, unless the agreement is
limited to a specific portion of the tax.
(ii) Impermissible agreements. The
following are examples of agreements
that cause a tax to fail to have a
generally applicable manner of determination and collection: an agreement to
be personally liable on a tax that does
not generally impose personal liability,
to provide additional credit support such
as a third party guarantee, or to pay
unanticipated shortfalls; an agreement
regarding the minimum market value of
property subject to property tax; and an
agreement not to challenge or seek
deferral of the tax.
(iii) Permissible agreements. The following are examples of agreements that
do not cause a tax to fail to have a
generally applicable manner of determination and collection: an agreement to
use a grant for specified purposes
(whether or not that agreement is secured); a representation regarding the
expected value of the property following
the improvement; an agreement to insure the property and, if damaged, to
restore the property; a right of a grantor
to rescind the grant if property taxes are
not paid; and an agreement to reduce or
limit the amount of taxes collected to
further a bona fide governmental purpose. For example, an agreement to
abate taxes to encourage a property
owner to rehabilitate property in a distressed area is a permissible agreement.
(5) Payments in lieu of taxes. A tax
equivalency payment and any other payment in lieu of a tax is treated as a
generally applicable tax if—
(i) The payment is commensurate
with and not greater than the amounts
imposed by a statute for a tax of general
application; and
(ii) The payment is designated for a
public purpose and is not a special
charge (as described in paragraph (e)(3)
of this section). For example, a payment
in lieu of taxes made in consideration
for the use of property financed with
tax-exempt bonds is treated as a special
charge.

(f) Certain
waste
remediation
bonds—(1) Scope. This paragraph (f)
applies to bonds issued to finance hazardous waste clean-up activities on privately owned land (hazardous waste
remediation bonds).
(2) Persons that are not private users. Payments from nongovernmental
persons who are not (other than coincidentally) either users of the site being
remediated or persons potentially responsible for disposing of hazardous
waste on that site are not taken into
account as private security. This paragraph (f)(2) applies to payments that
secure (directly or indirectly) the payment of principal of, or interest on, the
bonds under the terms of the bonds.
This paragraph (f)(2) applies only if the
payments are made pursuant to either a
generally applicable state or local taxing
statute or a state or local statute that
regulates or restrains activities on an
industry-wide basis of persons who are
engaged in generating or handling hazardous waste, or in refining, producing,
or transporting petroleum, provided that
those payments do not represent, in
substance, payment for the use of proceeds. For this purpose, a state or local
statute that imposes payments that have
substantially the same character as those
described in Chapter 38 of the Code are
treated as generally applicable taxes.
(3) Persons that are private users. If
payments from nongovernmental persons who are either users of the site
being remediated or persons potentially
responsible for disposing of hazardous
waste on that site do not secure (directly
or indirectly) the payment of principal
of, or interest on, the bonds under the
terms of the bonds, the payments are not
taken into account as private payments.
This paragraph (f)(3) applies only if at
the time the bonds are issued the payments from those nongovernmental persons are not material to the security for
the bonds. For this purpose, payments
are not material to the security for the
bonds if—
(i) The payments are not required for
the payment of debt service on the
bonds;
(ii) The amount and timing of the
payments are not structured or designed
to reflect the payment of debt service on
the bonds;
(iii) The receipt or the amount of the
payment is uncertain (for example, as of
the issue date, no final judgment has
been entered into against the nongovernmental person);

(iv) The payments from those nongovernmental persons, when and if received, are used either to redeem bonds
of the issuer or to pay for costs of any
hazardous waste remediation project;
and
(v) In the case when a judgment (but
not a final judgment) has been entered
by the issue date against a nongovernmental person, there are, as of the issue
date, costs of hazardous waste remediation other than those financed with the
bonds that may be financed with the
payments.
(g) Examples. The following examples illustrate the application of this
section:
Example 1. Aggregation of payments. State B
issues bonds with proceeds of $10 million. B uses
$9.7 million of the proceeds to construct a 10story office building. B uses the remaining
$300,000 of proceeds to make a loan to Corporation Y. In addition, Corporation X leases 1 floor of
the building for the term of the bonds. Under all
of the facts and circumstances, it is reasonable to
allocate 10 percent of the proceeds to that 1 floor.
As a percentage of the present value of the debt
service on the bonds, the present value of Y’s loan
repayments is 3 percent and the present value of
X’s lease payments is 8 percent. The bonds meet
the private security or payment test because the
private payments taken into account are more than
10 percent of the present value of the debt service
on the bonds.
Example 2. Indirect private payments. J, a
political subdivision of a state, will issue several
series of bonds from time to time and will use the
proceeds to rehabilitate urban areas. Under all of
the facts and circumstances, the private business
use test will be met with respect to each issue that
will be used for the rehabilitation and construction
of buildings that will be leased or sold to nongovernmental persons for use in their trades or
businesses. Nongovernmental persons will make
payments for these sales and leases. There is no
limitation either on the number of issues or the
aggregate amount of bonds that may be outstanding. No group of bondholders has any legal claim
prior to any other bondholders or creditors with
respect to specific revenues of J, and there is no
arrangement whereby revenues from a particular
project are paid into a trust or constructive trust,
or sinking fund, or are otherwise segregated or
restricted for the benefit of any group of bondholders. There is, however, an unconditional obligation by J to pay the principal of, and the interest
on, each issue. Although not directly pledged
under the terms of the bond documents, the leases
and sales are underlying arrangements. The payments relating to these leases and sales are taken
into account as private payments to determine
whether each issue of bonds meets the private
security or payment test.
Example 3. Computation of payment in variable
yield issues. (i) City M issues general obligation
bonds with proceeds of $10 million to finance a
5-story office building. The bonds bear interest at
a variable rate that is recomputed monthly according to an index that reflects current market yields.
The yield that the interest index would produce on
the issue date is 6 percent. M leases 1 floor of the
office building to Corporation T, a nongovernmental person, for the term of the bonds. Under all of
the facts and circumstances, T is treated as using

24

more than 10 percent of the proceeds. Using the 6
percent yield as the discount rate, M reasonably
expects on the issue date that the present value of
lease payments to be made by T will be 8 percent
of the present value of the total debt service on
the bonds. After the issue date of the bonds,
interest rates decline significantly, so that the yield
on the bonds over their entire term is 4 percent.
Using this actual 4 percent yield as the discount
rate, the present value of lease payments made by
T is 12 percent of the present value of the actual
total debt service on the bonds. The bonds are not
private activity bonds because M reasonably expected on the issue date that the bonds would not
meet the private security or payment test and
because M did not take any subsequent deliberate
action to meet the private security or payment test.
(ii) The facts are the same as Example 3(i),
except that 5 years after the issue date M leases a
second floor to Corporation S, a nongovernmental
person, under a long-term lease. Because M has
taken a deliberate action, the present value of the
lease payments must be computed. On the date
this lease is entered into, M reasonably expects
that the yield on the bonds over their entire term
will be 5.5 percent, based on actual interest rates
to date and the then-current rate on the variable
yield bonds. M uses this 5.5 percent yield as the
discount rate. Using this 5.5 percent yield as the
discount rate, as a percentage of the present value
of the debt service on the bonds, the present value
of the lease payments made by S is 3 percent. The
bonds are private activity bonds because the
present value of the aggregate private payments is
greater than 10 percent of the present value of
debt service.
Example 4. Payments not in respect of financed
property. In order to further public safety, City Y
issues tax assessment bonds the proceeds of which
are used to move existing electric utility lines
underground. Although the utility lines are owned
by a nongovernmental utility company, that company is under no obligation to move the lines. The
debt service on the bonds will be paid using
assessments levied by City Y on the customers of
the utility. Although the utility lines are privately
owned and the utility customers make payments to
the utility company for the use of those lines, the
assessments are payments in respect of the cost of
relocating the utility line. Thus, the assessment
payments are not made in respect of property used
for a private business use. Any direct or indirect
payments to Y by the utility company for the
undergrounding are, however, taken into account
as private payments.
Example 5. Payments from users of proceeds
that are not private business users taken into
account. City P issues general obligation bonds to
finance the renovation of a hospital that it owns.
The hospital is operated for P by D, a nongovernmental person, under a management contract that
results in private business use under § 1.141–3. P
will use the revenues from the hospital (after the
required payments to D and the payment of
operation and maintenance expenses) to pay the
debt service on the bonds. The bonds meet the
private security or payment test because the revenues from the hospital are payments in respect of
property used for a private business use.
Example 6. Limitation of amount of payments to
amount of private business use not determined
annually. City Q issues bonds with a term of 15
years and uses the proceeds to construct an office
building. The debt service on the bonds is level
throughout the 15-year term. Q enters into a
5-year lease with Corporation R under which R is
treated as a user of 11 percent of the proceeds. R
will make lease payments equal to 20 percent of

the annual debt service on the bonds for each year
of the lease. The present value of R’s lease
payments is equal to 12 percent of the present
value of the debt service over the entire 15-year
term of the bonds. If, however, the lease payments
taken into account as private payments were
limited to 11 percent of debt service paid in each
year of the lease, the present value of these
payments would be only 8 percent of the debt
service on the bonds over the entire term of the
bonds. The bonds meet the private security or
payment test, because R’s lease payments are
taken into account as private payments in an
amount not to exceed 11 percent of the debt
service of the bonds.
Example 7. Allocation of payments to funds not
derived from a borrowing. City Z purchases
property for $1,250,000 using $1,000,000 of proceeds of its tax increment bonds and $250,000 of
other revenues that are in its redevelopment fund.
Within 60 days of the date of purchase, Z declared
its intent to sell the property pursuant to a
redevelopment plan and to use that amount to
reimburse its redevelopment fund. The bonds are
secured only by the incremental property taxes
attributable to the increase in value of the property
from the planned redevelopment of the property.
Within 18 months after the issue date, Z sells the
financed property to Developer M for $250,000,
which Z uses to reimburse the redevelopment
fund. The property that M uses is financed both
with the proceeds of the bonds and Z’s redevelopment fund. The payments by M are properly
allocable to the costs of property financed with the
amounts in Z’s redevelopment fund. See paragraphs (c)(3)(i) and (v) of this section.
Example 8. Allocation of payments to different
sources of funding—improvements. In 1997, City L
issues bonds with proceeds of $8 million to
finance the acquisition of a building. In 2002, L
spends $2 million of its general revenues to
improve the heating system and roof of the
building. At that time, L enters into a 10-year
lease with Corporation M for the building providing for annual payments of $1 million to L. The
lease payments are at fair market value, and the
lease payments do not otherwise have a significant
nexus to either the issue or to the expenditure of
general revenues. Eighty percent of each lease
payment is allocated to the issue and is taken into
account under the private payment test because
each lease payment is properly allocated to the
sources of funding in a manner that reasonably
corresponds to the relative amounts of the sources
of funding that are expended on the building.
Example 9. Security not provided by users of
proceeds not taken into account. County W issues
certificates of participation in a lease of a building
that W owns and covenants to appropriate annual
payments for the lease. A portion of each payment
is specified as interest. More than 10 percent of
the building is used for private business use. None
of the proceeds of the obligations are used with
respect to the building. W uses the proceeds of the
obligations to make a grant to Corporation Y for
the construction of a factory that Y will own. Y
makes no payments to W, directly or indirectly, for
its use of proceeds, and Y has no relationship to
the users of the leased building. If W defaults
under the lease, the trustee for the holders of the
certificates of participation has a limited right of
repossession under which the trustee may not
foreclose but may lease the property to a new
tenant at fair market value. The obligations are
secured by an interest in property used for a
private business use. However, because the property is not provided by a private business user and

is not financed property, the obligations do not
meet the private security or payment test.
Example 10. Allocation of payments among
issues. University L, a political subdivision, issued
three separate series of revenue bonds during
1989, 1991, and 1993 under the same bond
resolution. L used the proceeds to construct facilities exclusively for its own use. Bonds issued
under the resolution are equally and ratably secured and payable solely from the income derived
by L from rates, fees, and charges imposed by L
for the use of the facilities. The bonds issued in
1989, 1991, and 1993 are not private activity
bonds. In 1997, L issues another series of bonds
under the resolution to finance additional facilities.
L leases 20 percent of the new facilities for the
term of the 1997 bonds to nongovernmental
persons who will use the facilities in their trades
or businesses. The present value of the lease
payments from the nongovernmental users will
equal 15 percent of the present value of the debt
service on the 1997 bonds. L will commingle all
of the revenues from all its bond-financed facilities in its revenue fund. The present value of the
portion of the lease payments from nongovernmental lessees of the new facilities allocable to the
1997 bonds under paragraph (d) of this section is
less than 10 percent of the present value of the
debt service on the 1997 bonds because the bond
documents provide that the bonds are equally and
ratably secured. Accordingly, the 1997 bonds do
not meet the private security test. The 1997 bonds
meet the private payment test, however, because
the private lease payments for the new facility are
properly allocated to those bonds (that is, because
none of the proceeds of the prior issues were used
for the new facilities). See paragraph (c) of this
section.
Example 11. Generally applicable tax. (i) Authority N issues bonds to finance the construction
of a stadium. Under a long-term lease, Corporation
X, a professional sports team, will use more than
10 percent of the stadium. X will not, however,
make any payments for this private business use.
The security for the bonds will be a ticket tax
imposed on each person purchasing a ticket for an
event at the stadium. The portion of the ticket tax
attributable to tickets purchased by persons attending X’s events will, on a present value basis,
exceed 10 percent of the present value of the debt
service on N’s bonds. The bonds meet the private
security or payment test. The ticket tax is not a
generally applicable tax and, to the extent that the
tax receipts relate to X’s events, the taxes are
payments in respect of property used for a private
business use.
(ii) The facts are the same as Example 11(i),
except that the ticket tax is imposed by N on
tickets purchased for events at a number of large
entertainment facilities within the N’s jurisdiction
(for example, other stadiums, arenas, and concert
halls), some of which were not financed with
tax-exempt bonds. The ticket tax is a generally
applicable tax and therefore the revenues from this
tax are not payments in respect of property used
for a private business use. The receipt of the ticket
tax does not cause the bonds to meet the private
security or payment test.

§ 1.141–5 Private loan financing test.
(a) In general. Bonds of an issue are
private activity bonds if more than the
lesser of 5 percent or $5 million of the
proceeds of the issue is to be used
(directly or indirectly) to make or finance loans to persons other than gov-

