On October 26, 2015, the Internal Revenue Service released final allocation and accounting regulations (the "Final Regulation") under the private activity bond rules for tax-exempt bonds, generally providing greater flexibility for financing mixed-use projects and use of public-private partnerships. The Final Regulations finalize proposed regulations issued in 2006 and reflect a number of the recommendations submitted to the IRS in public comments. 

One of the conditions for tax-exemption for interest on state or local bonds is that they are not "private activity bonds" (other than certain specified types of "qualified private activity bonds"). The determination of whether a state or local bond issue consists of private activity bonds is generally based on whether the proceeds of the bonds are used in a private trade or business and whether the security for or payments on the bonds are derived from property used in a private trade or business. 

Mixed-Use Projects 
The Final Regulations adopt rules that will make it easier to finance the governmental portion of projects that are used partly for governmental purposes (including use by the general public) and partly for private trade or business purposes. The proposed regulations provided two alternative allocation rules for such mixed-use projects, one method (the "discrete portion method") requiring that different sources of funds (i.e., tax-exempt bond proceeds and other sources) be allocated to physically discrete portions of the facility, and the other method (the "undivided portion method") allowing allocations on a notional basis of relative use, but the undivided portion method was only available in limited circumstances and issuers were required to affirmatively elect which method they were using. The Final Regulations eliminate the discrete portion method and adopt the undivided portion method as the exclusive allocation method for mixed-use projects. This should enhance the ability of issuers to finance the governmental portion of mixed-use projects where the private business use and the governmental use are not limited to specific discrete areas, e.g., by allowing "floating" allocations.

Public-Private Partnerships
The Final Regulations adopt rules that will make it easier to finance the governmental portion of facilities used by partnerships consisting of both governmental partners and private partners. Under the proposed regulations, while a partnership consisting entirely of governmental partners could be treated as a governmental user, the inclusion of a single private partner caused the entire partnership to be treated as a private business user. The Final Regulations allow a bond-financed facility used by a partnership consisting of both governmental partners and private partners as being used in part by the governmental partners and in part by the private partners. The measurement of use by the private partners is based on such partners' greatest percentage share of any of certain specified partnership items during the period that the partnership uses the property. This provision in the Final Regulations is intended to promote the use of tax-exempt financing for the governmental portion of public-private partnerships and other financing structure involving private interests.

Anticipatory Remedial Actions
When there is a change in use of a tax-exempt bond facility to a use that would not qualify for tax-exempt financing under the tax rules, an issuer is generally required to take a "remedial action" in order to prevent retroactive taxability of interest on the bonds. This remedial action typically involves redemption or defeasance of bonds allocable to the facility undergoing the change in use. The proposed regulations would have allowed remedial actions in anticipation of a future change in use only in very limited circumstances. The Final Regulations significantly expand the ability of issuers to take such an anticipatory remedial action.

Effective Dates 
The Final Regulations will generally apply to bonds sold on or after the date that is 90 days after the Final Regulations are published in the Federal Register, but the rules on remedial actions will apply to any changes in use occurring after such date. In addition, permissive application of the Final Regulations is allowed for certain bonds issued prior to such effective date.