The Internal Revenue Service has announced in Notice 2014-9 that current refunding issues of Recovery Zone Facility Bonds qualify as tax-exempt provided that the current refunding issue meets certain requirements.  Generally, if the current refunding issue satisfies all of the rules applicable to Recovery Zone Facility Bonds (other than the statutory deadline), the current refunding issue will be tax-exempt.

Authorization for the issuance of Recovery Zone Facility Bonds was added to the Internal Revenue Code in 2009 by passage of the American Recovery and Reinvestment Act, otherwise known as the  Stimulus.  Under the Stimulus, state and local governments were authorized to issue up to $15 Billion of these bonds, with each state getting a share of the volume allocation based on unemployment.  The authorization came with a sunset provision: all bonds had to be issued before January 1, 2011. 

All bonds issued were considered “exempt facility bonds” under I.R.C. Section 142 for purposes of tax-exemption.

Recovery Zone Facility Bonds were authorized by the Stimulus to assist struggling local communities designated under the law as “recovery zones.”  “Recovery zones” included areas designated as such by the issuer due to significant poverty, unemployment, home foreclosures, or “general distress.”  Areas affected by the closure of military bases or which had been designated as “empowerment or renewal communities” at the time the Stimulus was passed could also qualify.

If a community was properly designated as a “recovery zone,” the proceeds of the bonds could be used to finance “recovery zone property.”  The Stimulus defines “recovery zone property” as any property to which the accelerated cost recovery system rules under I.R.C. Section 168 apply (or would apply but for I.R.C. Section 179), and if: (1) the property was constructed, reconstructed, renovated or acquired by the taxpayer after the recovery zone designation went into effect; (2) the original use of the property in the recovery zone commences with the taxpayer; and (3) substantially all of the use of the property occurs in the recovery zone and is in the active conduct of a qualified business under the Stimulus.

In addition to meeting the “recovery zone” and “recovery zone property” requirements, Recovery Zone Facility Bonds had to be designated as such by the issuer, and had to meet a “95% use” requirement; that is, 95% of the net proceeds of the issuance had to be used for recovery zone property.

Because the Stimulus failed to address whether current refundings of these bonds occurring after the “sunset date” qualify for tax-exempt status, the IRS provided the instant guidance.  Current refundings of Recovery Zone Facility Bonds will be tax-exempt if the current refunding meets all of the following requirements:

1. The refunded bonds met the January 1, 2011 deadline;
2. The issue price of the refunding bonds must be no greater than the outstanding stated principal amount of the refunded bonds, provided, however, that if there was more than a de minimus amount of original issue discount or premium, the present value of the refunded bonds must be used; and
3. the refunding bonds must meet all of the requirements for Recovery Zone Facility Bonds (other than the deadline requirement), including the requirement that the average maturity of the refunding bonds be no longer than 120% of the average reasonably expected economic life of the facilities financed by the refunded bonds.

If all of these requirements are met, the refunding bonds are treated by the IRS as a tax-exempt issuance of Recovery Zone Facility Bonds, notwithstanding that the issuance occurs after the January 1, 2011 deadline.  This determination by the IRS does not apply to other types of bonds to which a deadline has attached, including “Build America Bonds” which were also authorized by the Stimulus.