Federal law distinguishes between two general types of municipal bonds: governmental bonds and private activity bonds. Governmental bonds are used for public purposes, such as government office buildings, parks, or prisons. Private activity bonds, by contrast, are used for projects that primarily benefit private companies or individuals.
Generally, governmental bonds are exempt from federal, state, and local income taxes. Depending on their use and the type of project financed, private activity bonds may be taxable or tax-exempt. A municipal bond is considered a private activity bond if it meets one of two criteria:
· More than 10 percent of the proceeds are for private business use, and principal or interest payments on more than 10 percent of the proceeds are secured by an interest in the property used for private business use or payments received from such use.
· More than the lesser of 5 percent or $5 million of bond proceeds are used to make loans to private entities.
Even if a municipal bond meets the above criteria and is thus a private activity bond used for private purposes, it may still be tax-exempt if it is used for a qualified project.
To be considered a qualified private activity bond, proceeds may be used for 27 types of projects grouped into seven overall categories:
· Exempt facility bonds are used to build, renovate, or maintain facilities that may be privately owned or primarily used by private entities, including airports, high-speed rail lines, and other transportation-related projects; certain residential rental properties, such as low-income apartment complexes; and certain privately owned utilities, including water, sewer, and electricity.
· Qualified mortgage bonds, sometimes referred to as single family mortgage revenue bonds, are used to make low-interest loans for first-time homebuyers within income limitations.
· Qualified small issue bonds are bond issues used to finance manufacturing facilities.
· Qualified redevelopment bonds are used to buy land or buildings in a blighted area, relocate inhabitants, rehabilitate the buildings, or clear the land for redevelopment.
· Qualified veterans’ mortgage revenue bonds are used to make low-interest home loans to veterans.
· Qualified 501(c)(3) bonds are used to finance facilities owned and used by charitable organizations.
In general, most of the qualified projects above count toward an overall state cap on the amount of tax-exempt private activity bonds that may be issued by each state every year. Federal law and regulations are complex, however, and some of the projects are not subject to the cap, or may have other restrictions. Each state receives either a flat minimum or, for more populous states, an amount based on population.
Local governments may apply to ECD for allocations to issue small issue bonds for manufacturing or exempt facility bonds for other qualified projects.