25

ernmental persons. Section 1.141–2(d)
applies in determining whether the private loan financing test is met. In determining whether the proceeds of an issue
are used to make or finance loans,
indirect, as well as direct, use of the
proceeds is taken into account.
(b) Measurement of test. In determining whether the private loan financing
test is met, the amount actually loaned
to a nongovernmental person is not
discounted to reflect the present value of
the loan repayments.
(c) Definition of private loan—(1) In
general. Any transaction that is generally characterized as a loan for federal
income tax purposes is a loan for purposes of this section. In addition, a loan
may arise from the direct lending of
bond proceeds or may arise from transactions in which indirect benefits that
are the economic equivalent of a loan
are conveyed. Thus, the determination
of whether a loan is made depends on
the substance of a transaction rather
than its form. For example, a lease or
other contractual arrangement (for example, a management contract or an
output contract) may in substance constitute a loan if the arrangement transfers tax ownership of the facility to a
nongovernmental person. Similarly, an
output contract or a management contract with respect to a financed facility
generally is not treated as a loan of
proceeds unless the agreement in substance shifts significant burdens and
benefits of ownership to the nongovernmental purchaser or manager of the
facility.
(2) Application only to purpose investments—(i) In general. A loan may
be either a purpose investment or a
nonpurpose investment. A loan that is a
nonpurpose investment does not cause
the private loan financing test to be met.
For example, proceeds invested in loans,
such as obligations of the United States,
during a temporary period, as part of a
reasonably required reserve or replacement fund, as part of a refunding escrow, or as part of a minor portion (as
each of those terms are defined in
§ 1.148–1 or § 1.148–2) are generally
not treated as loans under the private
loan financing test.
(ii) Certain prepayments treated as
loans. Except as otherwise provided, a
prepayment for property or services is
treated as a loan for purposes of the
private loan financing test if a principal
purpose for prepaying is to provide a
benefit of tax-exempt financing to the

seller. A prepayment is not treated as a
loan for purposes of the private loan
financing test if—
(A) The prepayment is made for a
substantial business purpose other than
providing a benefit of tax-exempt financing to the seller and the issuer has
no commercially reasonable alternative
to the prepayment; or
(B) Prepayments on substantially the
same terms are made by a substantial
percentage of persons who are similarly
situated to the issuer but who are not
beneficiaries of tax-exempt financing.
(3) Grants—(i) In general. A grant of
proceeds is not a loan. Whether a transaction may be treated as a grant or a
loan depends on all of the facts and
circumstances.
(ii) Tax increment financing—(A) In
general. Generally, a grant using proceeds of an issue that is secured by
generally applicable taxes attributable to
the improvements to be made with the
grant is not treated as a loan, unless the
grantee makes any impermissible agreements relating to the payment that results in the taxes imposed on that taxpayer not to be treated as generally
applicable taxes under § 1.141–4(e).
(B) Amount of loan. If a grant is
treated as a loan under this paragraph
(c)(3), the entire grant is treated as a
loan unless the impermissible agreement
is limited to a specific portion of the
tax. For this purpose, an arrangement
with each unrelated grantee is treated as
a separate grant.
(4) Hazardous waste remediation
bonds. In the case of an issue of
hazardous waste remediation bonds,
payments from nongovernmental persons that are either users of the site
being remediated or persons potentially
responsible for disposing of hazardous
waste on that site do not establish that
the transaction is a loan for purposes of
this section. This paragraph (c)(4) applies only if those payments do not
secure the payment of principal of, or
interest on, the bonds (directly or indirectly), under the terms of the bonds and
those payments are not taken into account under the private payment test
pursuant to § 1.141–4(f)(3).
(d) Tax assessment loan exception—
(1) General rule. For purposes of this
section, a tax assessment loan that satisfies the requirements of this paragraph
(d) is not a loan for purposes of the
private loan financing test.
(2) Tax assessment loan defined. A
tax assessment loan is a loan that arises
when a governmental person permits or

requires property owners to finance any
governmental tax or assessment of general application for an essential governmental function that satisfies each of the
requirements of paragraphs (d)(3)
through (5) of this section.
(3) Mandatory tax or other assessment. The tax or assessment must be an
enforced contribution that is imposed
and collected for the purpose of raising
revenue to be used for a specific purpose (that is, to defray the capital cost
of an improvement). Taxes and assessments do not include fees for services.
The tax or assessment must be imposed
pursuant to a state law of general application that can be applied equally to
natural persons not acting in a trade or
business and persons acting in a trade or
business. For this purpose, taxes and
assessments that are imposed subject to
protest procedures are treated as enforced contributions.
(4) Specific essential governmental
function—(i) In general. A mandatory
tax or assessment that gives rise to a tax
assessment loan must be imposed for
one or more specific, essential governmental functions.
(ii) Essential governmental functions.
For purposes of paragraph (d) of this
section, improvements to utilities and
systems that are owned by a governmental person and that are available for
use by the general public (such as
sidewalks, streets and street-lights; electric, telephone, and cable television systems; sewage treatment and disposal
systems; and municipal water facilities)
serve essential governmental functions.
For other types of facilities, the extent
to which the service provided by the
facility is customarily performed (and
financed with governmental bonds) by
governments with general taxing powers
is a primary factor in determining
whether the facility serves an essential
governmental function. For example,
parks that are owned by a governmental
person and that are available for use by
the general public serve an essential
governmental function. Except as otherwise provided in this paragraph
(d)(4)(ii), commercial or industrial facilities and improvements to property
owned by a nongovernmental person do
not serve an essential governmental
function. Permitting installment payments of property taxes or other taxes is
not an essential governmental function.
(5) Equal basis requirement—(i) In
general. Owners of both business and
nonbusiness property benefiting from
the financed improvements must be eli-

26

gible, or required, to make deferred
payments of the tax or assessment giving rise to a tax assessment loan on an
equal basis (the equal basis requirement). A tax or assessment does not
satisfy the equal basis requirement if the
terms for payment of the tax or assessment are not the same for all taxed or
assessed persons. For example, the equal
basis requirement is not met if certain
property owners are permitted to pay the
tax or assessment over a period of years
while others must pay the entire tax or
assessment immediately or if only certain property owners are required to
prepay the tax or assessment when the
property is sold.
(ii) General rule for guarantees. A
guarantee of debt service on bonds, or
of taxes or assessments, by a person that
is treated as a borrower of bond proceeds violates the equal basis requirement if it is reasonable to expect on the
date the guarantee is entered into that
payments will be made under the guarantee.
(6) Coordination with private business tests. See §§ 1.141–3 and 1.141–4
for rules for determining whether tax
assessment loans cause the bonds financing those loans to be private activity bonds under the private business use
and the private security or payment
tests.
(e) Examples. The following examples illustrate the application of this
section:
Example 1. Turnkey contract not treated as a
loan. State agency Z and federal agency H will
each contribute to rehabilitate a project owned by
Z. H can only provide its funds through a
contribution to Z to be used to acquire the
rehabilitated project on a turnkey basis from an
approved developer. Under H’s turnkey program,
the developer must own the project while it is
rehabilitated. Z issues its notes to provide funds
for construction. A portion of the notes will be
retired using the H contribution, and the balance
of the notes will be retired through the issuance by
Z of long-term bonds. Z lends the proceeds of its
notes to Developer B as construction financing
and transfers title to B for a nominal amount. The
conveyance is made on condition that B rehabilitate the property and reconvey it upon completion,
with Z retaining the right to force reconveyance if
these conditions are not satisfied. B must name Z
as an additional insured on all insurance. Upon
completion, B must transfer title to the project
back to Z at a set price, which price reflects B’s
costs and profit, not fair market value. Further,
this price is adjusted downward to reflect any
cost-underruns. For purposes of section 141(c),
this transaction does not involve a private loan.
Example 2. Essential government function requirement not met. City D creates a special taxing
district consisting of property owned by nongovernmental persons that requires environmental
clean-up. D imposes a special tax on each parcel
within the district in an amount that is related to
the expected environmental clean-up costs of that

parcel. The payment of the tax over a 20-year
period is treated as a loan by the property owners
for purposes of the private loan financing test. The
special district issues bonds, acting on behalf of D,
that are payable from the special tax levied within
the district, and uses the proceeds to pay for the
costs of environmental clean-up on the property
within the district. The bonds meet the private
loan financing test because more than 5 percent of
the proceeds of the issue are loaned to nongovernmental persons. The issue does not meet the tax
assessment loan exception because the improvements to property owned by a nongovernmental
person are not an essential governmental function
under section 141(c)(2). The issue also meets the
private business tests of section 141(b).

§ 1.141–6 Allocation and accounting
rules.
(a) Allocation of proceeds to expenditures. For purposes of §§ 1.141–1
through 1.141–15, the provisions of
§ 1.148–6(d) apply for purposes of allocating proceeds to expenditures. Thus,
allocations generally may be made using
any reasonable, consistently applied accounting method, and allocations under
section 141 and section 148 must be
consistent with each other.
(b) Allocation of proceeds to property. [Reserved]
(c) Special rules for mixed use facilities. [Reserved]
(d) Allocation of proceeds to common
areas. [Reserved]
(e) Allocation of proceeds to bonds.
[Reserved]
(f) Treatment of partnerships. [Reserved]
(g) Examples. [Reserved]
§ 1.141–7 Special rules for output contracts.
[Reserved]
§ 1.141–8 $15 million limitation for
output facilities.
[Reserved]
§ 1.141–9 Unrelated or disproportionate use test.
(a) General rules—(1) Description of
test. Under section 141(b)(3) (the unrelated or disproportionate use test), an
issue meets the private business tests if
the amount of private business use and
private security or payments attributable
to unrelated or disproportionate private
business use exceeds 5 percent of the
proceeds of the issue. For this purpose,
the private business use test is applied
by taking into account only use that is
not related to any government use of
proceeds of the issue (unrelated use) and
use that is related but disproportionate

to any government use of those proceeds (disproportionate use).
(2) Application of unrelated or disproportionate use test—(i) Order of application. The unrelated or disproportionate use test is applied by first
determining whether a private business
use is related to a government use.
Next, private business use that relates to
a government use is examined to determine whether it is disproportionate to
that government use.
(ii) Aggregation of unrelated and disproportionate use. All the unrelated use
and disproportionate use financed with
the proceeds of an issue are aggregated
to determine compliance with the unrelated or disproportionate use test. The
amount of permissible unrelated and
disproportionate private business use is
not reduced by the amount of private
business use financed with the proceeds
of an issue that is neither unrelated use
nor disproportionate use.
(iii) Deliberate actions. A deliberate
action that occurs after the issue date
does not result in unrelated or disproportionate use if the issue meets the
conditions of § 1.141–12(a).
(b) Unrelated use—(1) In general.
Whether a private business use is related
to a government use financed with the
proceeds of an issue is determined on a
case-by-case basis, emphasizing the operational relationship between the government use and the private business
use. In general, a facility that is used for
a related private business use must be
located within, or adjacent to, the governmentally used facility.
(2) Use for the same purpose as
government use. Use of a facility by a
nongovernmental person for the same
purpose as use by a governmental person is not treated as unrelated use if the
government use is not insignificant.
Similarly, a use of a facility in the same
manner both for private business use
that is related use and private business
use that is unrelated use does not result
in unrelated use if the related use is not
insignificant. For example, a privately
owned pharmacy in a governmentally
owned hospital does not ordinarily result
in unrelated use solely because the pharmacy also serves individuals not using
the hospital. In addition, use of parking
spaces in a garage by a nongovernmental person is not treated as unrelated use
if more than an insignificant portion of
the parking spaces are used for a government use (or a private business use
that is related to a government use),

27

even though the use by the nongovernmental person is not directly related to
that other use.
(c) Disproportionate use—(1) Definition of disproportionate use. A private
business use is disproportionate to a
related government use only to the extent that the amount of proceeds used
for that private business use exceeds the
amount of proceeds used for the related
government use. For example, a private
use of $100 of proceeds that is related
to a government use of $70 of proceeds
results in $30 of disproportionate use.
(2) Aggregation of related uses. If
two or more private business uses of the
proceeds of an issue relate to a single
government use of those proceeds, those
private business uses are aggregated to
apply the disproportionate use test.
(3) Allocation rule. If a private business use relates to more than a single
use of the proceeds of the issue (for
example, two or more government uses
of the proceeds of the issue or a government use and a private use), the amount
of any disproportionate use may be
determined by—
(i) Reasonably allocating the proceeds used for the private business use
among the related uses;
(ii) Aggregating government uses that
are directly related to each other; or
(iii) Allocating the private business
use to the government use to which it is
primarily related.
(d) Maximum use taken into account.
The determination of the amount of
unrelated use or disproportionate use of
a facility is based on the maximum
amount of reasonably expected government use of a facility during the measurement period. Thus, no unrelated use
or disproportionate use arises solely because a facility initially has excess capacity that is to be used by a nongovernmental person if the facility will be
completely used by the issuer during the
term of the issue for more than an
insignificant period.
(e) Examples. The following examples illustrate the application of this
section:
Example 1. School and remote cafeteria. County
X issues bonds with proceeds of $20 million and
uses $18.1 million of the proceeds for construction
of a new school building and $1.9 million of the
proceeds for construction of a privately operated
cafeteria in its administrative office building,
which is located at a remote site. The bonds are
secured, in part, by the cafeteria. The $1.9 million
of proceeds is unrelated to the government use
(that is, school construction) financed with the
bonds and exceeds 5 percent of $20 million. Thus,
the issue meets the private business tests.

Example 2. Public safety building and courthouse. City Y issues bonds with proceeds of $50
million for construction of a new public safety
building ($32 million) and for improvements to an
existing courthouse ($15 million). Y uses $3
million of the bond proceeds for renovations to an
existing privately operated cafeteria located in the
courthouse. The bonds are secured, in part, by the
cafeteria. Y’s use of the $3 million for the
privately operated cafeteria does not meet the
unrelated or disproportionate use test because
these expenditures are neither unrelated use nor
disproportionate use.
Example 3. Unrelated garage. City Y issues
bonds with proceeds of $50 million for construction of a new public safety building ($30.5
million) and for improvements to an existing
courthouse ($15 million). Y uses $3 million of the
bond proceeds for renovations to an existing
privately operated cafeteria located in the courthouse. The bonds are secured, in part, by the
cafeteria. Y also uses $1.5 million of the proceeds
to construct a privately operated parking garage
adjacent to a private office building. The private
business use of the parking garage is unrelated to
any government use of proceeds of the issue.
Since the proceeds used for unrelated uses and
disproportionate uses do not exceed 5 percent of
the proceeds, the unrelated or disproportionate use
test is not met.
Example 4. Disproportionate use of garage.
County Z issues bonds with proceeds of $20
million for construction of a hospital with no
private business use ($17 million); renovation of
an office building with no private business use ($1
million); and construction of a garage that is
entirely used for a private business use ($2
million). The use of the garage is related to the
use of the office building but not to the use of the
hospital. The private business use of the garage
results in $1 million of disproportionate use because the proceeds used for the garage ($2
million) exceed the proceeds used for the related
government use ($1 million). The bonds are not
private activity bonds, however, because the disproportionate use does not exceed 5 percent of the
proceeds of the issue.
Example 5. Bonds for multiple projects. (i)
County W issues bonds with proceeds of $80
million for the following purposes: (1) $72 million
to construct a County-owned and operated waste
incinerator; (2) $1 million for a County-owned and
operated facility for the temporary storage of
hazardous waste prior to final disposal; (3) $1
million to construct a privately owned recycling
facility located at a remote site; and (4) $6 million
to build a garage adjacent to the County-owned
incinerator that will be leased to Company T to
store and repair trucks that it owns and uses to
haul County W refuse. Company T uses 75
percent of its trucks to haul materials to the
incinerator and the remaining 25 percent of its
trucks to haul materials to the temporary storage
facility.
(ii) The $1 million of proceeds used for the
recycling facility is used for an unrelated use. The
garage is related use. In addition, 75 percent of the
use of the $6 million of proceeds used for the
garage is allocable to the government use of
proceeds at the incinerator. The remaining 25
percent of the proceeds used for the garage ($1.5
million) relates to the government use of proceeds
at the temporary storage facility. Thus, this portion
of the proceeds used for the garage exceeds the
proceeds used for the temporary storage facility by
$0.5 million and this excess is disproportionate
use (but not unrelated use). Thus, the aggregate
amount of unrelated use and disproportionate use

financed with the proceeds of the issue is $1.5
million. Alternatively, under paragraph (c)(3)(iii)
of this section, the entire garage may be treated as
related to the government use of the incinerator
and, under that allocation, the garage is not
disproportionate use. In either event, section
141(b)(3) limits the aggregate unrelated use and
disproportionate use to $4 million. Therefore, the
bonds are not private activity bonds under this
section.

