On October 26, 2015, the Internal Revenue Service released final allocation and accounting regulations (the Final Regulations) under Section 141 of the Internal Revenue Code of 1986, as amended (the Code) related to accounting for private business use (discussed further below), allocation of tax-exempt bond proceeds to projects and certain remedial actions for changes in use of bond-financed facilities. The Final Regulations streamline and improve proposed regulations published in 2006.

This alert briefly describes some of the key features of the Final Regulations, which generally apply to tax-exempt bonds issued to finance projects for state and local governments (governmental bonds) and bonds issued under Section 145 of the Code (501(c)(3) bonds) for organizations described in Section 501(c)(3) of the Code (501(c)(3) organizations).

Public Private Partnerships and Mixed-Use Developments

  • Qualified equity (discussed further below) may be allocated to private use of a mixed-use project on an ongoing, flexible basis, rather than to specific uses or specific areas.
  • Partnerships are treated as an aggregate of the partners; use by a partnership will only result in the use allocated to a partner that is a private business user (discussed further below) being private business use. Otherwise, if the partnership was treated as a separate entity, use by a partnership with a private partner would have all been deemed private business use.

Remedial Actions

  • Anticipatory redemption or defeasance of tax-exempt bonds is allowed in certain circumstances permitting a remedial action to be taken prior to the actual change in use.
  • The bonds to be redeemed or defeased as part of a remedial action may be selected based on a test of weighted average maturity, adding flexibility to the current rule.


The Code restricts use of projects financed by governmental or 501(c)(3) bonds by a person in a trade or business (including the federal government, any federal agency and, except for 501(c)(3) bonds, a 501(c)(3) organization) (a private business user) other than a state or local government unit; such use is referred to as “private business use.” Generally, for a governmental or 501(c)(3) bond to be tax-exempt: (1) not more than 10 percent of the property (5 percent for certain unrelated or disproportionate uses and for 501(c)(3) bonds) financed with the proceeds of the bonds may be used for any private business use (the private business use test); and (2) not more than 10 percent of the debt service (5 percent for certain unrelated or disproportionate uses and for 501(c)(3) bonds) on the bonds may be secured by any interest in property used for a private business use, payments in respect of such property or derived from payments in respect of property used for a private business use (the private payments test).

While both tests must be violated to cause taxability of bonds, in many transactions, where private parties are paying for or profiting from use of bond-financed facilities, much of the analysis is focused on the private business use test. The Final Regulations provide allocation and accounting rules that address such allocations for a project that has multiple users and multiple sources of financing.

The existing regulations under the Code also contain rules on remedial actions that can be taken if a change in the use of bond-financed property would otherwise cause taxability of bonds. The Final Regulations make two changes to such remedial action rules to facilitate the redemption or defeasance of bonds related to the bond-financed property subject to such change in use.

Floating Equity

For eligible mixed-use projects (further described below), the Final Regulations allow qualified equity (further described below) to be allocated first to any private business use of the project before any bond proceeds. The qualified equity does not have to be specifically allocated to any one use or any discreet physical portion of the project. In a mixed-use project financed with a combination of bond proceeds and qualified equity, the portion and type of private business use may change from year to year, and the aggregate private business use of the facility will only be taken into account for the private business use test to the extent it exceeds the amount of qualified equity in the project. This adds flexibility to compliance with the rules on private business use.

Eligible mixed-use projects are projects financed with both governmental bonds (or 501(c)(3) bonds) and qualified equity pursuant to the same plan of financing and owned by one or more governmental entities (or, for 501(c)(3) bonds, 501(c)(3) organizations) or a partnership in which at least one partner is a government entity or 501(c)(3) organization, as applicable (subject to the rules on ownership for 501(c)(3) bonds). Qualified equity is funds that are not derived from tax-exempt bonds or tax-advantaged bonds (bonds that provide a federal tax benefit, such as tax-credit bonds), and must be spent on capital expenditures of the project on a date no earlier than the date on which a reimbursement would be permissible for the tax-exempt bonds and no later than the beginning of the measurement period for the tax-exempt bonds (generally the later of the issue date or the date the project is placed in service); it does not include contributions of existing property.

Aggregate Treatment of Partnerships

The Final Regulations allow for a partnership to be treated as an aggregate of its partners for the private business use test. Use by a partnership that has a private business user as a partner will be private business use only to the extent of such partner’s greatest percentage share of any partnership item of income, gain, loss, deduction or credit for the applicable period; otherwise, if treated as a separate entity, all of the use by the partnership would be private business use. This provision expands the options for the owners, operators and users of a bond-financed project.

Anticipatory Remedial Actions

One of the available remedies for a change in use of a bond-financed facility that would otherwise cause impermissible amounts of private business use is a redemption or defeasance of a portion of the applicable bonds. Currently, this remedy only applies to situations where the change in the use of the bond-financed facility has in fact occurred (or occurs simultaneously with the remedial action). Issuers in some cases have found it more advantageous to redeem or defease the required amount of bonds in anticipation of the change in use. The Final Regulations now explicitly allow an anticipatory redemption or defeasance, so long as the issuer declares its official intent to take such remedial action prior to the date thereof that identifies the financed property or loan with respect to which the remedial action is being taken and the anticipated change in use.

Selection of Bonds for Redemption or Defeasance

The remedial action rule for a redemption or defeasance of bonds upon a change in use generally provides that the required amount of bonds of the applicable issue(s) be redeemed or defeased pro rata across maturities or constitute the longest maturities. The Final Regulations allow for any maturity or portion thereof to be redeemed so long as the remaining weighted average maturity of the issue after the redemption or defeasance is not greater than the remaining weighted average maturity of the issue determined without regard to the redemption or defeasance. As a transition, redemption or defeasance of the longest maturities is still allowed for bonds sold before January 25, 2016 (to accommodate certain indenture provisions regarding allocations of redemptions of term bonds).


The Final Regulations on allocation and accounting are applicable to bonds sold on or after January 25, 2016, but generally may be applied retroactively, and the Final Regulations on remedial actions are applicable to changes in use occurring on or after January 25, 2016.