A structure for borrowing in the tax-exempt bond market against future property tax receipts to finance infrastructure projects has come under fire from a House subcommittee.

The subcommittee criticized use of the structure by the New York Yankees to help finance a new baseball stadium. Rep. Dennis Kucinich (D.-Ohio), the subcommittee chairman, charged at a hearing in September that the Yankees claimed an inflated property value in order to boost the amount of tax-exempt bonds that could be issued to finance the ballpark. He repeated the charges at a second hearing on October 24.

The same day, the Internal Revenue Service reissued regulations in final form that make the structure possible.

State and local governments can borrow at reduced interest rates in the tax-exempt bond market to finance schools, roads, hospitals and other public facilities. The market is supposed to be off limits to private borrowing. There are exceptions for 15 types of private projects that Congress felt throw off public benefits. Sports stadiums are not on the list.

New York City used a combination of taxable and tax-exempt debt to finance new stadiums for its two baseball teams, the Yankees and Mets. The city owns the land under the two ballparks. 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 built or is building its stadium as the “agent” for the IDA. The IDA holds legal title to the stadium. Each team signed an agreement promising to operate and maintain it.

Each team must make four kinds of payments to the IDA. It pays 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 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. Under IRS rules, no more than 10% of payments used to repay tax-exempt bonds or of the security behind such bonds can come from private sources.

Cities can issue tax-exempt bonds that essentially borrow against future property tax collections. The taxes must be “generally applicable taxes.” In this case, the taxes pledged to support each bond offering were specially-negotiated taxes from a single taxpayer. Are they still essentially general property tax collections? The IRS said yes in two private rulings issued to New York City in 2006. The city has another ruling request pending for an additional $360-plus million in bonds tied to Yankee stadium on top of the $950 million in bonds issued for the project in 2006.

The subcommittee charged that the city purposely overstated the value of the site for the new Yankee stadium as a way of labeling more of the payments from the club as payments in lieu of property taxes and, therefore, of increasing the amount of tax-exempt debt as a share of total borrowing. Kucinich charged at the hearing that city officials originally assessed the 17-acre stadium site in the Bronx at $26.8 million and, one day later with an eye on the bond offering, increased the assessment to $204 million. The city responds that the first assessment was based on the lot remaining vacant.

Meanwhile, the IRS has since revised its regulations on when PILOT payments will be considered “generally applicable taxes.” The agency said it was concerned that the approach it was using in 2006 could be interpreted in an “overly broad manner.”

Under the new rules, issued in final form on October 24, PILOT payments will be treated as generally applicable taxes as long as 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 used for the same government or public purposes as general property tax collections and cannot be a “special charge.”

The IRS said that, to be considered “commensurate,” 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 adjustments in the “fixed” percentage or discount through 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.

Tax increment bonds that are secured by tax payments from a particular project are already used in many states. New York law barred the state from using such bonds, so another structure had to be found.

Keith Martin