§ 1.141–10 Coordination with volume
cap.
[Reserved]
§ 1.141–11 Acquisition of nongovernmental output property.
[Reserved]
§ 1.141–12 Remedial actions.
(a) Conditions to taking remedial action. An action that causes an issue to
meet the private business tests or the
private loan financing test is not treated
as a deliberate action if the issuer takes
a remedial action described in paragraph
(d), (e), or (f) of this section with
respect to the nonqualified bonds and if
all of the requirements in paragraphs
(a)(1) through (5) of this section are
met.
(1) Reasonable expectations test met.
The issuer reasonably expected on the
issue date that the issue would meet
neither the private business tests nor the
private loan financing test for the entire
term of the bonds. For this purpose, if
the issuer reasonably expected on the
issue date to take a deliberate action
prior to the final maturity date of the
issue that would cause either the private
business tests or the private loan financing test to be met, the term of the bonds
for this purpose may be determined by
taking into account a redemption provision if the provisions of § 1.141–
2(d)(2)(ii)(A) through (C) are met.
(2) Maturity not unreasonably long.
The term of the issue must not be
longer than is reasonably necessary for
the governmental purposes of the issue
(within the meaning of § 1.148–
1(c)(4)). Thus, this requirement is met if
the weighted average maturity of the
bonds of the issue is not greater than
120 percent of the average reasonably
expected economic life of the property
financed with the proceeds of the issue
as of the issue date.
(3) Fair market value consideration.
Except as provided in paragraph (f) of
this section, the terms of any arrangement that results in satisfaction of either
the private business tests or the private

28

loan financing test are bona fide and
arm’s-length, and the new user pays fair
market value for the use of the financed
property. Thus, for example, fair market
value may be determined in a manner
that takes into account restrictions on
the use of the financed property that
serve a bona fide governmental purpose.
(4) Disposition proceeds treated as
gross proceeds for arbitrage purposes.
The issuer must treat any disposition
proceeds as gross proceeds for purposes
of section 148. For purposes of eligibility for temporary periods under section
148(c) and exemptions from the requirement of section 148(f) the issuer may
treat the date of receipt of the disposition proceeds as the issue date of the
bonds and disregard the receipt of disposition proceeds for exemptions based
on expenditure of proceeds under
§ 1.148–7 that were met before the
receipt of the disposition proceeds.
(5) Proceeds expended on a governmental purpose. Except for a remedial
action under paragraph (d) of this section, the proceeds of the issue that are
affected by the deliberate action must
have been expended on a governmental
purpose before the date of the deliberate
action.
(b) Effect of a remedial action—(1)
In general. The effect of a remedial
action is to cure use of proceeds that
causes the private business use test or
the private loan financing test to be met.
A remedial action does not affect application of the private security or payment
test.
(2) Effect on bonds that have been
advance refunded. If proceeds of an
issue were used to advance refund another bond, a remedial action taken with
respect to the refunding bond proportionately reduces the amount of proceeds of the advance refunded bond that
is taken into account under the private
business use test or the private loan
financing test.
(c) Disposition proceeds—(1) Definition. Disposition proceeds are any
amounts (including property, such as an
agreement to provide services) derived
from the sale, exchange, or other disposition (disposition) of property (other
than investments) financed with the proceeds of an issue.
(2) Allocating disposition proceeds to
an issue. In general, if the requirements
of paragraph (a) of this section are met,
after the date of the disposition, the
proceeds of the issue allocable to the
transferred property are treated as financing the disposition proceeds rather

than the transferred property. If a disposition is made pursuant to an installment
sale, the proceeds of the issue continue
to be allocated to the transferred property. If an issue does not meet the
requirements for remedial action in
paragraph (a) of this section or the
issuer does not take an appropriate remedial action, the proceeds of the issue
are allocable to either the transferred
property or the disposition proceeds,
whichever allocation produces the
greater amount of private business use
and private security or payments.
(3) Allocating disposition proceeds to
different sources of funding. If property
has been financed by different sources
of funding, for purposes of this section,
the disposition proceeds from that property are first allocated to the outstanding
bonds that financed that property in
proportion to the principal amounts of
those outstanding bonds. In no event
may disposition proceeds be allocated to
bonds that are no longer outstanding or
to a source of funding not derived from
a borrowing (such as revenues of the
issuer) if the disposition proceeds are
not greater than the total principal
amounts of the outstanding bonds that
are allocable to that property. For purposes of this paragraph (c)(3), principal
amount has the same meaning as in
§ 1.148–9(b)(2) and outstanding bonds
do not include advance refunded bonds.
(d) Redemption or defeasance of
nonqualified bonds—(1) In general. The
requirements of this paragraph (d) are
met if all of the nonqualified bonds of
the issue are redeemed. Proceeds of
tax-exempt bonds must not be used for
this purpose, unless the tax-exempt
bonds are qualified bonds, taking into
account the purchaser’s use of the facility. If the bonds are not redeemed within
90 days of the date of the deliberate
action, a defeasance escrow must be
established for those bonds within 90
days of the deliberate action.
(2) Special rule for dispositions for
cash. If the consideration for the disposition of financed property is exclusively
cash, the requirements of this paragraph
(d) are met if the disposition proceeds
are used to redeem a pro rata portion of
the nonqualified bonds at the earliest
call date after the deliberate action. If
the bonds are not redeemed within 90
days of the date of the deliberate action,
the disposition proceeds must be used to
establish a defeasance escrow for those
bonds within 90 days of the deliberate
action.

(3) Notice of defeasance. The issuer
must provide written notice to the Commissioner of the establishment of the
defeasance escrow within 90 days of the
date the defeasance escrow is established.
(4) Special limitation. The establishment of a defeasance escrow does not
satisfy the requirements of this paragraph (d) if the period between the issue
date and the first call date of the bonds
is more than 10 1/2 years.
(5) Defeasance escrow defined. A
defeasance escrow is an irrevocable escrow established to redeem bonds on
their earliest call date in an amount that,
together with investment earnings, is
sufficient to pay all the principal of, and
interest and call premium on, bonds
from the date the escrow is established
to the earliest call date. The escrow may
not be invested in higher yielding investments or in any investment under
which the obligor is a user of the
proceeds of the bonds.
(e) Alternative use of disposition proceeds—(1) In general. The requirements
of this paragraph (e) are met if—
(i) The deliberate action is a disposition for which the consideration is exclusively cash;
(ii) The issuer reasonably expects to
expend the disposition proceeds within
two years of the date of the deliberate
action;
(iii) The disposition proceeds are
treated as proceeds for purposes of
section 141 and are used in a manner
that does not cause the issue to meet
either the private business tests or the
private loan financing test, and the issuer does not take any action subsequent
to the date of the deliberate action to
cause either of these tests to be met; and
(iv) If the issuer does not use all of
the disposition proceeds for an alternative use described in paragraph
(e)(1)(iii) of this section, the issuer uses
those remaining disposition proceeds for
a remedial action that meets paragraph
(d) of this section.
(2) Special rule for use by 501(c)(3)
organizations. If the disposition proceeds are to be used by a 501(c)(3)
organization, the nonqualified bonds
must in addition be treated as reissued
for purposes of sections 141, 145, 147,
149, and 150 and, under this treatment,
satisfy all of the applicable requirements
for qualified 501(c)(3) bonds. Thus, beginning on the date of the deliberate
action, nonqualified bonds that satisfy
these requirements must be treated as

29

qualified 501(c)(3) bonds for all purposes, including sections 145(b) and
150(b).
(f) Alternative use of facility. The
requirements of this paragraph (f) are
met if—
(1) The facility with respect to which
the deliberate action occurs is used in an
alternative manner (for example, used
for a qualifying purpose by a nongovernmental person or used by a 501(c)(3)
organization rather than a governmental
person);
(2) The nonqualified bonds are
treated as reissued, as of the date of the
deliberate action, for purposes of sections 55 through 59 and 141, 142, 144,
145, 146, 147, 149 and 150, and under
this treatment, the nonqualified bonds
satisfy all the applicable requirements
for qualified bonds throughout the remaining term of the nonqualified bonds;
(3) The deliberate action does not
involve a disposition to a purchaser that
finances the acquisition with proceeds of
another issue of tax-exempt bonds; and
(4) Any disposition proceeds other
than those arising from an agreement to
provide services (including disposition
proceeds from an installment sale) resulting from the deliberate action are
used to pay the debt service on the
bonds on the next available payment
date or, within 90 days of receipt, are
deposited into an escrow that is restricted to the yield on the bonds to pay
the debt service on the bonds on the
next available payment date.
(g) Rules for deemed reissuance. For
purposes of determining whether bonds
that are treated as reissued under paragraphs (e) and (f) of this section are
qualified bonds—
(1) The provisions of the Code and
regulations thereunder in effect as of the
date of the deliberate action apply; and
(2) For purposes of paragraph (f) of
this section, section 147(d) (relating to
the acquisition of existing property)
does not apply.
(h) Authority of Commissioner to provide for additional remedial actions.
The Commissioner may, by publication
in the Federal Register or the Internal
Revenue Bulletin, provide additional remedial actions, including making a remedial payment to the United States,
under which a subsequent action will
not be treated as a deliberate action for
purposes of § 1.141–2.
(i) Effect of remedial action on continuing compliance. Solely for purposes
of determining whether deliberate actions that are taken after a remedial

action cause an issue to meet the private
business tests or the private loan financing test—
(1) If a remedial action is taken under paragraph (d), (e), or (f) of this
section, the private business use or private loans resulting from the deliberate
action are not taken into account for
purposes of determining whether the
bonds are private activity bonds; and
(2) After a remedial action is taken,
the amount of disposition proceeds is
treated as equal to the proceeds of the
issue that had been allocable to the
transferred property immediately prior to
the disposition. See paragraph (k) of this
section, Example 5.
(j) Nonqualified bonds—(1) Amount
of nonqualified bonds. The percentage
of outstanding bonds that are nonqualified bonds equals the highest percentage
of private business use in any 1-year
period commencing with the deliberate
action.
(2) Allocation of nonqualified bonds.
Allocations to nonqualified bonds must
be made on a pro rata basis, except that,
for purposes of paragraph (d) of this
section (relating to redemption or
defeasance), an issuer may treat bonds
with longer maturities (determined on a
bond-by-bond basis) as the nonqualified
bonds.
(k) Examples. The following examples illustrate the application of this
section:
Example 1. Disposition proceeds less than outstanding bonds used to retire bonds. On June 1,
1997, City C issues 30-year bonds with an issue
price of $10 million to finance the construction of
a hospital building. The bonds have a weighted
average maturity that does not exceed 120 percent
of the reasonably expected economic life of the
building. On the issue date, C reasonably expects
that it will be the only user of the building for the
entire term of the bonds. Six years after the issue
date, C sells the building to Corporation P for $5
million. The sale price is the fair market value of
the building, as verified by an independent appraiser. C uses all of the $5 million disposition
proceeds to immediately retire a pro rata portion
of the bonds. The sale does not cause the bonds to
be private activity bonds because C has taken a
remedial action described in paragraph (d) of this
section so that P is not treated as a private
business user of bond proceeds.
Example 2. Lease to nongovernmental person.
The facts are the same as in Example 1, except
that instead of selling the building, C, 6 years after
the issue date, leases the building to P for 7 years
and uses other funds to redeem all of the $10
million outstanding bonds within 90 days of the
deliberate act. The bonds are not treated as private
activity bonds because C has taken the remedial
action described in paragraph (d) of this section.
Example 3. Sale for less than fair market value.
The facts are the same as in Example 1, except
that the fair market value of the building at the
time of the sale to P is $6 million. Because the
transfer was for less than fair market value, the

bonds are ineligible for the remedial actions under
this section. The bonds are private activity bonds
because P is treated as a user of all of the
proceeds and P makes a payment ($6 million) for
this use that is greater than 10 percent of the debt
service on the bonds, on a present value basis.
Example 4. Fair market value determined taking
into account governmental restrictions. The facts
are the same as in Example 1, except that the
building was used by C only for hospital purposes
and C determines to sell the building subject to a
restriction that it be used only for hospital purposes. After conducting a public bidding procedure
as required by state law, the best price that C is
able to obtain for the building subject to this
restriction is $4.5 million from P. C uses all of the
$4.5 million disposition proceeds to immediately
retire a pro rata portion of the bonds. The sale
does not cause the bonds to be private activity
bonds because C has taken a remedial action
described in paragraph (d) of this section so that P
is not treated as a private business user of bond
proceeds.
Example 5. Alternative use of disposition proceeds. The facts are the same as in Example 1,
except that C reasonably expects on the date of
the deliberate action to use the $5 million disposition proceeds for another governmental purpose
(construction of governmentally owned roads)
within two years of receipt, rather than using the
$5 million to redeem outstanding bonds. C treats
these disposition proceeds as gross proceeds for
purposes of section 148. The bonds are not private
activity bonds because C has taken a remedial
action described in paragraph (e) of this section.
After the date of the deliberate action, the proceeds of all of the outstanding bonds are treated as
used for the construction of the roads, even though
only $5 million of disposition proceeds was actually used for the roads.
Example 6. Alternative use of financed property.
The facts are the same as in Example 1, except
that C determines to lease the hospital building to
Q, an organization described in section 501(c)(3),
for a term of 10 years rather than to sell the
building to P. In order to induce Q to provide
hospital services, C agrees to lease payments that
are less than fair market value. Before entering
into the lease, an applicable elected representative
of C approves the lease after a noticed public
hearing. As of the date of the deliberate action, the
issue meets all the requirements for qualified
501(c)(3) bonds, treating the bonds as reissued on
that date. For example, the issue meets the two
percent restriction on use of proceeds of finance
issuance costs of section 147(g) because the issue
pays no costs of issuance from disposition proceeds in connection with the deemed reissuance. C
and Q treat the bonds as qualified 501(c)(3) bonds
for all purposes commencing with the date of the
deliberate action. The bonds are treated as qualified 501(c)(3) bonds commencing with the date of
the deliberate action.
Example 7. Deliberate action before proceeds
are expended on a governmental purpose. County
J issues bonds with proceeds of $10 million that
can be used only to finance a correctional facility.
On the issue date of the bonds, J reasonably
expects that it will be the sole user of the bonds
for the useful life of the facility. The bonds have a
weighted average maturity that does not exceed
120 percent of the reasonably expected economic
life of the facility. After the issue date of the
bonds, but before the facility is placed in service,
J enters into a contract with the federal government pursuant to which the federal government
will make a fair market value, lump sum payment
equal to 25 percent of the cost of the facility. In

30

exchange for this payment, J provides the federal
government with priority rights to use of 25
percent of the facility. J uses the payment received
from the federal government to defease the
nonqualified bonds. The agreement does not cause
the bonds to be private activity bonds because J
has taken a remedial action described in paragraph
(d) of this section. See paragraph (a)(5) of this
section.
Example 8. Compliance after remedial action.
In 1997, City G issues bonds with proceeds of $10
million to finance a courthouse. The bonds have a
weighted average maturity that does not exceed
120 percent of the reasonably expected economic
life of the courthouse. G uses $1 million of the
proceeds for a private business use and more than
10 percent of the debt service on the issue is
secured by private security or payments. G later
sells one-half of the courthouse property to a
nongovernmental person for cash. G immediately
redeems 60 percent of the outstanding bonds. This
percentage of outstanding bonds is based on the
highest private business use of the courthouse in
any 1-year period commencing with the deliberate
action. For purposes of subsequently applying
section 141 to the issue, G may continue to use all
of the proceeds of the outstanding bonds in the
same manner (that is, for both the courthouse and
the existing private business use) without causing
the issue to meet the private business use test. The
issue, however, continues to meet the private
security or payment test. The result would be the
same if D, instead of redeeming the bonds,
established a defeasance escrow for those bonds,
provided that the requirement of paragraph (d)(4)
of this section was met.

§ 1.141–13 Refunding issues.
[Reserved]
§ 1.141–14 Anti-abuse rules.
(a) Authority of Commissioner to reflect substance of transactions. If an
issuer enters into a transaction or series
of transactions with respect to one or
more issues with a principal purpose of
transferring to nongovernmental persons
(other than as members of the general
public) significant benefits of taxexempt financing in a manner that is
inconsistent with the purposes of section
141, the Commissioner may take any
action to reflect the substance of the
transaction or series of transactions, including—
(1) Treating separate issues as a
single issue for purposes of the private
activity bond tests;
(2) Reallocating proceeds to expenditures, property, use, or bonds;
(3) Reallocating payments to use or
proceeds;
(4) Measuring private business use on
a basis that reasonably reflects the economic benefit in a manner different than
as provided in § 1.141–3(g); and
(5) Measuring private payments or
security on a basis that reasonably re-

flects the economic substance in a manner different than as provided in
§ 1.141–4.
(b) Examples. The following examples illustrate the application of this
section:
Example 1. Reallocating proceeds to indirect
use. City C issues bonds with proceeds of $20
million for the stated purpose of financing improvements to roads that it owns. As a part of the
same plan of financing, however, C also agrees to
make a loan of $7 million to Corporation M from
its general revenues that it otherwise would have
used for the road improvements. The interest rate
of the loan corresponds to the interest rate on a
portion of the issue. A principal purpose of the
financing arrangement is to transfer to M significant benefits of the tax-exempt financing. Although C actually allocates all of the proceeds of
the bonds to the road improvements, the Commissioner may reallocate a portion of the proceeds of
the bonds to the loan to M because a principal
purpose of the financing arrangement is to transfer
to M significant benefits of tax-exempt financing
in a manner that is inconsistent with the purposes
of section 141. The bonds are private activity
bonds because the issue meets the private loan
financing test. The bonds also meet the private
business tests. See also §§ 1.141–3(a)(2), 1.141–
4(a)(1), and 1.141–5(a), under which indirect use
of proceeds and payments are taken into account.
Example 2. Taking into account use of amounts
derived from proceeds that would be otherwise
disregarded. County B issues bonds with proceeds
of $10 million to finance the purchase of land. On
the issue date, B reasonably expects that it will be
the sole user of the land. Subsequently, the federal
government acquires the land for $3 million in a
condemnation action. B uses this amount to make
a loan to Corporation M. In addition, the interest
rate on the loan reflects the tax-exempt interest
rate on the bonds and thus is substantially less
than a current market rate. A principal purpose of
the arrangement is to transfer to M significant
benefits of the tax-exempt financing. Although the
condemnation action is not a deliberate action, the
Commissioner may treat the condemnation proceeds as proceeds of the issue because a principal
purpose of the arrangement is to transfer to M
significant benefits of tax-exempt financing in a
manner inconsistent with the purposes of section
141. The bonds are private activity bonds.
Example 3. Measuring private business use on
an alternative basis. City F issues bonds with a
30-year term to finance the acquisition of an
industrial building having a remaining reasonably
expected useful economic life of more than 30
years. On the issue date, F leases the building to
Corporation G for 3 years. F reasonably expects
that it will be the sole user of the building for the
remaining term of the bonds. Because of the local
market conditions, it is reasonably expected that
the fair rental value of the industrial building will
be significantly greater during the early years of
the term of the bonds than in the later years. The
annual rental payments are significantly less than
fair market value, reflecting the interest rate on the
bonds. The present value of these rental payments
(net of operation and maintenance expenses) as of
the issue date, however, is approximately 25
percent of the present value of debt service on the
issue. Under § 1.141–3, the issue does not meet
the private business tests, because only 10 percent
of the proceeds are used in a trade or business by
a nongovernmental person. A principal purpose of
the issue is to transfer to G significant benefits of

