Rev. Rul. 80-10

1980-1 C.B. 21, 1980-2 I.R.B. 7.

                       Internal Revenue Service
                                 Revenue Ruling

                 INDUSTRIAL DEVELOPMENT BONDS; USE OF PROCEEDS

                          Published: January 14, 1980

26 CFR 1.103-8: Interest on bonds to finance certain exempt facilities.

(Also 1.103-1.)

(Also Section 61; 1.61-7.)

  Industrial development bonds; use of proceeds. A political subdivision proposes to issue $750,000 of idustrial development bonds to finance the $500,000 rehabilitation of an individual's substandard rental units and the removal of an existing $250,000 lien against the property. Substantially all of the proceeds will not be used to provide an exempt facility, the exception of section 103(b)(4)(A) of the Code will not apply, and the bond interest will not be excludable under section 103(a)(1).

ISSUE

  Will section 103(a)(1) of the Internal Revenue Code exclude from the gross incomes of the bondholders the interest on industrial development bonds to be issued to finance the rehabilitation of rental property under the circumstances described below?

FACTS

  A, an individual taxpayer, owns 50 substandard rental units situated on land within city M.  There is an outstanding lien of $250,000 against the property. A desires to rehabilitate the rental units at an estimated cost of $10,000 per unit and rent the units to low-income families.  A requested M to issue bonds to finance the cost of rehabilitation.  M agreed to provide financing but will require that the existing lien be removed so that M will hold the first lien.

  M proposes to issue $750,000 of industrial development bonds described in section 103(b)(2) of the Code and to loan the bond proceeds to A for removal of the existing lien and rehabilitation of the rental units.  The security for the bonds will be the rehabilitated property and the loan payments to be made by A.  M proposes to treat the bonds as issued to provide exempt facilities described in section 103(b)(4)(A) (residential real property for family units).  The bonds are not arbitrage bonds as defined in section 103(c)(2). Because certain prior exempt small issues issued in 1975 are outstanding, M did not elect to issue an exempt small issue under section 103(b)(6).

  On May 1, 1979, M took 'some other similar official action,' within the meaning of section 1.103-8(a)(5) of the Income Tax Regulations, toward the issuance of the bonds.  M proposes to issue the bonds on July 2, 1979, and rehabilitation will commence on August 1, 1979.

LAW AND ANALYSIS

  Section 103(a)(1) of the Code provides that gross income does not include interest on obligations of a political subdivision of a state.

  Section 103(b)(1) of the Code provides that, with certain exceptions, the interest on 'industrial development bonds' is not excludable from gross income.

  Section 103(b)(4)(A) of the Code provides that section 103(b)(1) shall not apply to industrial development bonds if substantially all of the bond proceeds are to be used to provide residential real property for family units.

  The 'substantially all' test in section 103(b)(4) of the Code will be satisfied if 90 percent or more of the proceeds of an issue of governmental obligations are used to provide an exempt facility. Section 1.103-8(a)(1)(i) of the regulations.

  In Situation 2 of Rev. Rul. 77-317, 1977-2 C.B. 32, a political subdivision proposes to issue $4,800,000 of industrial development bonds, $4,000,000 of which will be used to acquire facilities to be leased to a nonexempt lessee, unrelated to the previous owner, and $800,000 of which will be used to retire the lessee's existing indebtedness.  The political subdivision proposes to elect to treat the bonds as an exempt small issue under section 103(b)(6)(D) of the Code.  The Revenue Ruling concludes that because $800,000 of the bond proceeds will be used to provide the lessee with working capital by retirement of the lessee's debt, substantially all (90 percent or more) of the bond proceeds will not be used to acquire land and property subject to depreciation.  Therefore, the bonds will not qualify as an exempt small issue under section 103(b)(6)(D) and the interest on the bonds will not be excludable from the gross incomes of the bondholders under section 103(a)(1).

  In this case, 33 1/3 percent ($250,000/$750,000) of the bond proceeds will be used to remove A's outstanding lien against the

rental units.  This amount of the bond proceeds will be used to refinance A's debt and not to provide an exempt facility within the meaning of section 103(b)(4)(A) of the Code. Therefore, because substantially all (90 percent or more) of the bond proceeds will not be used to provide an exempt facility, the bonds will not qualify for the exception provisions of section 103(b)(4)(A).

HOLDING

  The interest on M's bonds will not be excludable from the gross incomes of the bondholders under the provisions of section 103(a)(1) of the Code.

Rev. Rul. 80-10, 1980-1 C.B. 21, 1980-2 I.R.B. 7.