On October 26, 2015, the IRS released final regulations under Sections 141 and 145 of the Internal Revenue Code concerning the use of property financed with tax-exempt bond proceeds. The bulk of the new regulations fill a long-reserved spot in Treasury Regulation Section 1.141-6 concerning allocation of bond proceeds to financed property. In addition, in an important new development, amendments to Treasury Regulations Sections 1.141-3 and 1.145-2 now provide that partnerships that include governmental entities or Section 501(c)(3) tax-exempt organizations can use and own bond-financed property. Permitted use is in proportion to the exempt’s ownership of the joint venture, except to the extent that the use generates unrelated business income for the exempt joint venturer. The new regulations can be applied to outstanding bonds as well as new bonds.
The change will come into play when an exempt organization, such as a hospital, transfers or leases bond-financed property to a joint venture. Until now, if a tax-exempt or governmental entity transferred its operations to a joint venture with a for-profit entity, any tax-exempt bonds that financed the property used by the joint venture had to be redeemed or other corrective action taken. The bonds could not stay outstanding while financing property used by the joint venture. Under the new regulations, a joint venture can use bond-financed property to the extent of the exempt organization’s ownership interest in the joint venture. For example, if an exempt organization owns 40 percent of the joint venture, and the joint venture’s use of the bond-financed property does not generate unrelated business income for the exempt owner, 40 percent of the property owned or used by the joint venture is treated as used by an exempt organization in a good use and can be bond-financed. If an exempt organization transfers its hospital to a whole-hospital joint venture and the joint venture is properly structured, it is now possible that a portion of the bonds that financed the hospital can remain outstanding.
The final regulations are more liberal than previous regulations proposed in 2006. Under the proposed regulations, only a joint venture owned entirely by governmental or exempt entities could use bond-financed property. However, property financed by bonds issued on behalf of Section 501(c)(3) (rather than governmental) entities must be owned by a tax-exempt or governmental organization. Under the earlier proposed regulations, a joint venture owned entirely by exempt or governmental organizations and having at least one exempt (rather than governmental) owner could not own bond-financed property. The new regulations permit a joint venture to own bond-financed property to the extent of exempt ownership of the joint venture.