tax-exempt financing in a manner inconsistent
with the purposes of section 141. The method of
measuring private business use over the reasonably
expected useful economic life of financed property
is for the administrative convenience of issuers of
state and local bonds. In cases where this method
is used in a manner inconsistent with the purposes
of section 141, the Commissioner may measure
private business use on another basis that reasonably reflects economic benefit, such as in this case
on an annual basis. If the Commissioner measures
private business use on an annual basis, the bonds
are private activity bonds because the private
payment test is met and more than 10 percent of
the proceeds are used in a trade or business by a
nongovernmental person.
Example 4. Treating separate issues as a single
issue. City D enters into a development agreement
with Corporation T to induce T to locate its
headquarters within D’s city limits. Pursuant to the
development agreement, in 1997 D will issue $20
million of its general obligation bonds (the 1997
bonds) to purchase land that it will grant to T. The
development agreement also provides that, in
1998, D will issue $20 million of its tax increment
bonds (the 1998 bonds), secured solely by the
increase in property taxes in a special taxing
district. Substantially all of the property within the
special taxing district is owned by T or D. T will
separately enter into an agreement to guarantee the
payment of tax increment to D in an amount
sufficient to retire the 1998 bonds. The proceeds
of the 1998 bonds will be used to finance
improvements owned and operated by D that will
not give rise to private business use. Treated
separately, the 1997 issue meets the private business use test, but not the private security or
payment test; the 1998 issue meets the private
security or payment test, but not the private
business use test. A principal purpose of the
financing plan including the two issues is to
transfer significant benefits of tax-exempt financing to T for its headquarters. Thus, the 1997 issue
and the 1998 issue may be treated by the Commissioner as a single issue for purposes of applying
the private activity bond tests. Accordingly, the
bonds of both the 1997 issue and the 1998 issue
may be treated as private activity bonds.
Example 5. Reallocating proceeds. City E acquires an electric generating facility with a useful
economic life of more than 40 years and enters
into a 30-year take or pay contract to sell 30
percent of the available output to investor-owned
utility M. E plans to use the remaining 70 percent
of available output for its own governmental
purposes. To finance the entire cost of the facility,
E issues $30 million of its series A taxable bonds
at taxable interest rates and $70 million series B
bonds, which purport to be tax-exempt bonds, at
tax-exempt interest rates. E allocates all of M’s
private business use to the proceeds of the series A
bonds and all of its own government use to the
proceeds of the series B bonds. The series A bonds
have a weighted average maturity of 15 years,
while the series B bonds have a weighted average
maturity of 26 years. M’s payments under the take
or pay contract are expressly determined by reference to 30 percent of M’s total costs (that is, the
sum of the debt service required to be paid on
both the series A and the series B bonds and all
other operating costs). The allocation of all of M’s
private business use to the series A bonds does not
reflect economic substance because the series of
transactions transfers to M significant benefits of
the tax-exempt interest rates paid on the series B
bonds. A principal purpose of the financing arrangement is to transfer to M significant benefits
of the tax-exempt financing. Accordingly, the

31

Commissioner may allocate M’s private business
use on a pro rata basis to both the series B bonds
as well as the series A bonds, in which case the
series B bonds are private activity bonds.
Example 6. Allocations respected. The facts are
the same as in Example 5, except that the debt
service component of M’s payments under the take
or pay contract is based exclusively on the
amounts necessary to pay the debt service on the
taxable series A bonds. E’s allocation of all of M’s
private business use to the series A bonds is
respected because the series of transactions does
not actually transfer benefits of tax-exempt interest
rates to M. Accordingly, the series B bonds are not
private activity bonds. The result would be the
same if M’s payments under the take or pay
contract were based exclusively on fair market
value pricing, rather than the tax-exempt interest
rates on E’s bonds. The result also would be the
same if the series A bonds and the series B bonds
had substantially equivalent weighted average
maturities and E and M had entered into a
customary contract providing for payments based
on a ratable share of total debt service. E would
not be treated by the Commissioner in any of
these cases as entering into the contract with a
principal purpose of transferring the benefits of
tax-exempt financing to M in a manner inconsistent with the purposes of section 141.

§ 1.141–15 Effective dates.
(a) Scope. The effective dates in this
section apply for purposes of
§§ 1.141–0 through 1.141–14, and
1.145–0 through 1.145–2 (the private
activity bond regulations), and § 1.150–
1(a)(3) and the definition of bond documents contained in § 1.150–1(b).
(b) Effective dates. Except as otherwise provided in this section, the private
activity bond regulations, § 1.150–
1(a)(3), and the definition of bond documents contained in § 1.150–1(b) apply
to bonds issued on or after May 16,
1997, (the effective date) that are subject to section 1301 of the Tax Reform
Act of 1986.
(c) Refunding bonds. The private activity bond regulations, § 1.150–1(a)(3),
and the definition of bond documents
contained in § 1.150–1(b) do not apply
to bonds issued on or after the effective
date to refund a bond to which the
private activity bond regulations do not
apply unless—
(1) The weighted average maturity of
the refunding bonds is longer than—
(i) The weighted average maturity of
the refunded bonds; or
(ii) 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
(2) 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 private activity
bond regulations, § 1.150–1(a)(3), and
the definition of bond documents contained in § 1.150–1(b) may be applied
in whole, but not in part, to—
(1) Bonds that are outstanding on the
effective date and subject to section
141; or
(2) Refunding bonds issued on or
after the effective date.
(e) Permissive retroactive application
of certain sections. The following sections may each be applied to any bonds
issued before the effective date:
(1) Section 1.141–3(b)(4);
(2) Section 1.141–3(b)(6); and
(3) Section 1.141–12.
§ 1.141–16 Effective dates for qualified
private activity bond provisions.
(a) Scope. The effective dates of this
section apply for purposes of
§§ 1.142–0 through 1.142–2, 1.144–0
through 1.144–2, 1.147–0 through
1.147–2, and 1.150–4.
(b) Effective dates. Except as otherwise provided in this section, the regulations designated in paragraph (a) of this
section apply to bonds issued on or after
May 16, 1997, (the effective date).
(c) Permissive application. The regulations designated in paragraph (a) of
this section may be applied in whole,
but not in part, to bonds outstanding on
the effective date.
Par. 7. Sections 1.142–0 and 1.142–3
are added and §§ 1.142–1 and 1.142–2
are revised to read as follows:
§ 1.142–0 Table of Contents. This section lists the captioned paragraphs contained in §§ 1.142–1 through 1.142–3.
§ 1.142–1 Exempt facility bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
§ 1.142–2 Remedial actions.
(a) General rule.
(b) Reasonable expectations requirement.
(c) Redemption or defeasance.
(1) In general.
(2) Notice of defeasance.
(3) Special limitation.
(4) Special rule for dispositions of
personal property.
(5) Definitions.
(d) When a failure to properly use
proceeds occurs.

(1) Proceeds not spent.
(2) Proceeds spent.
(e) Nonqualified bonds.
§ 1.142–3 Refunding issues.
[Reserved]
§ 1.142–1 Exempt facility bonds.
(a) Overview. Interest on a private
activity bond is not excludable from
gross income under section 103(a) unless the bond is a qualified bond. Under
section 141(e)(1)(A), an exempt facility
bond issued under section 142 may be a
qualified bond. Under section 142(a), an
exempt facility bond is any bond issued
as a part of an issue using 95 percent or
more of the proceeds for certain exempt
facilities.
(b) Scope. Sections 1.142–0 through
1.142–3 apply for purposes of the rules
for exempt facility bonds under section
142, except that, with respect to net
proceeds that have been spent,
§ 1.142–2 does not apply to bonds
issued under section 142(d) (relating to
bonds issued to provide qualified residential rental projects) and section
142(f)(2) and (4) (relating to bonds
issued to provide local furnishing of
electric energy or gas).
(c) Effective dates. For effective dates
of §§ 1.142–0 through 1.142–2, see
§ 1.141–16.
§ 1.142–2 Remedial actions.
(a) General rule. If less than 95 percent of the net proceeds of an exempt
facility bond are actually used to provide an exempt facility, and for no other
purpose, the issue will be treated as
meeting the use of proceeds requirement
of section 142(a) if the issue meets the
condition of paragraph (b) of this section and the issuer takes the remedial
action described in paragraph (c) of this
section.
(b) Reasonable expectations requirement. The issuer must have reasonably
expected on the issue date that 95
percent of the net proceeds of the issue
would be used to provide an exempt
facility and for no other purpose for the
entire term of the bonds (disregarding
any redemption provisions). To meet
this condition the amount of the issue
must have been based on reasonable
estimates about the cost of the facility.
(c) Redemption or defeasance—(1) In
general. The requirements of this paragraph (c) are met if all of the nonqualified bonds of the issue are redeemed on

32

the earliest call date after the date on
which the failure to properly use the
proceeds occurs under paragraph (d) of
this section. Proceeds of tax-exempt
bonds (other than those described in
paragraph (d)(1) of this section) must
not be used for this purpose. If the
bonds are not redeemed within 90 days
of the date on which the failure to
properly use proceeds occurs, a
defeasance escrow must be established
for those bonds within 90 days of that
date.
(2) Notice of defeasance. The issuer
must provide written notice to the Commissioner of the establishment of the
defeasance escrow within 90 days of the
date the escrow is established.
(3) Special limitation. The establishment of a defeasance escrow does not
satisfy the requirements of this paragraph (c) if the period between the issue
date and the first call date is more than
10 1/2 years.
(4) Special rule for dispositions of
personal property. For dispositions of
personal property exclusively for cash,
the requirements of this paragraph (c)
are met if the issuer expends the disposition proceeds within 6 months of the
date of the disposition to acquire replacement property for the same qualifying purpose of the issue under section
142.
(5) Definitions. For purposes of paragraph (c)(4) of this section, disposition
proceeds means disposition proceeds as
defined in § 1.141–12(c).
(d) When a failure to properly use
proceeds occurs—(1) Proceeds not
spent. For net proceeds that are not
spent, a failure to properly use proceeds
occurs on the earlier of the date on
which the issuer reasonably determines
that the financed facility will not be
completed or the date on which the
financed facility is placed in service.
(2) Proceeds spent. For net proceeds
that are spent, a failure to properly use
proceeds occurs on the date on which an
action is taken that causes the bonds not
to be used for the qualifying purpose for
which the bonds were issued.
(e) Nonqualified bonds. For purposes
of this section, the nonqualified bonds
are a portion of the outstanding bonds in
an amount that, if the remaining bonds
were issued on the date on which the
failure to properly use the proceeds
occurs, at least 95 percent of the net
proceeds of the remaining bonds would
be used to provide an exempt facility. If
no proceeds have been spent to provide
an exempt facility, all of the outstanding

bonds are nonqualified bonds. The
nonqualified bonds must be determined
on a pro rata allocation basis, except
that an issuer may treat bonds with
longer maturities (determined on a
bond-by-bond basis) as the nonqualified
bonds.
§ 1.142–3 Refunding issues.
[Reserved]
Par. 8. Sections 1.144–0 is added and
§§ 1.144–1 and 1.144–2 are revised to
read as follows:
§ 1.144–0 Table of Contents. This section lists the captioned paragraphs contained in §§ 1.144–1 and 1.144–2.
§ 1.144–1 Qualified small issue bonds,
qualified student loan bonds, and qualified redevelopment bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
§ 1.144–2 Remedial actions.
§ 1.144–1 Qualified small issue bonds,
qualified student loan bonds, and qualified redevelopment bonds.
(a) Overview. Interest on a private
activity bond is not excludable from
gross income under section 103(a) unless the bond is a qualified bond. Under
section 141(e)(1)(D), a qualified small
issue bond issued under section 144(a)
may be a qualified bond. Under section
144(a), any qualified small issue bond is
any bond issued as a part of an issue 95
percent or more of the proceeds of
which are to be used to provide certain
manufacturing facilities or certain depreciable farm property and which meets
other requirements. Under section
141(e)(1)(F) a qualified redevelopment
bond issued under section 144(c) is a
qualified bond. Under section 144(c), a
qualified redevelopment bond is any
bond issued as a part of an issue 95
percent or more of the net proceeds of
which are to be used for one or more
redevelopment purposes and which
meets certain other requirements.
(b) Scope. Sections 1.144–0 through
1.144–2 apply for purposes of the rules
for small issue bonds under section
144(a) and qualified redevelopment
bonds under section 144(c), except that
§ 1.144–2 does not apply to the requirements for qualified small issue bonds
under section 144(a)(4) (relating to the
limitation on capital expenditures) or
under section 144(a)(10) (relating to the
aggregate limit of tax-exempt bonds per
taxpayer).

(c) Effective dates. For effective dates
of §§ 1.144–0 through 1.144–2, see
§ 1.141–16.
§ 1.144–2 Remedial actions. The remedial action rules of § 1.142–2 apply to
qualified small issue bonds issued under
section 144(a) and to qualified redevelopment bonds issued under section
144(c), for this purpose treating those
bonds as exempt facility bonds and the
qualifying purposes for those bonds as
exempt facilities.
Par. 9. Sections 1.145–0 through
1.145–2 are added to read as follows:
§ 1.145–0 Table of Contents. This section lists the captioned paragraphs contained in §§ 1.145–1 and 1.145–2.
§ 1.145–1 Qualified 501(c)(3) bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
§ 1.145–2 Application of private activity bond regulations.
(a) In general.
(b) Modification of private business
tests.
(c) Exceptions.
(1) Certain provisions relating to governmental programs.
(2) Costs of issuance.
§ 1.145–1 Qualified 501(c)(3) bonds.
(a) Overview. Interest on a private
activity bond is not excludable from
gross income under section 103(a) unless the bond is a qualified bond. Under
section 141(e)(1)(G), a qualified
501(c)(3) bond issued under section 145
is a qualified bond. Under section 145, a
qualified 501(c)(3) bond is any bond
issued as a part of an issue that satisfies
the requirements of sections 145(a)
through (d).
(b) Scope. Sections 1.145–0 through
1.145–2 apply for purposes of section
145(a).
(c) Effective dates. For effective dates
of §§ 1.145–0 through 1.145–2, see
§ 1.141–15.
§ 1.145–2 Application of private activity bond regulations.
(a) In general. Except as provided in
this section, §§ 1.141–0 through
1.141–15 apply to section 145(a). For
example, under this section, § 1.141–1,
and § 1.141–2, an issue ceases to be an
issue of qualified 501(c)(3) bonds if the

33

issuer or a conduit borrower 501(c)(3)
organization takes a deliberate action,
subsequent to the issue date, that causes
the issue to fail to comply with the
requirements of sections 141(e) and 145
(such as an action that results in revocation of exempt status of the 501(c)(3)
organization).
(b) Modification of private business
tests. In applying §§ 1.141–0 through
1.141–15 to section 145(a)—
(1) References to governmental persons include 501(c)(3) organizations
with respect to their activities that do
not constitute unrelated trades or businesses under section 513(a);
(2) References to ‘‘10 percent’’ and
‘‘proceeds’’ in the context of the private
business use test and the private security
or payment test mean ‘‘5 percent’’ and
‘‘net proceeds’’; and
(3) References to the private business
use test in §§ 1.141–2 and 1.141–12
include the ownership test of section
145(a)(1).
(c) Exceptions—(1) Certain provisions relating to governmental programs. The following provisions do not
apply to section 145: § 1.141–2(d)(4)
(relating to the special rule for dispositions of personal property in the ordinary course of an established governmental program) and § 1.141–2(d)(5)
(relating to the special rule for general
obligation bond programs that finance a
large number of separate purposes).
(2) Costs of issuance. Section 1.141–
3(g)(6) does not apply to section
145(a)(2) to the extent that it provides
that costs of issuance are allocated ratably among the other purposes for
which the proceeds are used. For purposes of section 145(a)(2), costs of
issuance are treated as private business
use.
Par. 10. Sections 1.147–0 through
1.147–2 are added to read as follows:
§ 1.147–0 Table of Contents. This section lists the captioned paragraphs contained in §§ 1.147–1 and 1.147–2.
§ 1.147–1 Other requirements applicable to certain private activity bonds.
(a) Overview.
(b) Scope.
(c) Effective dates.
§ 1.147–2 Remedial actions.
§ 1.147–1 Other requirements applicable to certain private activity bonds.
(a) Overview. Interest on a private
activity bond is not excludable from

gross income under section 103(a) unless the bond is a qualified bond. Under
section 147, certain requirements must
be met for a private activity bond to
qualify as a qualified bond.
(b) Scope. Sections 1.147–0 through
1.147–2 apply for purposes of the rules
in section 147 for qualified private activity bonds that permit use of proceeds
to acquire land for environmental purposes (section 147(c)(3)), permit use of
proceeds for certain rehabilitations (section 147(d)(2) and (3)), prohibit use of
proceeds to finance skyboxes, airplanes,
gambling establishments and similar facilities (section 147(e)), and require public approval (section 147(f)), but not for
the rules limiting use of proceeds to
acquire land or existing property under
sections 147(c)(1) and (2), and (d)(1).
(c) Effective dates. For effective dates
of §§ 1.147–0 through 1.147–2, see
§ 1.141–16.
§ 1.147–2 Remedial actions.
The remedial action rules of
§ 1.142–2 apply to the rules in section
147 for qualified private activity bonds
that permit use of proceeds to acquire
land for environmental purposes (section
147(c)(3)), permit use of proceeds for
certain rehabilitations (section 147(d)(2)
and (3)), prohibit use of proceeds to
finance skyboxes, airplanes, gambling
establishments and similar facilities
(section 147(e)), and require public approval (section 147(f)), for this purpose
treating those private activity bonds subject to the rules under section 147 as
exempt facility bonds and the qualifying
purposes for those bonds as exempt
facilities.
Par. 11. Section 1.148–6 is amended
by adding new paragraphs (a)(3) and
(d)(1)(iii) to read as follows:
§ 1.148–6 General allocation and accounting rules.
(a) * * *
(3) Absence of allocation and accounting methods. If an issuer fails to
maintain books and records sufficient to
establish the accounting method for an
issue and the allocation of the proceeds
of that issue, the rules of this section are
applied using the specific tracing
method. This paragraph (a)(3) applies to
bonds issued on or after May 16, 1997.
*

