# Prop. Treas. Reg. § 1.141-5: Private loan financing test. Proposed regulation, not in force. FI-72-88, 94-31430, published 1994-12-30 . Interprets 26 U.S.C. § 141. Par. 4. Sections 1.141-0 through 1.141-16 are added to read as follows: (a) In general--(1) General rule. Bonds of an issue are private activity bonds if more than the lesser of 5 percent of the proceeds or $5 million of the sale proceeds of the issue is to be used (directly or indirectly) to make or finance loans to persons other than governmental units. Section 1.141-2(d) applies in determining whether the private loan financing test is met. (2) Direct and indirect use of proceeds determinative. In determining whether the proceeds of an issue are used to make or finance loans, indirect, as well as direct, use of the proceeds is taken into account. Any use of proceeds by a governmental person that results in the expenditure of those proceeds (rather than the acquisition of investment property), such as a grant, is treated as the ultimate use of those proceeds. For purposes of this paragraph (a)(2), investment property has the meaning in Sec. 1.148-1, except that tax- exempt bonds may be treated as investment property. See Sec. 1.148-6 for rules to determine when proceeds are expended. (3) Measurement of test. In determining whether the private loan financing test is met, the amount actually loaned to a nongovernmental person is not discounted to reflect the present value of the loan repayments. (b) Definition of loan--(1) General federal tax principles apply. Any transaction that, for federal income tax purposes generally, is characterized as a loan is a loan for purposes of this section. Thus, the determination of whether a loan is made depends on the substance of a transaction. For example, a lease or other contractual arrangement (for example, a management contract) may in substance constitute a loan if the arrangement transfers tax ownership of the facility to a nongovernmental person. Similarly, an output contract with respect to a financed facility generally is not treated as a loan of proceeds unless the agreement in substance shifts significant burdens and benefits of ownership to the nongovernmental purchaser or manager of the facility. (2) Exception if no use of bonds proceeds. Any use of proceeds that does not, treating the user as a nongovernmental person that is not a natural person, give rise to private business use, is not a loan of proceeds. See Sec. 1.141-3. (3) Hazardous waste remediation bonds. In the case of an issue of hazardous waste remediation bonds, payments from nongovernmental persons that are either users of the site being remediated or persons potentially responsible for disposing of hazardous waste on that site do not indicate a loan for purposes of this section. This paragraph (b)(3) applies only if those payments do not secure the payment of principal of, or interest on, the bonds (directly or indirectly), under the terms of the bonds and those payments are not taken into account under the private payment test pursuant to Sec. 1.141-4(f)(3). (4) Prepayments. A prepayment does not result in a loan of proceeds if the prepayment is not investment-type property. In applying the definition of investment-type property under Sec. 1.148-1, providing the benefits of tax-exempt financing to the seller of the property or service is treated as an investment return to the issuer. (5) Grants--(i) In general. A grant of proceeds is not a loan. Whether a transaction is a grant or a loan depends on all the facts and circumstances. (ii) Tax increment financing--(A) In general. Generally, a loan does not result from the making of a grant using proceeds of an issue that is secured by generally applicable taxes attributable to the improvements to be made with the grant unless the grantee makes any special agreements relating to the payment that results in those taxes failing to be generally applicable under Sec. 1.141-4(e). (B) Amount of loan. If a grant is treated as a loan under this paragraph (b)(5), the entire grant is treated as a loan unless the special agreement is limited to a specific portion of the related tax. (c) Tax assessment bond exception--(1) General rule. For purposes of this section, a tax assessment loan that meets the requirements of this paragraph (c) is not a loan. (2) Tax assessment loan defined--(i) In general. A tax assessment loan is a loan that arises for federal tax purposes when a governmental unit permits or requires its residents to pay a tax or assessment over a period of years. The tax assessment loan exception may apply if the assessed property is used by a nongovernmental person in its trade or business (whether or not private business use) or for nonbusiness purposes. In addition, a tax assessment loan must satisfy the following requirements: (A) Mandatory tax or assessment. The loan must arise from the imposition of a mandatory tax or other assessment of general application. (B) Essential governmental function. The mandatory tax or assessment (collectively, assessments) must be imposed for one or more specific, essential governmental functions (as opposed to installment payments of property taxes or other taxes); (C) Equal basis requirement. If the property that is subject to the tax or assessment is used by a nongovernmental person, owners of both business and nonbusiness property benefiting from the financed improvements are eligible or required to make deferred payments of the assessment on an equal basis (the equal basis requirement). (ii) [Reserved] (3) Mandatory tax or other assessment. An assessment is