A NEW STRUCTURE or financing baseball stadiums should also work for road and other infrastructure projects.

The Internal Revenue Service released two private rulings in late October that describe how new ballparks for the New York Yankees and Mets are being financed.

New York City wanted to use as much tax-exempt financing as possible. It issued a combination of taxable and tax-exempt debt for the ballparks. The structure is expected to save the two baseball clubs more than a $100 million each.

Assetsthatwillbeputtomorethan10%“private business use” are a challenge to finance in the tax-exempt bond market; the bonds will not be tax exempt if more than 10% of the payments used to repay the bonds or the security behind the bonds also comes from a private party. Both stadiums will have too much private business use; each is for a private baseball team. Bonds that flunk both the private business use test and the payment or security test are labeled “private activity bonds.” In other words, they are viewed as a borrowing for a private project.

The tax-exempt bond market is supposed to be off limits to private borrowing. There are exceptions for 15 types of projects that Congress felt throw off public benefits. Sports stadiums are not on this list.

New York City owns the land where the ballparks are being built. It leased the land in each case to a local government agency called an industrial development authority, or IDA. The IDA subleased the land to the baseball team and issued a combination of tax-exempt and taxable debt to finance construction of the stadium. Each team is building its stadium as the “agent” for the IDA. The IDA will hold legal title to the stadium. The team will sign an agreement promising to operate and maintain it.

Each team will make four kinds of periodic payments to the IDA. It will pay rent for use of the ballpark, unspecified installment sale payments, a percentage of net revenue from stadium parking and PILOT payments that are specially- negotiated property taxes. (The term PILOT stands for payments in lieu of taxes.) The parties are being careful about which parts of the debt are secured by which payments. The PILOT payments are dedicated to the tax-exempt debt, and the rents and installment sale payments are each used to secure a different series of taxable debt.

The question with which the IRS wrestled in the rulings is whether the PILOT payments are a form of private payment. A city can use revenue from “generally applicable taxes” to secure a bond offering without endangering the tax exemption on the bonds. However, the payments in this case were specially negotiated. Are they still essentially property taxes? The IRS said yes based on a highly technical two-part test in the IRS regulations (and after concluding that the payments did not follow any set formula for negotiated PILOT agreements in New York). The rulings are PLRs 200641001 and 200641002.

The agency has since revised its regulations.

New regulations issued in late October leave the same two-part test for PILOT payments, but they explain in more detail how the IRS wants the test interpreted. The agency said it was concerned that the old rules could be interpreted in an “overly broad manner.”

PILOT payments will be treated as a generally applicable tax as long two things are true. First, they must be “commensurate with and not greater than” the regular tax for which they are a substitute. Second, the payments must be “designated for a public purpose” and cannot be a “special charge.”

The IRS said that, to be considered “commensurate,” in the future the payments must either be a fixed percentage or fixed adjustment to the regular tax. A fixed adjustment means a fixed dollar discount off the regular tax or a fixed reduction based on the characteristics of the property, such as the size of the business or number of employees. There can be a one-time increase in rate at the end of construction. In the case of property taxes, the payment must be tied to current property values; the property must be reassessed for PILOT purposes with the same frequency that other property is reassessed. The IRS said the PILOT payments cannot be tied to the amount of debt service, and they cannot be fixed amounts that do not vary with the assessed value of the property.

The new rules will apply to bonds sold on or after February 19, 2007. The IRS is collecting comments in the meantime. Comments are due by January 16.

Tax increment bonds that are secured by tax payments from a particu- lar project are already used in many states. New York law barred the state from using such bonds, so another structure had to be found. There is no reason states and cities cannot use the same PILOT structure to finance other new infrastructure projects. The structure should also work with other types of taxes besides property taxes.

Keith Martin