*

*

*

*

(d) * * *
(1) * * *
(iii) Timing. An issuer must account
for the allocation of proceeds to expen-

ditures not later than 18 months after
the later of the date the expenditure is
paid or the date the project, if any, that
is financed by the issue is placed in
service. This allocation must be made in
any event by the date 60 days after the
fifth anniversary of the issue date or the
date 60 days after the retirement of the
issue, if earlier. This paragraph
(d)(1)(iii) applies to bonds issued on or
after May 16, 1997.
*

*

*

*

*

Par. 12. Section 1.150–1 is amended
as follows:
1. Paragraph (a)(3) is added.
2. Paragraph (b) is amended by adding a new definition in alphabetical
order.
The additions read as follows:
§ 1.150–1 Definitions.
(a) * * *
(3) Exception to general effective
date. See § 1.141–15 for the effective
date of the definition of bond documents
contained in paragraph (b) of this section.
*

*

*

*

*

(b) * * *
Bond documents means the bond indenture or resolution, transcript of proceedings, and any related documents.
*

*

*

*

*

Par. 13. Section 1.150–4 is added to
read as follows:
§ 1.150–4 Change in use of facilities
financed with tax-exempt private activity
bonds.
(a) Scope. This section applies for
purposes of the rules for change of use
of facilities financed with private activity bonds under sections 150(b)(3) (relating to qualified 501(c)(3) bonds),
150(b)(4) (relating to certain exempt
facility bonds and small issue bonds),
150(b)(5) (relating to facilities required
to be owned by governmental units or
501(c)(3) organizations), and 150(c).
(b) Effect of remedial actions—(1) In
general. Except as provided in this
section, the change of use provisions of
sections 150(b)(3) through (5), and
150(c) apply even if the issuer takes a
remedial action described in §§ 1.142–
2, 1.144–2, or 1.145–2.
(2) Exceptions—(i) Redemption. If
nonqualified bonds are redeemed within
90 days of a deliberate action under
§ 1.145–2(a) or within 90 days of the
date on which a failure to properly use

34

proceeds occurs under § 1.142–2 or
§ 1.144–2, sections 150(b)(3) through
(5) do not apply during the period
between that date and the date on which
the nonqualified bonds are redeemed.
(ii) Alternative qualifying use of facility. If a bond-financed facility is used
for an alternative qualifying use under
§§ 1.145–2 and 1.141–12(f), sections
150(b)(3) and (5) do not apply because
of the alternative use.
(iii) Alternative use of disposition
proceeds. If disposition proceeds are
used for a qualifying purpose under
§§ 1.145–2 and 1.141–12(e), 1.142–
2(c)(4), or 1.144–2, sections 150(b)(3)
through (5) do not apply because of the
deliberate action that gave rise to the
disposition proceeds after the date on
which all of the disposition proceeds
have been expended on the qualifying
purpose. If all of the disposition proceeds are so expended within 90 days of
the date of the deliberate action, however, sections 150(b)(3) through (5) do
not apply because of the deliberate
action.
(c) Allocation rules—(1) In general.
If a change in use of a portion of the
property financed with an issue of qualified private activity bonds causes section 150(b)(3), (b)(4), or (b)(5) to apply
to an issue, the bonds of the issue
allocable to that portion under section
150(c)(3) are the same as the nonqualified bonds determined for purposes of
§§ 1.142–1, 1.144–1, and 1.145–1, except that bonds allocable to all common
areas are also allocated to that portion.
(2) Special rule when remedial action
is taken. If an issuer takes a remedial
action with respect to an issue of private
activity bonds under §§ 1.142–2,
1.144–2, or 1.145–2, the bonds of the
issue allocable to a portion of property
are the same as the nonqualified bonds
determined for purposes of those sections.
(d) Effective dates. For effective dates
of this section, see § 1.141–16.
PART 602—OMB CONTROL
NUMBERS UNDER THE
PAPERWORK REDUCTION ACT
Par. 14. The authority citation for
part 602 continues to read as follows:
Authority: 26 U.S.C. 7805.
Par. 15. In § 602.101, paragraph (c)
is amended by adding entries in numerical order to the table to read as follows:

§ 602.101 OMB Control numbers.
*

*

*

*

*

(c) * * *
CFR part or section
where identified and
described
*
1.141–1
1.141–12
1.142–2
*
1.148–6
*

*

*

*

*

*

*

Current OMB
control No.
*
*
1545–1451
1545–1451
1545–1451
*
*
1545–1451
*
*

Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved December 30, 1996.
Donald C. Lubick,
Acting Assistant Secretary of the
Treasury.
(Filed by the Office of the Federal Register on
January 10, 1997, 8:45 a.m., and published in the
issue of the Federal Register for January 16, 1997,
62 F.R. 2275.)

Section 338.—Certain Stock
Purchases Treated as Asset
Acquisitions
26 CFR 1.338(b)–2T: Allocation of adjusted
grossed-up basis among target assets (temporary).

T.D. 8711
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Intangibles Under Sections 1060
and 338
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final and temporary regulations.
SUMMARY: This document amends the
temporary regulations under sections
1060 and 338(b) of the Internal Revenue
Code (Code) relating to purchase price
allocations in taxable asset acquisitions
and deemed asset purchases. The
amendments revise the treatment of intangible assets in such acquisitions to
take into account the enactment of section 197 by the Omnibus Budget Reconciliation Act of 1993. This document
also makes conforming amendments to
the final regulations under section 338.
The regulations provide guidance regarding taxable asset acquisitions and
deemed asset purchases resulting from

elections under section 338. The text of
the temporary regulations herein also
serves as the text of REG–252665–96.
EFFECTIVE DATE: These regulations
are effective February 14, 1997.
For dates of applicability, see
§§ 1.338(b)–2T(c)(4) and 1.1060–
1T(a)(2)(ii).
FOR FURTHER INFORMATION CONTACT: Brendan P. O’Hara, Office of
Assistant Chief Counsel (Corporate),
(202) 622–7530 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
These regulations amend the current
temporary regulations under sections
1060 (§ 1.1060–1T) and 338(b)
(§§ 1.338(b)–2T and 1.338(b)–3T) (the
current regulations) with respect to the
treatment of acquired intangible assets.
They also amend related examples in
the final regulations under section 338.
Section 1060 provides for the allocation
of purchase price among the assets of a
trade or business under regulations. Section 338(b) provides for a similar allocation, also under regulations, for a
deemed purchase of assets under section
338. The current regulations employ a
residual method of allocation. The legislative history of section 1060, adopted
in 1986, noted with approval the use of
the residual method under the section
338(b) regulations and required that the
same method be used pursuant to regulations to be prescribed under section
1060. S. Rep. No. 99–313, 99th Cong.,
2d Sess. 253, 254 (1986); 1986–3 C.B.
Vol. 3, 253–54.
The current regulations place each
acquired asset into one of four asset
classes. The purchase price is allocated
among the classes in priority order. No
asset in any class except for the last
class is allocated more than its fair
market value. If the aggregate purchase
price allocable to a particular class is
less than the aggregate fair market value
of the assets within the class, each asset
is allocated an amount in proportion to
its fair market value and nothing is
allocated to any junior class.
The four classes under the current
regulations are as follows:
Class I—Cash and cash equivalents;
Class II—Certificates of deposit, U.S.
government securities, readily marketable stock or securities, and foreign
currency;

35

Class III—All assets not in Class I, II,
or IV; and
Class IV—Intangible assets in the nature
of goodwill and going concern value.
Section 197 was enacted as part of
the Omnibus Budget Reconciliation Act
of 1993, Public Law 103–66, 107 Stat.
312 (1993) (the 1993 Act). Prior to the
1993 Act, acquired goodwill and going
concern value were not amortizable, but
other acquired intangible assets were
amortizable if they could be separately
identified and their useful lives determined with reasonable accuracy. Section
197 responded to policy and administrative concerns regarding the treatment of
acquired intangibles by providing similar treatment for goodwill, going concern value, and certain other intangible
assets acquired in a taxable acquisition
and held in connection with a trade or
business. The 1993 Act allows taxpayers
to amortize certain acquired intangible
assets (amortizable section 197 intangibles) over 15 years, subject to certain
exceptions.
The report of the House Committee
on Ways and Means accompanying the
1993 Act states that:
It is expected that the present [regulations under sections 338 and 1060] will
be amended to reflect the fact that
[section 197] allows an amortization
deduction with respect to intangible assets in the nature of goodwill and going
concern value. It is anticipated that the
residual method specified in the regulations will be modified to treat all amortizable section 197 intangibles as Class
IV assets and that this modification will
apply to any acquisition of property to
which [section 197] applies.
H.R. Rep. 111, 103d Cong., 1st Sess.
760, 776 (May 23, 1993), 1993–3 C.B.
336, 352.
The current regulations have not yet
been amended in accordance with the
legislative history of section 197. These
new temporary regulations accomplish
that change, with slight modifications,
as discussed below.
Explanation of Provisions
The temporary and final regulations
are amended to conform to the legislative history of the 1993 Act by placing
all amortizable section 197 intangibles
other than goodwill and going concern
value in Class IV.
However, the new regulations also
include nonamortizable section 197 intangibles in Class IV. Some section 197

intangibles are amortizable by the buyer
though they were not amortizable by the
seller. Other section 197 intangibles may
not be amortizable because of the application of the anti-churning rules of
section 197(f)(9). Although sections
338(b) and 1060 do not require conformity between the buyer and seller on
purchase price allocations, they reflect
strong policies encouraging conformity,
including mandatory application of the
rule of Commissioner v. Danielson, 378
F.2d 771 (3d Cir. 1967), cert. denied,
389 U.S. 858 (1967), in cases where the
parties have agreed to an allocation, and
a reporting system designed to reveal
situations where the parties’ allocations
are inconsistent. These policies favoring
conformity are best served by requiring
both parties to include the same assets
in each class. Moreover, this rule is also
more consistent with section 1060(b) as
amended by the 1993 Act. Section
1060(b)(1) requires the parties to report,
under regulations, ‘‘the amount of consideration received for the assets which
is allocable to section 197 intangibles.’’
The term section 197 intangibles is
more inclusive than amortizable section
197 intangibles. The goals of consistency, simplification, and administrability will be better achieved with respect
to allocations to section 197 intangibles
if all such assets are removed from
Class III and isolated in a junior class
(or classes). Accordingly, these regulations classify all section 197 intangibles
(other than goodwill and going concern
value) as Class IV assets.
To reconcile the original intention of
Congress in requiring the residual
method of allocation for goodwill and
going concern value with the legislative
history of the 1993 Act, these regulations provide that goodwill and going
concern value will be assigned to a true
residual class, Class V. This method is
consistent with the policies of section
197 (which regards many intangible assets as the functional equivalent of
goodwill and going concern value and
thus treats them uniformly) as well as
the original intention of the Tax Reform
Act of 1986, Public Law 99–514, 100
Stat. 2085 (1986) (that goodwill and
going concern value not be valued separately for purchase price allocation purposes). Allocating goodwill and going
concern value to Class V avoids the
need for determining the value of goodwill and going concern value through a
non-residual method. Although this approach places some section 197 intangibles in Class V instead of Class IV, it

carries out the expectation set forth in
the legislative history of the 1993 Act
by making section 197 intangibles junior
to all other assets in the allocation
scheme. The practical significance of
placing goodwill and going concern
value in Class V is generally limited to
circumstances in which fewer than all of
the amortizable section 197 intangibles
acquired in a single transaction are
subsequently disposed of at a gain.
Those situations, in any case, require
some method of allocation among the
intangibles.
Effective Date
These regulations are effective for
applicable asset acquisitions, as defined
in section 1060(c), completed on or after
February 14, 1997, and for acquisition
dates, as defined in section 338(h)(2),
on or after February 14, 1997.
As described above, the current regulations have been in conflict with the
1993 Act legislative history concerning
the classification of amortizable section
197 intangibles other than goodwill and
going concern value since August 10,
1993, generally (the date of enactment
of section 197), and, in some cases,
since 1991.
The legislative history to the 1993
Act clearly contemplates that changes to
the classification system would be made
by amended regulations. In the absence
of such amendments, the only system
available under regulations was the fourclass system established before the enactment of section 197. Further, the IRS
revised Form 8594, Asset Acquisition
Statement under Section 1060, in January of 1996 in a manner consistent with
the legislative history, i.e., by placing all
amortizable section 197 intangibles in
Class IV. For acquisition dates before
February 14, 1997, if section 197 applies to any asset acquired or deemed
acquired, the taxpayer (and all related
parties) may consistently (in all transactions in which AGUB, ADSP, MADSP,
or consideration must be allocated under
section 338 or 1060)—
(i) apply these new rules in full as
written;
(ii) apply the current temporary regulations as written; or
(iii) apply the current temporary
regulations as written, but treat all amortizable section 197 intangibles as Class
IV assets.