an enforced contribution that is imposed and collected for the purpose of raising revenue to be used for a specific purpose (that is, to defray the capital cost of an improvement). Assessments must be levied on a property frontage basis, an ad valorem basis, or any other comparable method that results in equivalent mandatory assessment to all residents benefiting from the improvements in an amount proportionate to the benefit to the assessed property. Assessments do not include fees for services. (4) Specific essential governmental function. For this purpose, in general, the term essential governmental function has the same meaning as under section 7871. An essential governmental function does not include any function to the extent that it is not customarily performed (and financed with governmental bonds) by governments with general taxing powers. In determining whether an activity is customarily performed by a governmental unit, isolated instances of bond financing are disregarded. Examples of specific essential governmental functions for purposes of this section include street paving and street-light installation, sewage treatment and disposal, and municipal water facilities, but not commercial or industrial ventures. A specific essential governmental function does not include permitting installment payments of property taxes or other taxes or any improvement to property owned by a nongovernmental person. (5) Equal basis requirement--(i) In general. An assessment does not satisfy the equal basis requirement if the terms for payment of the assessment are not the same for all assessed persons (for example, if certain residents are permitted to pay the assessment over a period of years while others must pay the entire assessment immediately or if the assessment is required to be prepaid when the property is sold). In addition, the amounts payable and the rates used to determine those amounts must be determined on the basis of non-discriminatory criteria. Thus, for example, an assessment does not satisfy the equal basis requirement if imposed on a different basis for business and non- business beneficiaries. The equal basis requirement is not, however, violated solely because an assessment varies on the basis of the relative benefit conferred. (ii) Additional security. The equal basis requirement is not violated as a result of one benefitted party acquiring a guaranty of a third party to pay debt service on bonds if it is not reasonably expected that payments will be made because of the additional assurances that otherwise not have been made and the guarantor's recourse is limited to the assessments and the benefitted property. (6) Coordination with private business tests. See Secs. 1.141-3 and 1.141-4 for rules for determining whether tax assessment loans cause the bonds financing those loans to be private activity bonds under the private business use and the private security or payment tests. (d) Nonpurpose investment exception. Any loan that is a nonpurpose investment is not treated as a loan for purposes of this section. Thus, for example, proceeds invested in loans such as obligations of the United States during any available temporary period, as part of a reasonably required reserve or replacement fund, as part of a refunding escrow, or as part of a minor portion (as each of those terms is defined under Sec. 1.148-1(b)) are not loans for purposes of this section. This paragraph (d) does not apply to any nonpurpose investment acquired pursuant to a plan to avoid the limitations of section 141(c) and this section. (e) Examples. The following examples illustrate the application of this section: Example 1. State agency Z and federal agency H will each contribute to rehabilitate a project owned by Z. H can only provide its funds through a contribution to Z to be used to acquire the rehabilitated project on a turnkey basis from an approved developer. Under H's turnkey program, the developer must own the project while it is rehabilitated. Z issues its notes to provide funds for construction. A portion of the notes will be retired using the H contribution, and the balance of the notes will be retired through the issuance by Z of long-term bonds. Z lends the proceeds of its note to Developer B as construction financing and transfers title to B for a nominal amount. The conveyance is made on condition that B rehabilitate the property and reconvey it upon completion, with Z retaining the right to force reconveyance if these conditions are not satisfied. B must name Z as an additional insured on all insurance. Upon completion, B must transfer title to the project back to Z at a set price, which price reflects B's costs and profit, not fair market value. Further, this price is adjusted downward to reflect any cost-underruns. For purposes of section 141(c), this transaction does not involve a private loan. Example 2. Assessment district U issues bonds the proceeds of which are used to construct water and sewer improvements in the district. At the time that the bonds are issued, all of the property in the district is owned by several developers, each of which is in the trade or business of developing the property in the district for residential use. In accordance with the procedures required by applicable State law, U imposes assessments on each parcel in the district. U requires that, at the time that a developer sells a residential parcel, the developer must prepay the remaining amount of the assessment. The assessments do not satisfy the equal basis requirement, because the payment terms are not the same for all assessed persons.