Rev. Rul. 83-17

1983-1 C.B. 26, 1983-4 I.R.B. 9.

                       Internal Revenue Service
                                 Revenue Ruling

    INDUSTRIAL DEVELOPMENT BONDS;  EXEMPT SMALL ISSUE;  CAPITAL EXPENDITURES

                          Published: January 24, 1983

26 CFR 1.103-10: Exemption for certain small issues of industrial development bonds

(Also Section 61; 1.61-7.)

  Industrial development bonds;  exempt small issue;  capital expenditures.  An exchange of land in a city by a nonexempt person for other land in the city, within 3 years of a proposed issuance by the city of an exempt small issue of industrial development bonds to finance facilities for the nonexempt person, is a capital expenditure within the meaning of section 103(b)(6)(D) of the Code to the extent of the fair market value of the land exchanged.  The aggregate face amount of the proposed bonds will exceed the exempt small issue limitation, and the interest on the bonds will not be excludable from gross income.  Rev. Rul. 77-146 distinguished.

ISSUE

  Will industrial development bonds to be issued by a city exceed the  $10,000,000 exempt small issue limitation provided in section 103(b)(6)(D) of the Internal Revenue Code, under the circumstances described below?

FACTS

  In 1975, corporation X, which is not an exempt person within the meaning of section 103(b)(3) of the Code, acquired unimproved real estate in city CI for a purchase price of $2,000,000.  X intended to construct and use manufacturing facilities on the property.  However, the construction plans were delayed and X did not make any improvements to the property after the purchase.

  During 1981, X located a more suitable site in CI for its manufacturing facilities.  The new site includes a building usable as a warehouse.  On July 1, 1981, X completed an even exchange of its unimproved real estate acquired in 1975 for the new improved real estate site.  The fair market value of the property received by X in the exchange was $4,000,000 and was equal to the value of the property exchanged.  No gain was recognized by X on the exchange since it qualified for nonrecognition of gain under section 1031 of the Code. X did not own or operate any other property in CI.

  X requested CI to issue industrial development bonds during 1982 to finance the construction of the manufacturing facilities on X's newly acquired site. It is estimated that the manufacturing facilities will cost $7,500,000.

  CI proposes to issue industrial development bonds on September 30, 1982, in the face amount of $7,500,000 to finance construction of X's facilities. Before the issuance of the bonds, CI will file a statement electing to treat the bonds as an exempt small issue of $10,000,000 or less under the provisions of section 103(b)(6)(D) of the Code.  The bonds will not be "arbitrage bonds" within the meaning of section 103(c)(2).

LAW AND ANALYSIS

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

  Section 103(b)(1) of the Code provides that, except as otherwise provided in section 103(b), any industrial development bond will be treated as an obligation that is not described in section 103(a)(1).

  Section 103(b)(6)(D) of the Code provides that, at the election of the issuer, section 103(b)(1) will not apply to any obligation issued as part of an issue if the aggregate face amount of the issue is $10,000,000 or less and if substantially all (90 percent or more) of the proceeds of the issue are to be used to acquire or construct land or property of a character subject to the allowance for depreciation.  To determine the aggregate face amount of a bond issue, the face amount of the bonds to be issued, the outstanding face amount of certain prior exempt small issues, and the aggregate amount of capital expenditures for certain facilities must all be taken into account.

  Section 1.103-10(b)(2)(ii) of the Income Tax Regulations provides that an expenditure (regardless of how paid, whether in cash, notes, or stock in a taxable or nontaxable transaction) is a section 103(c)(6)(D) (redesignated as section 103(b)(6)(D) ) capital expenditure if:

    (a) The capital expenditure was financed other than out of the proceeds of issues taken into account,

    (b) The capital expenditures were paid or incurred during the 6-year period that begins 3 years before the date of issuance of the issue and ends 3 years after that date,

    (c) The principal user of the facility in connection with which the property resulting from the capital expenditures is used and the principal user of the facility financed by the proceeds of the issue in question is the same person or two or more related persons,

    (d) Both facilities referred to in (c) were located in the same incorporated municipality or in the same county (outside the incorporated municipality in the county), and

    (e) The capital expenditures were properly chargeable to the capital account of any person or state or local governmental unit (whether or not the person is the principal user of the facility or a related person).