36

Special Analyses
It has been determined that this Treasury decision is not a significant regulatory action as defined in EO 12866.
Therefore, a regulatory assessment is not
required. It also has 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. Pursuant to section 7805(f) of the Code, these
regulations will be submitted to the
Chief Counsel for Advocacy of the
Small Business Administration for comment on their impact on small business.
Drafting Information
The principal author of these regulations is Brendan P. O’Hara, Office of
the Assistant Chief Counsel (Corporate),
IRS. However, other personnel from the
IRS and Treasury Department participated in their development.
*

*

*

*

*

Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is
amended as follows:
PART 1—INCOME TAXES
Paragraph 1. The authority citation for
part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In § 1.338–0, entries for
§ 1.338(b)–2T(b)(2)(v) and § 1.338(b)–
2T(c)(4) are added to read as follows:
§ 1.338–0 Outline of topics.
*

*

*

*

*

§ 1.338(b)–2T Allocation of adjusted
grossed-up basis among target assets
(temporary).
*

(b)
(2)
(v)
(c)
(4)

*

*

*

*

*

*

***
***
Class V assets.
***
Effective dates.
*

*

*

Par. 3. Section 1.338–3 is amended
by:
1. Revising paragraph (b)(4).
2. Revising paragraph (d)(8)(ii) Example 1, paragraph (e); Example 2,
paragraphs (a), (b), and (d); Example 3,

paragraph (d); and Example 4, paragraphs (d) and (f). The revisions read as
follows:
§ 1.338–3 Deemed sale and aggregate
deemed sale price.
*

*

*

*

*

(b) * * *
(4) Classes of assets. The classes of
assets are defined in § 1.338(b)–2T(b).
*

*

*

*

*

(d) * * *
(8) * * *
(ii) * * *
Example 1. * * *
(e) The facts are the same as in paragraph (a) of
this Example 1, except that T also has goodwill (a
Class V asset) with an appraised value of $10,000.
The results are the same as in paragraphs (b) and
(c) of this Example 1. Because the ADSP does not
exceed the fair market value of the Class III asset,
no amount is allocated to the Class V assets
(assets in the nature of goodwill and going
concern value).
Example 2. * * *
(a) P purchases all of the T stock for $140,000.
On July 1 of Year 1, T has liabilities (not
including the tax liability for deemed sale gain of
its assets) of $50,000, cash (a Class I asset) of
$10,000, readily marketable securities (a Class II
asset) with a basis of $4,000 and a fair market
value of $10,000, goodwill (a Class V asset) with
a basis of $3,000, and the following Class III
assets:
Asset

Basis

FMV Ratio

1. Land . . . . . . . . . . . . $ 5,000 $ 35,000 .14
Inventory . . . . . . . . .
10,000
50,000 .20
Equipment A
5,000
90,000 .36
(recomputed basis
$80,000) . . . . . . . . .
4. Equipment B
10,000
75,000 .30
(recomputed basis
$20,000) . . . . . . . . .
Totals. . . . . . . . . . . . $30,000 $250,000 1.00
(b) The ADSP exceeds $20,000. Thus, $10,000
of the ADSP is allocated to the cash and $10,000
to the marketable securities. Except as provided in
section 7701(g), the amount allocated to an asset
(other than a Class V asset) cannot exceed its fair
market value. See § 1.338(b)–2T(c)(1) (relating to
fair market value limitation).
*
*
*
*
*
(d) Because, under the preliminary calculations
of the ADSP, the amount to be allocated to the
Class I, II, III, and IV assets does not exceed their
aggregate fair market value, no ADSP amount is
allocated to goodwill. Accordingly, the deemed
sale of the goodwill results in a capital loss of
$3,000. The portion of the ADSP allocable to the
Class III assets is finally determined by taking into
account this loss as follows:
ADSPIII = (G ⫺ (I + II)) + L + TR × [(II ⫺ BII) +
(ADSPIII ⫺ BIII) + (ADSPV ⫺ BV)]
ADSPIII = ($140,000 ⫺ ($10,000 + $10,000)) +
$50,000 + .34 × [($10,000 ⫺ $4,000) + (ADSPIII
⫺ $30,000) + ($0 ⫺ $3,000)]
ADSPIII = $160,820 + .34ADSPIII
.66ADSPIII = $160,820
ADSPIII = $243,666.67
*
*
Example 3. * * *

(d)(1) Based on the preliminary allocation, the
ADSP is determined as follows: (In the formula,
the amount allocated to the Class I assets is
referred to as I, the amount allocated to the Class
II assets as II, and the amount allocated to the
Class III assets as III.)
ADSP = G + L + TR × [(II ⫺ BII) + (III ⫺ BIII) +
(ADSP ⫺ (I + II + III + BV))]
ADSP = $150,000 + $50,000 + .34 × [($10,000 ⫺
$4,000) + ($250,000 ⫺ $30,000) + (ADSP ⫺
($10,000 + $10,000 + $250,000 + $3,000))]
ADSP = $200,000 + .34ADSP ⫺ $15,980
.66ADSP = $184,020
ADSP = $278,818.18
(2) Because the ADSP as determined exceeds
the aggregate fair market value of the Class I, II,
III, and IV assets, the $250,000 amount preliminarily allocated to the Class III assets is appropriate. Thus, the amount of the ADSP allocated to
Class III assets equals their aggregate fair market
value ($250,000), and the allocated ADSP amount
for each Class III asset is its fair market value.
Further, because there are no Class IV assets, the
allocable ADSP amount for the Class V asset
(goodwill) is $8,818.18 (the excess of the ADSP
over the aggregate ADSP amounts for the Class I,
II, and III assets).
Example 4. * * *
(d) Because the portion of the preliminary
ADSP allocable to Class III assets ($243,666.67)
does not exceed their fair market value
($250,000), no amount is allocated to Class V
assets for T. Further, this amount ($243,666.67) is
allocated among T’s Class III assets in proportion
to their fair market values. See paragraph (e) of
Example 2. Tentatively, $48,733.34 of this amount
is allocated to the T1 stock.
*
*
*
*
*
(f) The facts are the same as in paragraph (a) of
this Example 4, except that the T1 inventory has a
$12,500 basis and a $62,500 value, the T1 stock
has a $62,500 value, and T owns 80% of the T1
stock. In preliminarily calculating ADSPIII, the T1
stock can be disregarded but, because T owns only
80% of the T1 stock, only 80% of T1 asset basis
and value should be taken into account in calculating T’s ADSP. By taking into account 80% of
these amounts, the remaining calculations and
results are the same as in paragraphs (b), (c), (d),
and (e) of this Example 4, except that the
grossed-up basis in T’s recently purchased T1
stock is $44,455.00 ($35,564.00/0.8).

Par. 4. Section 1.338(b)–2T is
amended by:
1. Revising paragraphs (b)(2), (c)(1),
and (c)(3)(iii).
2. Adding paragraph (c)(4).
3. Revising paragraph (d) Example 1,
paragraphs (vi) and (x) through (xiii).
4. Revising paragraph (d) Example 2,
paragraphs (vi) through (viii).
The revisions and addition read as follows:
§ 1.338(b)–2T Allocation of adjusted
grossed-up basis among target assets
(temporary).
*

*

*

*

*

*

*

*

(b) * * *
(2) Other assets—(i) In general.
Subject to the limitations and other

37

special rules of paragraph (c) of this
section, adjusted grossed-up basis (as
reduced by Class I assets) is allocated
among Class II assets of target held at
the beginning of the day after the acquisition date in proportion to their fair
market values at such time, then among
Class III assets so held in such proportion, then among Class IV assets so held
in such proportion, and finally to Class
V assets.
(ii) Class II assets. Class II assets are
certificates of deposit, U.S. Government
securities, readily marketable stock or
securities (within the meaning of
§ 1.351–1(c)(3)), foreign currency, and
other items designated in the Internal
Revenue Bulletin by the Internal Revenue Service.
(iii) Class III assets. Class III assets
are all assets of target other than Class
I, II, IV, and V assets.
(iv) Class IV assets. Class IV assets
are all section 197 intangibles, as defined in section 197, except those in the
nature of goodwill and going concern
value.
(v) Class V assets. Class V assets are
section 197 intangibles in the nature of
goodwill and going concern value.
(c) * * *
(1) Basis not to exceed fair market
value. The amount of adjusted
grossed-up basis allocated to an asset
(other than Class V assets) shall not
exceed the fair market value of that
asset at the beginning of the day after
the acquisition date. For modification of
this fair market value limitation with
respect to certain contingent income
assets, see § 1.338(b)–3T(g).
*

*

*

*

*

(3) * * *
(iii) Allocation of adjusted grossed-up
basis. Subject to the limitations in paragraphs (c)(1) and (2) of this section,
adjusted grossed-up basis (after reduction by the amount of Class I assets) is
allocated among Class II, III, IV, and V
assets of target held at the beginning of
the day after the acquisition date in
proportion to their fair market values at
such time. For this purpose, the fair
market value of Class V assets is
deemed to be the excess, if any, of the
hypothetical purchase price over the
sum of the amount of the Class I assets
and the fair market values of the Class
II, III, and IV assets.
(4) Effective dates. This section applies for acquisition dates on or after
February 14, 1997. For acquisition dates
before February 14, 1997, if section 197
does not apply to any asset deemed

acquired, the provisions of the regulations in effect before February 14, 1997,
apply (see § 1.338(b)–2T as contained
in 26 CFR part 1 revised April 1, 1996).
For acquisition dates before February
14, 1997, if section 197 applies to any
asset deemed acquired, the taxpayer
(and all related parties) may consistently
(in all transactions in which AGUB,
ADSP, MADSP, or consideration must
be allocated under section 338 or
1060)—
(i) Apply the provisions of this section;
(ii) Apply the provisions of this section as in effect before February 14,
1997 (see § 1.338(b)–2T as contained in
26 CFR part 1 revised April 1, 1996); or
(iii) Apply the provisions of this section as in effect before February 14,
1997 (see § 1.338(b)–2T as contained in
26 CFR part 1 revised April 1, 1996),
but treat all amortizable section 197
intangibles as Class IV assets.
(d) * * *
Example 1. * * *
(vi) T has no Class IV assets. The amount
allocated to T’s Class V assets (assets in the nature
of goodwill and going concern value) is $150, i.e.,
$2,500 ⫺ $2,350.
*
*
*
*
*
(x) Assume that at the beginning of the day
after the acquisition date, T1’s cash and the fair
market values of its Class III and IV assets are as
follows:
Asset
Class
I
III
IV

Asset

Fair Market
Value

Cash. . . . . . . . . . . . . . . . . . .
$ 50*
Equipment . . . . . . . . . . . . . .
200
Patent. . . . . . . . . . . . . . . . . .
350
Total . . . . . . . . . . . . . . . . . .
$ 600
* Amount
(xi) The amount of AGUB allocable to T1’s
Class III and IV assets is first reduced by the $50
of cash.
(xii) Since the remaining amount of AGUB
($570) is an amount which exceeds the fair market
value of T1’s only Class III asset, the equipment,
the amount allocated to the equipment is its fair
market value ($200). After that, the remaining
amount of AGUB ($370) exceeds the fair market
value of T1’s only Class IV asset, the patent.
Thus, the amount allocated to the patent is its fair
market value ($350).
(xiii) The amount allocated to T1’s Class V
assets (assets in the nature of goodwill and going
concern value) is $20, i.e., $570 ⫺ $550.
Example 2. * * *
(vi) The amount of AGUB ($2,700) available to
allocate to T’s assets is reduced by the amount of
cash to $2,500, i.e., $2,700 ⫺ $200. This $2,500
balance is then allocated among the Class II, III,
IV, and V assets in proportion to, and not in
excess of, their fair market values (as determined
under § 1.338(b)–2T(c)(3)(iii)).
(vii) Under paragraph (c)(3) of this section, the
fair market value of the Class V assets is deemed
to be $150, i.e., the $3,000 hypothetical purchase
price minus $2,850 (the sum of T’s cash, $200,

and the fair market value of its Class II, III, and
IV assets, $2,650). The allocation is as follows:
Portfolio of marketable securities . . . . . . $ 268*
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . .
268
Accounts receivable . . . . . . . . . . . . . . . . .
536
Building . . . . . . . . . . . . . . . . . . . . . . . . . .
714
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
178
Investment in T1 . . . . . . . . . . . . . . . . . . .
402
Goodwill and going concern value . . . . .
134
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
* All numbers rounded for convenience.
(viii) If the AGUB of T is increased (or decreased) as a result of a subsequent adjustment,
the hypothetical purchase price and the deemed
fair market value of the Class V assets shall be
redetermined and the increase (or decrease) in
AGUB shall be allocated among T’s acquisition
date assets pursuant to § 1.338(b)–3T(f). The
increase (or decrease) in AGUB is allocated
pursuant to § 1.338(b)–3T(f) even if the hypothetical purchase price, as redetermined, no longer
exceeds AGUB, as redetermined.

Par. 5. Section 1.338(b)–3T is
amended by:
1. Revising paragraphs (e)(1), (f)(1),
and (f)(2).
2. In paragraph (j), redesignating Example (1) through Example (8) as Example 1 through Example 8.
3. Revising the following newly designated examples in paragraph (j): Example 1; Example 2; Example 3, paragraph (i) and paragraphs (v) through
(vii); and Example 6 through Example 8.
The revisions read as follows:
§ 1.338(b)–3T Subsequent adjustments
to adjusted grossed-up basis (temporary).
*

*

*

*

*

(e) * * *
(1) In general. If adjusted grossed-up
basis was allocated in accordance with
the rules of § 1.338(b)–2T(b)(2), a decrease in adjusted gross-up basis (as
determined under paragraph (c)(3) of
this section) is allocated in the following
order: first, as a reduction in the bases
of target’s Class V acquisition date
assets, second, as a reduction of the
bases of target’s Class IV acquisition
date assets in proportion to their fair
market values at the beginning of the
day after the acquisition date, third, as a
reduction of the bases of target’s Class
III acquisition date assets in proportion
to their fair market values at the beginning of the day after the acquisition
date, and finally, as a reduction of the
bases of target’s Class II acquisition
date assets in proportion to their fair
market values at the beginning of the
day after the acquisition date. The decrease in adjusted grossed-up basis allocated to an asset shall not exceed the
adjusted grossed-up basis of target previously allocated to that asset. If ad-

38

justed grossed-up basis was allocated
among target’s assets pursuant to
§ 1.338(b)–2T(c)(3), a decrease in adjusted grossed-up basis (as determined
under paragraph (c)(3) of this section) is
accounted for in accordance with the
rules of paragraph (f) of this section.
*

*

*

*

*

(f) * * *
(1) Scope. This paragraph (f) applies
if adjusted grossed-up basis was allocated among new target’s Class II, III,
IV, and V assets in accordance with
§ 1.338(b)–2T(c)(3) and an adjustment
event occurs after the close of the new
target’s first taxable year.
(2) Allocation of increases (decreases) in adjusted grossed-up basis. If
an adjustment event after the close of
new target’s first taxable year increases
(or decreases) adjusted grossed-up basis,
the following items shall be redetermined, taking into account such adjustment event: the hypothetical purchase
price, the deemed fair market value of
Class V assets, and the adjusted
grossed-up basis allocable to each acquisition date asset under § 1.338(b)–
2T(c)(3) (the redetermined (c)(3)
amount). (The redetermination of the
deemed fair market value of Class V
assets under this paragraph (f)(2) is
made by taking into account the target’s
Class I assets and the fair market values
of its Class II, III, and IV assets at the
beginning of the day after the acquisition date.) If the redetermined (c)(3)
amount for an acquisition date asset
exceeds the amount of adjusted
grossed-up basis previously allocated to
such asset (taking into account prior
adjustments under this paragraph (f)), an
amount of adjusted grossed-up basis
equal to such excess shall be allocated
to such asset. If the amount of the
adjusted grossed-up basis previously allocated to an acquisition date asset (taking into account prior adjustments under
this paragraph (f)) exceeds the redetermined (c)(3) amount for that asset, an
amount equal to such excess shall be
allocated as a reduction in the basis of
such asset. The rules of paragraph (d)(2)
of this section (or paragraph (e)(2) of
this section) apply for the treatment of
amounts allocable under this paragraph
(f) to an acquisition date asset that has
been disposed of, depreciated, amortized, or depleted.
*

*

*

*

*

(j) * * *
Example 1. (i)(A) T’s assets other than goodwill
and going concern value, and their fair market

values at the beginning of the day after the
acquisition date, are as follows:

Asset
Class

Asset
Class

III
III
V

Asset

Fair Market
Value

III
III

Building . . . . . . . . . . . . . . .
$100
Stock of X (not a target) . .
200
Total . . . . . . . . . . . . . . . . . .
$300
(B) T has no liabilities other than a contingent
obligation and T does not use the elective formula
under section 338(h)(11).
(ii)(A) On September 1, 1997, P purchases all
of the outstanding stock of T for $270 and makes
an express election for T. The grossed-up basis of
the T stock and T’s adjusted grossed-up basis
(AGUB) are both $270. The AGUB is ratably
allocated among T’s Class III assets in proportion
to their fair market values as follows:
Asset

Basis

Building ($270 x 100/300) . . . . . .
$ 90
Stock ($270 x 200/300) . . . . . . . . .
180
Total . . . . . . . . . . . . . . . . . . . .
$270
(B) No amount is allocated to the Class V
assets. New T is a calendar year taxpayer. Assume
that the X stock is a capital asset in the hands of
new T.
(iii) On January 1, 1998, new T sells the X
stock and uses the proceeds to purchase inventory.
(iv) On June 30, 1999, the contingent liability
of old T becomes fixed and determinable. The
amount of the liability is $60.
(v) T’s AGUB increases by $60 from $270 to
$330. This $60 increase in AGUB is first allocated
among T’s acquisition date assets in accordance
with the provisions of § 1.338(b)–2T. Since the
redetermined AGUB for T ($330) exceeds the sum
of the fair market values at the beginning of the
day after the acquisition date of the Class III
acquisition date assets ($300), AGUB allocated to
those assets is limited to those fair market values
under § 1.338(b)–2T(c)(1). As there are no Class
IV assets, the remaining AGUB of $30 is allocated
to goodwill and going concern value (Class V
assets). The amount of increase in AGUB allocated to each acquisition date asset is determined
as follows:

