So, the issue becomes a taxable private activity bond issue. Generally, nonqualified use occurs
when the issuer or other entity controlling expenditure or use of the proceeds or financed property
takes an action that results in insufficient bond proceeds being allocated to the qualified purpose
for which the bonds were issued. However, with respect to unspent proceeds, a failure to properly
use those proceeds may occur as early as the date on which the issuer or other entity controlling
expenditure of the proceeds reasonably expects that the bond proceeds won't be expended on the
qualified purpose for which the bonds were issued.
Special Remedial Actions for Nonqualified Use. The Treas. Reg. provide that an issuer that fails
to use proceeds for a qualified purpose may, in certain cases, cure that failure using one of the
prescribed remedial actions. Generally, these remedial actions consist of the redemption or
defeasance of bonds. Additionally, if bond-financed personal property is disposed of exclusively
for cash, remedial action may include the alternative use of the disposition proceeds to acquire
replacement property within six months of the disposition date. Other remedial actions may be
available to the issuer of qualified 501(c)(3) bonds.
The following regulations provide remedial actions available for certain qualified private activity
bonds:
Section 1.142-2 – exempt facility bonds
Section 1.144-2 – qualied small issue bonds and qualied redevelopment bonds
Section 1.145-2 – qualied 501(c)(3) bonds
Section 1.1394-1(m)(4) – qualied enterprise zone facility bonds, qualied empowerment zone
facility bonds and District of Columbia enterprise zone facility bonds
These regulations can be accessed through the IRS website under Tax Code, Regulations and
Official Guidance.
Proceeds May Not Be Used to Acquire Land or Other Existing Property. The IRC prohibits
the use of proceeds of certain types of qualified private activity bonds for certain expenditures,
even if those expenditures are associated with a qualified purpose. Under IRC Section 147(c), a
private activity bond is not a qualified bond if (1) 25% or more of the net proceeds of the bond
issue are to be used (directly or indirectly) for the acquisition of land (or an interest therein), or (2)
any portion of the proceeds of the issue is to be used (directly or indirectly) for the acquisition of
land (or an interest therein) to be used for farming purposes.
However, certain exceptions to this rule are available for first-time farmers (up to a specified
inflation-adjusted amount), and for land acquired for certain environmental purposes in
connection with an airport, mass commuting facility, high-speed intercity rail facility, dock or
wharf. Also, the restriction on land financing does not apply to any qualified mortgage bond,
qualified veterans’ mortgage bond, qualified student loan bond, qualified 501(c)(3) bond or any
exempt facility bond financing qualified public education facilities.
In addition to the restriction on financing land, generally, a qualified private activity bond won't
be tax-exempt if any amount of the net proceeds is used for the acquisition of existing property
unless the purpose of the acquisition is the first use of that property. This rule doesn’t apply
to qualified mortgage revenue bonds, qualified veterans’ mortgage revenue bonds or qualified
501(c)(3) bonds. Additionally, IRC Section 147(d)(2) provides an exception to this prohibition when
certain rehabilitation expenditures are made.
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