  Section 1.103-10(b)(2)(iii) of the regulations provides, in part, that if the actual amount of capital expenditures made with respect to a facility by a person (including a state or local governmental unit) other than the user of such facility (or related person) cannot be ascertained, the fair market value of the property with respect to which the capital expenditures were made, at the time of the capital expenditures, shall be deemed to be the amount of the capital expenditures.

  In Rev. Rul. 77-146, 1977-1 C.B. 24, city M proposed to issue industrial development bonds in 1977 to finance construction of facilities for use by partnership X.  M elected to treat the bonds as an exempt small issue under section 103(b)(6)(D) of the Code.  In 1976, partnership Y contributed land acquired in 1971 to X in exchange for a 30 percent interest in partnership X. The revenue ruling holds that the contribution of land by Y to X in exchange for an interest in X is not a section 103(b)(6)(D) capital expenditure by X. Compare section 1.103-10(b)(2)(v)(c) of the regulations, as limited by section 1.103-10(b)(2)(v)(d), which provides similar treatment in the case of an exchange of stock for property under section 351(a).

  The facts in Rev. Rul. 77-146 are distinguishable from the facts in this revenue ruling.  In Rev. Rul. 77-146, a person transferred land to a partnership in exchange for an interest in the partnership.   The transfer merely changed the form of the transferor's ownership of the land similar to a section 351 transfer to a controlled corporation, which is an excluded transaction under section 1.103-10(b)(2)(v)(c) of the regulations.  In the present case, X exchanged the original property for another piece of property that would have resulted in a taxable exchange but for section 1031 of the Code.  The regulations do not distinguish this type of exchange from being a capital expenditure in either a taxable or nontaxable exchange since the exchange does more than merely change the form of ownership of the investment as would be the case in transfers to controlled corporations under section 351 or transfers by partners to their own partnerships.

  The exempt small issue provisions under section 103(b)(6)(D) of the Code were enacted by Congress to place a definite limit on the total dollar amount that may be expended by or with respect to a nonexempt beneficiary of an exempt small issue of industrial development bonds for facilities in a political subdivision during a 6-year period (3 years before the date of the bond issue and 3 years after such date).  This limitation is determined by aggregating the face amount of the bonds, certain prior exempt small issues, and certain capital expenditures.

  A taxpayer who exchanges property for like kind property under the provisions of section 1031 of the Code actually realizes gain or loss from the transaction equal to the difference between the taxpayer's adjusted basis of the property given up and the fair market value of the property received.  Such gain or loss is not recognized under section 1031 because the property received is considered to be a continuation of the original investment.  However, the taxpayer does acquire different property as a result of the exchange.  This acquisition is the same as if the taxpayer sold the property exchanged and used the sale proceeds to purchase the new property.  A purchase of property is a capital expenditure for purposes of section 103(b)(6)(D), and section 1.103- 10(b)(2)(ii) of the regulations applies to any expenditure regardless of how paid.

  In this case, X acquired improved real estate on July 1, 1981, by exchanging the unimproved real estate it acquired in 1975.  Because this exchange is the equivalent of a purchase and will result in X's use in CI of different land and a building valued at $4,000,000, the acquisition of the new property through the exchange is a capital expenditure within the meaning of section 103(b)(6)(D) of the Code and section 1.103-10(b)(2)(ii) of the regulations. For purposes of section 103(b)(6)(D), the amount of the capital expenditure is $4,000,00, the fair market value of the land exchanged by X for the new land and building.  Therefore, because the capital expenditure occurred within 3 years before the proposed issue date of the bonds, the amount of the capital expenditure ($4,000,000) must be added to the face amount of CI's proposed bond issue ($7,500,000) to determine the aggregate face amount of the proposed issue.

HOLDING

  The aggregate face amount ($11,500,000) of the industrial development bonds to be issued by CI will exceed the $10,000,000 exempt small issue limitation in section 103(b)(6)(D) of the Code.  Therefore, the interest on the bonds will not be excludable from gross income under the provisions of section 103(a)(1).

EFFECT ON OTHER REVENUE RULINGS

  Rev. Rul. 77-146 is distinguished.

Rev. Rul. 83-17, 1983-1 C.B. 26, 1983-4 I.R.B. 9.