Asset

Rede- Increase
Original termined
in
AGUB AGUB
AGUB

Building . . . . . . . . .
$ 90
$100
$10
X Stock . . . . . . . . . .
180
200
20
Goodwill and going
concern value . . .
0
30
30
Total . . . . . . . .
$270
$330
$60
(vi) Since the X stock was disposed of before
the contingent liability became fixed and determinable, no amount of the increase in AGUB attributable to such stock may be allocated to any T asset.
Rather, such amount, $20, is allowed as a capital
loss to T for the taxable year 1999 under the
principles of Arrowsmith v. Commissioner, 344
U.S. 6 (1952). In addition, the $10 increase in
AGUB allocated to the building and the $30
increase in AGUB allocated to the goodwill and
going concern value are treated as basis redeterminations in 1999. See paragraph (d)(2) of this
section.
Example 2. (i) On January 1, 1998, P purchases
all of the outstanding stock of T and makes an
express election for T. T does not use the elective
formula under section 338(h)(11). Assume that the
AGUB of T is $500 and is allocated among T’s
acquisition date assets as follows:

Asset

Basis

Machinery . . . . . . . . . . . . . . . . .
$150
Land . . . . . . . . . . . . . . . . . . . . .
250
Goodwill and going concern
value . . . . . . . . . . . . . . . . . . .
100
Total . . . . . . . . . . . . . . . . . . . . .
$500
(ii) On September 30, 1998, P filed a claim
against the selling shareholders of T in a court of
appropriate jurisdiction alleging fraud in the sale
of the T stock.
(iii) On January 1, 2007, the former shareholders refund part of the purchase price to P in a
settlement of the lawsuit. This refund results in a
decrease of T’s AGUB of $140.
(iv) Under paragraph (e)(1) of this section, the
decrease in AGUB is allocated among T’s acquisition date assets. First, because $100 was originally
allocated to the Class V assets, $100 of the
decrease is allocated to those assets. As there were
no Class IV assets acquired, the remaining decrease in AGUB ($40) is allocated to the Class III
assets in proportion to their fair market values at
the beginning of the day after the acquisition date.
Thus, $15 is allocated to the machinery ($40 x
150/$400) and $25 to the land ($40 x 250/$400).
(v) Assume that, as a result of deductions under
section 168, the adjusted basis of the machinery
immediately before the decrease in AGUB is zero.
The machinery is treated as if it were disposed of
before the decrease is taken into account. In 2007,
T recognizes income of $15, the character of
which is determined under the principles of Arrowsmith v. Commissioner, 344 U.S. 6 (1952), and
the tax benefit rule. No adjustment to the basis of
T’s assets is made for any tax paid on this
amount. Assume also that, as a result of amortization deductions, the adjusted basis of the goodwill
and going concern value immediately before the
decrease in AGUB is $40. A similar adjustment to
income is made in 2007 with respect to the $60 of
previously amortized goodwill and going concern
value.
(vi) In summary, the basis of T’s acquisition
date assets, as of January 1, 2007, is as follows:
Asset

Basis

Machinery . . . . . . . . . . . . . . . . . . . .
$ 0
Land . . . . . . . . . . . . . . . . . . . . . . . .
225
Goodwill and going concern value
0
Example 3. (i) Assume that the facts are the
same as Example 2 of § 1.338(b)–2T(d) except
that the recently purchased stock is acquired for
$1,600 plus additional payments that are contingent upon T’s future earnings. Thus, T’s AGUB,
determined as of the beginning of the day after the
acquisition date (after reduction by T’s cash of
$200), is $2,500 and is allocable among T’s Class
II, III, IV, and V acquisition date assets pursuant
to § 1.338(b)–2T(c)(3)(iii) as follows:
Portfolio of marketable securities . . . . . . $ 268*
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . .
268
Accounts receivable . . . . . . . . . . . . . . . . .
536
Building . . . . . . . . . . . . . . . . . . . . . . . . . .
714
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
178
Investment in T1 . . . . . . . . . . . . . . . . . . .
402
Goodwill and going concern value . . . . .
134
Total . . . . . . . . . . . . . . . . . . . . . . . . . $2,500
* All numbers rounded for convenience.
*
*
*
*
*
(v) Under § 1.338(b)–2T(c)(3) the redetermined
fair market value of Class V assets is deemed to
be $400, i.e., the hypothetical purchase price, as
redetermined, of $3,250 minus $2,850 (the sum of
T’s cash, $200, and the fair market values of its
Class II, III, and IV assets, $2,650).

39

(vi) The amount of AGUB available to allocate
to T’s Class II, III, IV, and V acquisition date
assets is $2,700 (i.e., redetermined AGUB reduced
by cash). AGUB allocable to each of T’s acquisition date assets (i.e., the redetermined (c)(3)
amount) is redetermined using the deemed fair
market value of the Class V assets from paragraph
(v) of this Example as follows:
Portfolio of marketable securities . . . . . . $ 266*
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . .
266
Accounts receivable . . . . . . . . . . . . . . . . .
531
Building . . . . . . . . . . . . . . . . . . . . . . . . . .
708
Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
177
Investment in T1 . . . . . . . . . . . . . . . . . . .
398
Goodwill and going concern value . . . . .
354
Total . . . . . . . . . . . . . . . . . . . . . . . . . $2,700
* All numbers rounded for convenience.
(vii) As illustrated by this example, the application of paragraph (f) of this section results in a
basis increase for some assets and a basis decrease
for other assets. The amount of increase (or
decrease) in AGUB allocated to each acquisition
date asset is determined as follows:

Asset
Portfolio of marketable securities. . .
Inventory . . . . . . . . .
Accounts receivable
Building . . . . . . . . .
Land . . . . . . . . . . . .
Investment in T1 . .
Goodwill and going
concern value . . .
Total . . . . . . . . . . . .

Redetermined
Original (c)(3)
AGUB Amount

Increase
(or Decrease)
in
AGUB

$ 268
268
536
714
178
402

$ 266
266
531
708
177
398

$ (2)
(2)
(5)
(6)
(1)
(4)

134
$2,500

354
$2,700

220
$200

*
*
*
*
*
Example 6. (i)(A) T has three assets (other than
goodwill and going concern value) whose fair
market values as of the beginning of the day after
the acquisition date are as follows:
Asset
Class

Asset

Fair Market
Value

III
III
IV

Building . . . . . . . . . . . . . . .
$100
Equipment . . . . . . . . . . . . . .
50
Secret process . . . . . . . . . . .
50
Total . . . . . . . . . . . . . . . . . .
$200
(B) The secret process is a section 197 intangible. T has no liabilities. Assume that no election
under section 338(h)(10) or (h)(11) is in effect.
(ii) On January 1, 1998, P purchases all of the
outstanding T stock for $225 plus 50 percent of
the net profits generated by the secret process for
each of the next three years, determinable and
payable on January 1 of each following year. P
and T are calendar year taxpayers.
(iii) As of the beginning of January 2, 1998,
T’s AGUB is $225, allocated as follows:
Asset
Class
III
III
IV
V

Asset

Basis

Building . . . . . . . . . . . . . . . . . .
$100
Equipment . . . . . . . . . . . . . . . . .
50
Secret process . . . . . . . . . . . . . .
50
Goodwill and going concern
value . . . . . . . . . . . . . . . . . . .
25
Total . . . . . . . . . . . . . . . . . . . . .
$225
(iv) On January 1, 1999, $5 is paid by P for the
T stock by reason of the net profits from the
secret process. The payments are not attributable

in any respect to any of T’s other acquisition date
assets. As a result, T’s AGUB on January 1, 1999
is increased by $5.
(v) Assume that on January 1, 1999, the fair
market value of the secret process is redetermined
to be $52. (For purposes of this redetermination,
only those circumstances that resulted in the
increase to AGUB are taken into account.)
(vi) On January 1, 1999, only $2 of the $5
increase in AGUB is allocated to the secret
process because the increase in AGUB so allocated cannot increase the basis of the secret
process above its redetermined fair market value
($52). The balance of the increase is allocated to
goodwill and going concern value because the fair
market value limitation of § 1.338(b)–2T(c)(1)
precludes allocating additional AGUB to the Class
III and IV assets.
(vii) The price for which old target is deemed
to have sold the secret process is increased to
reflect the $2 increase allocated to its basis to new
target. See § 1.338–3(d) and paragraph (h)(1) of
this section.
(viii) If the fair market value of the secret
process as of January 1, 1999, is unchanged from
the fair market value as of the beginning of the
day after the acquisition date, then the $5 increase
in AGUB is allocated to T’s goodwill and going
concern value.
Example 7. (i) The facts are the same as in
Example 6 except that—
(A) The secret process is valued at $75 as of
the beginning of the day after the acquisition date;
and
(B) P pays $250 for the T stock and the former
T shareholders agree to refund a portion of the
purchase price to P for each of the three years that
the net income from the secret process is less than
$15 per year, determinable and payable on January
1 of the next year.
(ii) Assume that the secret process in the hands
of new T is an amortizable section 197 intangible
and, therefore, on January 1, 1999, new T’s
adjusted basis in the secret process is $70 (i.e.,
$75–$5 of allowable amortization).
(iii) Assume the net income from the process is
less than $15 for 1998, and on January 1, 1999, P
receives a refund that reduces the stock purchase
price by $3.
(iv) Assume that as of January 1, 1999, the fair
market value of the secret process is redetermined
to be $65. (For purposes of this redetermination,
only those circumstances that resulted in the
decrease to AGUB are taken into account.)
(v) As of January 1, 1999, the AGUB of T is
decreased by $3. This decrease is allocated to the
secret process, the basis of which becomes $67
(i.e., $70–$3) and is amortizable over the remaining 14 years.
(vi) The price for which old target is deemed to
have sold the secret process is decreased to reflect
the $3 decrease allocated to its basis to new target.
See § 1.338–3(d) and paragraph (h)(1) of this
section.
Example 8. The facts are the same as in
Example 6 except that the intangible Class IV
asset is a patent instead of a secret process. The
redetermination of the fair market value of the
patent on January 1, 1999, is made without regard
to the decrease in the remaining life of the patent
because that is not a circumstance that resulted in
the increase in AGUB.

Par. 6. Section 1.1060–1T is amended
by:
1. Designating the text of paragraph
(a)(2) following the heading as paragraph (a)(2)(i), adding a heading to

newly designated paragraph (a)(2)(i),
and adding paragraph (a)(2)(ii).
2. In paragraph (a)(3), revising the
outline of topics entries for (a)(2), (b)(2)
and (h)(3).
3. Revising the seventh sentence of
paragraph (b)(4).
4. Revising paragraphs (d)(2), (e)(1),
and (f)(3)(i).
5. Revising the following examples
in paragraph (g): Example 1; Example 2;
Example 3, paragraphs (i), (viii), and
(xi); and Example 4.
5. Revising paragraph (h)(3).
The additions and revisions read as
follows:
§ 1.1060–1T Special allocation rules for
certain asset acquisitions (temporary).
(a) * * *
(2) Effective date—(i) In general. * *
*
(ii) Allocation of consideration. Paragraphs (d) and (h)(3) of this section and
conforming amendments to other provisions of this section apply to applicable
asset acquisitions completed on or after
February 14, 1997. For applicable asset
acquisitions completed before February
14, 1997, if section 197 does not apply
to any of the acquired assets, the provisions of the regulations in effect before
February 14, 1997 apply (see § 1.1060–
1T as contained in 26 CFR part 1
revised April 1, 1996). For applicable
asset acquisitions completed before February 14, 1997, if section 197 applies to
any of the acquired assets, the taxpayer
(and related parties) may consistently (in
all transactions in which AGUB (as
defined in § 1.338(b)–1), ADSP (as defined in § 1.338–3), MADSP (as defined in § 1.338(h)(10)–1), or consideration must be allocated under section
338 or 1060)—
(A) Apply the provisions of this section;
(B) Apply the provisions of this section as in effect before February 14,
1997 (see § 1.1060–1T as contained in
26 CFR part 1 revised April 1, 1996); or
(C) Apply the provisions of this section as in effect before February 14,
1997 (see § 1.1060–1T as contained in
26 CFR part 1 revised April 1, 1996),
but treat all amortizable section 197
intangibles as Class IV assets.
(3) * * *
(a) * * *
(2) Effective date.
(i) In general.
(ii) Allocation of consideration.
*

*

*

40

*

*

(d) * * *
(2) Assets other than Class I assets.
(i) In general.
(ii) Class II assets.
(iii) Class III assets.
(iv) Class IV assets.
(v) Class V assets.
*

*

*

*

*

(h) * * *
(3) Interim procedures for Form
8594.
(b) * * *
(4) * * * The money and other
property that are treated as transferred in
exchange for the like-kind property (and
which are excluded from the assets to
which section 1060 applies) are considered to come from the following assets
in the following order: first from Class I
assets, then from Class II assets, then
from Class III assets, then from Class
IV assets, and then from Class V assets.
***
*

*

*

*

*

(d) * * *
(2) Assets other than Class I assets—
(i) In general. Subject to the limitations
and other special rules of paragraph (e)
of this section, consideration (as reduced
by the amount of Class I assets) is
allocated among Class II assets transferred by the seller in proportion to the
fair market values of such Class II
assets on the purchase date, then among
Class III assets transferred by the seller
in proportion to the fair market values
of such Class III assets on that date,
then among Class IV assets transferred
by the seller in proportion to the fair
market values of such Class IV assets
on that date, and finally to Class V
assets.
(ii) Class II assets. Class II assets are
certificates of deposit, U.S. government
securities, readily marketable stock or
securities (within the meaning of
§ 1.351–1(c)(3)), foreign currency, and
other items designated in the Internal
Revenue Bulletin by the Internal Revenue Service.
(iii) Class III assets. Class III assets
are all assets other than Class I, II, IV,
and V assets.
(iv) Class IV assets. Class IV assets
are all section 197 intangibles, as defined in section 197, except those in the
nature of goodwill and going concern
value.
(v) Class V assets. Class V assets are
section 197 intangibles in the nature of
goodwill and going concern value.
(e) * * *

(1) Allocation not to exceed fair market value. The amount of consideration
allocated to an asset (other than Class V
assets) shall not exceed the fair market
value of that asset on the purchase date.
*

*

*

*

*

(f) * * *
(3) * * *
(i) In general. A decrease in consideration is allocated in the following order:
first, as a reduction in the amount
previously allocated to Class V assets,
second, as a reduction in the amount
previously allocated to Class IV assets
in proportion to their fair market values,
third, as a reduction in the amount
previously allocated to Class III assets
in proportion to their fair market values,
and finally, as a reduction in the amount
previously allocated to Class II assets in
proportion to their fair market values.
Decreases in consideration allocated to
an asset shall not exceed the amount of
consideration previously allocated to
that asset. Except as provided in paragraph (f)(4)(ii) of this section (relating
to patents and similar property), the fair
market value is the fair market value on
the purchase date.
*

*

*

*

*

(g) * * *
Example 1. (i) On January 1, 1998, S, a sole
proprietor, sells to P, a corporation, a group of
assets which constitute a trade or business under
paragraph (b)(2) of this section. P pays S $2,000
in cash and assumes $1,000 in liabilities. Thus, the
total consideration is $3,000.
(ii) Assume that P acquires no Class I assets
and that on the purchase date, the fair market
values of the Class II, Class III, and Class IV
assets S sold to P are as follows:
Asset
Class
II

Asset

Fair
Market
Value

Portfolio of marketable
securities . . . . . . . . . . . . . . .
$ 400
Total Class II . . . . . . . . .
$ 400
III
Furniture and fixtures. . . . .
$ 800
Building . . . . . . . . . . . . . . .
800
Land . . . . . . . . . . . . . . . . . .
200
Equipment . . . . . . . . . . . . . .
400
Accounts receivable . . . . . .
100
Total Class III. . . . . . . . .
$2,300
IV
Covenant not to compete . .
$ 100
Total Class IV. . . . . . . . .
$ 100
(iii) Under paragraphs (d)(1) and (2) of this
section, the amount of consideration allocable to
the Class II, III, IV, and V assets is the total
consideration reduced by the amount of any Class
I assets. Since P acquired no Class I assets, the
total consideration of $3,000 is next allocated first
to Class II, then to Class III, and then to Class IV
assets. Since the fair market value of the Class II
assets is $400, $400 of consideration is allocated
to the Class II assets. Since the remaining amount
of consideration is $2,600 ($3,000 ⫺ $400), an
amount which exceeds the sum of the fair market
values of the Class III assets ($2,300), the amount
allocated to each Class III asset is its fair market

value. Since, after the allocation to Class III
assets, the remaining amount of consideration is
$300 ($3,000 ⫺ ($400 + $2,300)), an amount
which exceeds the fair market value of the Class
IV asset ($100), the amount allocated to the Class
IV asset is its fair market value. Thus, the total
amount allocated to the Class II assets is $400, the
total amount allocated to the Class III assets is
$2,300, and the total amount allocated to the Class
IV asset is $100.
(iv) The amount allocated to the Class V assets
(assets in the nature of goodwill and going
concern value) is $200 (i.e., $3,000 ⫺ ($400 +
$2,300 + $100)).
Example 2. (i) Assume the same facts as in
Example 1. Assume further that P and S each use
the calendar year as the taxable year and that, on
September 30, 1998, P files a claim against S
alleging fraud in the sale of all of the assets.
(ii) On January 1, 2007, S refunds $400 of the
purchase price to P in a settlement of the lawsuit.
(iii) Under paragraph (f)(3)(i) of this section, both
S and P take into account the $400 decrease in
consideration and allocate it among the assets.
First, since $200 of consideration previously was
allocated to the assets in the nature of goodwill
and going concern value (Class V assets), $200 of
the decrease in consideration is allocated to those
assets. Then, since $100 of consideration previously was allocated to the only Class IV asset, the
covenant not to compete, the next $100 of the
remaining decrease in consideration ($200) is
allocated to that asset. The remaining decrease in
consideration ($100) is then allocated to the Class
III assets in proportion to their fair market values
on the purchase date as follows:

Fair
market
value

Asset

Allocation
fraction

Decrease
in consideration
($100 x
Col. (2))

Furniture and
fixtures . . . .
$ 800 800/2,300
$ 34.78
Building . . . . .
800 800/2,300
34.78
Land . . . . . . . .
200 200/2,300
8.70
Equipment . . . .
400 400/2,300
17.39
Accounts
receivable . .
100 100/2,300
4.35
Total . . . . $2,300
$100.00
(iv) In summary, the redetermined consideration
that S received for the group of assets is $2,600
after taking into account the decrease in consideration. After allocating the decrease, P’s and S’s
redetermined consideration is as follows:

Asset

RedeterOriginal Decrease
mined
considin con- considereration sideration
ation

Portfolio of marketable securities . . . . . . . . . $ 400.00
Furniture and
fixtures . . . . .
800.00
Building . . . . . .
800.00
Land . . . . . . . . .
200.00
Equipment . . . . .
400.00
Accounts receivable . . . . . . . .
100.00
Covenant not to
compete . . . . .
100.00
Goodwill and
going concern
value . . . . . . .
200.00
Total . . . . . $3,000.00

41

$ 0.00

$ 400.00

34.78
34.78
8.70
17.39

765.22
765.22
191.30
382.61

4.35

95.65

100.00

0.00

200.00
0.00
$400.00 $2,600.00

(v) Assume that, as a result of deductions under
section 168, P’s adjusted basis in the equipment
immediately before the decrease in consideration
is zero. P, therefore, treats the equipment as if it
were disposed of before the decrease is taken into
account. In 2007, P recognizes income of $17.39,
the character of which is determined under the
principles of Arrowsmith v. Commissioner, 344
U.S. 6 (1952), and the tax benefit rule. No
adjustment to the basis of P’s assets is made for
any tax paid on this amount. Assume also that, as
a result of amortization deductions, the adjusted
basis of the covenant not to compete and the
goodwill and going concern value immediately
before the decrease in consideration is $120. A
similar adjustment to income is made in 2007 with
respect to the $180 of previously amortized covenant not to compete and goodwill and going
concern value.
Example 3. (i) On January 1, 1998, A transfers
assets X, Y, and Z worth $1,000 to B in exchange
for assets D, E, and F, worth $100, plus $1,000
cash.
*
*
*
*
*
(viii) A, as transferor of assets X, Y, and Z,
received $100 that must be allocated under section
1060 and paragraph (d) of this section. Since A
transferred no Class I, II, III, or IV assets to which
section 1060 applies, the $100 is allocated to
Class V assets (assets in the nature of goodwill
and going concern value).
*
*
*
*
*
(xi) B, as transferee of assets X, Y, and Z, gave
A $100 that must be allocated under section 1060
and paragraph (d) of this section. Since B received
from A no Class I, II, III, or IV assets to which
section 1060 applies, the $100 consideration is
allocated by B to Class V assets (assets in the
nature of goodwill and going concern value).
Example 4. (i) On January 1, 1998, S, a sole
proprietor, sells to P, a corporation, a group of
assets which constitutes a trade or business under
paragraph (b)(2) of this section. S, who plans to
retire immediately, also executes a covenant not to
compete in P’s favor. P pays S $3,000 in cash and
assumes $1,000 in liabilities. Thus, the total
consideration is $4,000.
(ii) On the purchase date, P and S also execute
a separate agreement that states that the fair
market values of the Class II, Class III, and Class
IV assets S sold to P are as follows:
Asset
Class
II

Asset

Fair
Market
Value

Portfolio of marketable
securities . . . . . . . . . . . . . . .
$ 500
Total Class II . . . . . . .
$ 500
III
Furniture and fixtures. . . . .
$ 800
Building . . . . . . . . . . . . . . .
800
Land . . . . . . . . . . . . . . . . . .
200
Equipment . . . . . . . . . . . . . .
400
Accounts receivable . . . . . .
200
Total Class III. . . . . . .
$2,400
IV
Covenant not to compete . .
$ 900
Total Class IV. . . . . . .
$ 900
(iii) P and S each allocate the consideration in
the transaction among the assets transferred under
paragraph (d) of this section in accordance with
the agreed upon fair market values of the assets,
so that $500 is allocated to Class II assets, $2,400
is allocated to Class III assets, $900 is allocated to
Class IV assets, and $200 ($4,000 total consideration less $3,800 allocated to asset classes II, III,
and IV) is allocated to the Class V assets (assets
in the nature of goodwill and going concern
value).

(iv) In connection with the examination of P’s
return, the District Director, in determining the fair
market values of the assets transferred, may
disregard the parties’ agreement. Assume that the
District Director correctly determines that the fair
market value of the covenant not to compete was
$100. Since the allocation of consideration among
Class II, III, and IV assets results in allocation up
to the fair market value limitation, the $800 of
unallocated consideration resulting from the District Director’s redetermination of the value of the
covenant not to compete is allocated to Class V
assets (assets in the nature of goodwill and going
concern value).

(h) * * *
(3) Interim procedures for Form
8594. Until such time, if any, as Form
8594 is revised to require otherwise, the
sum of the amounts allocated to Classes
IV and V should be reported on Form
8594 as Class IV assets.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved December 20, 1996.
Donald C. Lubick,
Acting Assistant Secretary
of the Treasury.

(Filed by the Office of the Federal Register on
January 9, 1997, 2:53 p.m. and published in the
issue of the Federal Register for January 16, 1997,
62 F.R. 2267)

Section 472.—Last-in, First-out
Inventories
26 CFR 1.472–1: Last-in, first-out inventories.

LIFO; price indexes, department
stores. The January 1997 Bureau of
Labor Statistics price indexes are accepted for use by department stores
employing the retail inventory and lastin, first-out inventory methods for valuing inventories for tax years ended on,
or with reference to, January 31, 1997.

the Income Tax Regulations and Rev.
Proc. 86–46, 1986–2 C.B. 739, for appropriate application to inventories of
department stores employing the retail
inventory and last-in, first-out inventory
methods for tax years ended on, or with
reference to, January 31, 1997.
The Department Store Inventory Price
Indexes are prepared on a national basis
and include (a) 23 major groups of
departments, (b) three special combinations of the major groups—soft goods,
durable goods, and miscellaneous goods,
and (c) a store total, which covers all
departments, including some not listed
separately, except for the following:
candy, foods, liquor, tobacco, and contract departments.

Rev. Rul. 97–15
The following Department Store Inventory Price Indexes for January 1997
were issued by the Bureau of Labor
Statistics on February 19, 1997. The
indexes are accepted by the Internal
Revenue Service, under § 1.472–1(k) of

BUREAU OF LABOR STATISTICS, DEPARTMENT STORE
INVENTORY PRICE INDEXES BY DEPARTMENT GROUPS
(January 1941 = 100, unless otherwise noted)

Groups

Jan. 1996

Jan. 1997

Percent Change from
Jan. 1996 to Jan.
19971

Piece Goods . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Domestics and Draperies . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s and Children’s Shoes . . . . . . . . . . . . . . . . . . . . .
Men’s Shoes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Infants’ Wear. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s Underwear . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s Hosiery . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Women’s and Girls’ Accessories . . . . . . . . . . . . . . . . . . . .
Women’s Outerwear and Girls’ Wear . . . . . . . . . . . . . . . .
Men’s Clothing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Men’s Furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Boys’ Clothing and Furnishings. . . . . . . . . . . . . . . . . . . . .
Jewelry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Notions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Toilet Articles and Drugs . . . . . . . . . . . . . . . . . . . . . . . . . .
Furniture and Bedding . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Floor Coverings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Housewares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Major Appliances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Radio and Television . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Recreation and Education2 . . . . . . . . . . . . . . . . . . . . . . . . .
Home Improvements2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Auto Accessories2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

519.0
648.4
628.8
887.6
641.1
519.1
289.4
554.2
400.3
602.7
560.6
478.5
994.5
802.7
875.4
668.9
563.6
800.5
247.6
78.9
112.6
123.1
107.7

536.5
648.0
636.8
895.6
622.7
522.0
291.3
539.6
404.3
614.3
580.0
478.5
993.2
773.4
906.5
658.4
579.1
818.0
246.8
78.4
111.7
132.9
107.6

3.4
⫺0.1
1.3
0.9
⫺2.9
0.6
0.7
⫺2.6
1.0
1.9
3.5
0.0
⫺0.1
⫺3.7
3.6
⫺1.6
2.8
2.2
⫺0.3
⫺0.6
⫺0.8
8.0
⫺0.1

Groups 1—15: Soft Goods. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Groups 16—20: Durable Goods . . . . . . . . . . . . . . . . . . . . . . . .
Groups 21—23: Misc. Goods2 . . . . . . . . . . . . . . . . . . . . . . . . . .

585.2
467.0
113.2

592.0
469.9
113.6

1.2
0.6
0.4

Store Total3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

544.9

550.0

0.9

1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.

42

1

Absence of a minus sign before percentage change in this column signifies price increase.
Indexes on a January 1986=100 base.
3
The store total index covers all departments, including some not listed separately, except for the following: candy, foods,
liquor, tobacco, and contract departments.
2

DRAFTING INFORMATION
The principal author of this revenue ruling is Stan Michaels of the Office of Assistant Chief Counsel (Income Tax and
Accounting). For further information regarding this revenue ruling, contact Mr. Michaels on (202) 622-4970 (not a toll-free
call).

43

Part III. Administrative, Procedural, and Miscellaneous
26 CFR 601.105: Examination of returns and
claims for refund, credit, or abatement; determination of correct tax liability.

Rev. Proc. 97–21
SECTION 1. PURPOSE
.01 This revenue procedure provides
the rules applicable to a new pilot
program under which pre-submission
conferences may be held in the national
office for matters that a district director
or a chief, appeals office, is preparing to
submit for technical advice under Rev.
Proc. 97–2, 1997–1 I.R.B. 64.
.02 In an effort to promote expeditious processing of requests for technical
advice, national office personnel generally will meet with the district or appeals office personnel and the taxpayer
prior to the time a request for technical
advice is submitted to the national office. The pre-submission conference procedures set forth in this revenue procedure are intended to facilitate agreement
between the parties as to the appropriate
scope of the request for technical advice, the factual information to be included in the request for technical advice, any collateral issues that either
should or should not be included in the
request for technical advice, and any
other substantive or procedural considerations that will allow the national office
to provide the parties with technical
advice as expeditiously as possible.
.03 The pre-submission conference
procedures are not intended to create
alternative procedures for determining
the merits of the substantive positions
advocated by the district or appeals
office or by the taxpayer, but instead are
intended only to facilitate the overall
technical advice process.
SECTION 2. BACKGROUND
.01 Rev. Proc. 97–2 provides the procedures applicable to the national office’s processing of requests for technical advice. Those procedures currently
contain no provision that permits the
district or appeals office personnel and
the taxpayer to consult with national
office personnel regarding a contemplated request for technical advice.
.02 This revenue procedure establishes a pre-submission conference pilot
program to be conducted during 1997 in
conjunction with the procedures set
forth in Rev. Proc. 97–2. If this pilot

program is successful, the Service will
consider extending the pilot program or
permanently adopting these or similar
pre-submission conference procedures.
SECTION 3. SCOPE
This revenue procedure applies to
matters that are subject to a request for
technical advice under the procedures of
Rev. Proc. 97–2. A request for a presubmission conference should be made
only after the district or appeals office
determines that it likely will seek technical advice and the parties agree that a
pre-submission conference should be requested.
SECTION 4. PROCEDURE
.01 Requests for a pre-submission
conference must be submitted in writing
by the district or appeals office. The
request should identify that it is being
submitted pursuant to this revenue procedure. The request should also identify
the associate or assistant chief counsel
office expected to have jurisdiction over
the request for technical advice. The
request should include a brief explanation of the primary issue so that an
assignment to the appropriate branch
can be made. Coordination with district
counsel is strongly encouraged. If the
request involves a designated issue or
industry under the Industry Specialization Program, coordination with the issue or industry specialist is also strongly
encouraged.
.02 An original and one copy of the
request should be submitted to the appropriate address listed below. Requests
from district offices should be sent to
the following address:
Internal Revenue Service
Attn: CC:DOM:CORP:T
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044
Requests from appeals offices should be
sent to the following address:
Internal Revenue Service
Attn: C:AP:FS
Box 68
901 D Street, SW
Washington, DC 20024
.03 Within 5 working days after it
receives the request, the branch assigned
responsibility for conducting the presubmission conference will contact the
district or appeals office to arrange a
mutually convenient time for the parties

44

to meet in the national office. The
district or appeals office will be responsible for coordinating with the taxpayer
as well as with any other Service personnel whose attendance the district or
appeals office believes would be appropriate.
.04 Pre-submission conferences generally will be held in person in the
national office. However, if the district
or appeals office personnel or the taxpayer is unable to attend the conference,
the conference may be conducted via
telephone.
.05 At least 10 working days before
the scheduled pre-submission conference, the district or appeals office and
the taxpayer should submit to the national office a statement of the pertinent
facts (including any facts in dispute), a
statement of the issues that the parties
would like to discuss, and any legal
analysis, authorities, or background
documents that the parties believe would
facilitate the national office’s understanding of the issues to be discussed at
the conference. The legal analysis provided in connection with the presubmission conference need not be as
fully developed as the analysis that
ultimately will accompany the request
for technical advice, but it should allow
the national office personnel to become
reasonably informed regarding the subject matter of the conference prior to the
meeting. The district or appeals office or
the taxpayer should ensure that the
national office receives a copy of any
required power of attorney, preferably
on Form 2848, Power of Attorney and
Declaration of Representative.
.06 Any discussion of substantive issues at a pre-submission conference is
advisory only, is not binding on the
Service in general or on the Office of
Chief Counsel in particular, and cannot
be relied upon as a basis for obtaining
retroactive relief under the provisions of
§ 7805(b) of the Internal Revenue
Code.
SECTION 5. REQUEST FOR
COMMENTS
The Service is interested in comments
regarding the use of pre-submission conferences and how these procedures may
be improved. A signed original and two
copies of all comments should be submitted by either mailing them to:

Internal Revenue Service
Attn: CC:DOM:CORP:R
Room 5228
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044
or hand delivering them between the
hours of 8:00 a.m. and 5:00 p.m. to:
Courier’s Desk
Internal Revenue Service
Attn: CC:DOM:CORP:R
Room 5228
1111 Constitution Avenue, NW
Washington, DC
Alternatively, comments may be submitted electronically via the Service’s
Internet site at ‘‘http://www.irs.ustreas.
gov/prod/tax_regs/comments.html’’. All
comments will be available for public
inspection and copying.

SECTION 6. EFFECT ON OTHER
DOCUMENTS
Rev. Proc. 97–2, 1997–1 I.R.B. 64, is
amplified to permit pre-submission conferences in the circumstances and under
the conditions specified in this revenue
procedure.
SECTION 7. EFFECTIVE DATE
This revenue procedure is effective
for pre-submission conference requests
submitted to the national office after
March 10, 1997 and before December
31, 1997.
DRAFTING INFORMATION
The principal authors of this revenue
procedure are Phillip J. Howard of the
Office of Assistant Chief Counsel
(Passthroughs and Special Industries)

45

and James L. Atkinson and Robert J.
Basso of the Office of Associate Chief
Counsel (Domestic). For further information regarding this revenue procedure,
contact the office expected to have
jurisdiction over the matter to be submitted for technical advice:
Income Tax and
Accounting . . . . . . . . (202) 622–4800
Passthroughs and Special
Industries. . . . . . . . . . (202) 622–3000
Corporate. . . . . . . . . . . . (202) 622–7700
Financial Institutions and
Products. . . . . . . . . . . (202) 622–3900
Employee Benefits and Exempt
Organizations . . . . . . (202) 622–6000
International . . . . . . . . . (202) 622–3810
Enforcement Litigation. (202) 622–3400
These telephone numbers are not tollfree calls.