Economic Recovery: The 2010 Recovery Bond Fix

With the enactment of the American Recovery and Reinvestment Tax Act of 2009 (the ARRA), the Federal government has provided two new types of bonds which local governmental units may issue - recovery zone economic development bonds and recovery zone facility bonds. In June, 2009, the Internal Revenue Service announced an allocation to all counties and several cities in Indiana to provide for the issuance of recovery zone economic development bonds and recovery zone facility bonds.

Some communities in Indiana have already taken advantage of this new bonding authority to undertake economic development projects. The authority to issue these types of bonds is presently set to expire at the end of this year. Many communities are contemplating uses for their recovery zone allocations for both economic development bonds and facility bonds. This summary is intended to provide you with the information you need to know to effectively utilize both recovery zone economic development bonds and recovery zone facility bonds to provide for improved public infrastructure and opportunities for economic development in your community.

Recovery Zone Bonds

• The ARRA provides new authority for state and local governments to issue bonds known as recovery zone bonds in the form of recovery zone economic development bonds and recovery zone facility bonds.
• The proceeds of such bonds must be used to fund projects that are located in "recovery zones."
• "Recovery zones" may be designated by a local government in any reasonable manner as may be determined in good faith.
• Recovery zones must meet at least one of the following criteria:
  • Any area designated by the bond issuer as having significant poverty, unemployment, rate of home foreclosures or general distress;
  • Any area designated by the issuer as economically distressed by reason of the closure or realignment of a military installation pursuant to the Defense Base Closure and Realignment Act of 1990; and
  • Any area for which a designation as an empowerment zone or renewal community is in effect.
• Recovery zone bonds may be issued to finance capital projects undertaken by governmental units (these bonds are known as Recovery Zone Economic Development Bonds or "RZEDBs") or issued on behalf of private companies to assist with the financing of private development in a recovery zone (such bonds being known as Recovery Zone Facility Bonds or "RZFBs").
• These new bonds must be issued before January 1, 2011.
• The ARRA authorizes a nationwide volume cap for RZFBs in the amount of $15 billion and a nationwide volume limitation for RZEDBs in the amount of $10 billion.The Treasury Secretary has allocated the national RZEDB and RZFB limitations among the states proportionally according to each state's 2008 employment decline. The IRS has provided for further sub-allocations to each county and major population centers within each state.
• Local governmental units may agree on further reallocations within counties and population centers.

Recovery Zone Economic Development Bonds

• The ARRA creates a new category of taxable obligation (RZEDBs) which may be used by local governmental units to finance capital projects that are intended to foster economic development.
• Interest is included in the income of bondholders for IRS purposes.
• The issuer of RZEDBs receives a payment directly from the Treasury Secretary equal to 45 percent of the interest cost of the bonds contemporaneously with the payment of interest on the bonds. As a result, the issuer is responsible for paying only 55 percent of the interest cost from its sources.
• To qualify as a RZEDB, the interest of such obligation would (but for its treatment as a RZEDB) be excludable from gross income (i.e., the project funded by the proceeds of the bonds must otherwise have qualified for tax-exempt financing).
• 100 percent of available project proceeds (no more than 2 percent of the proceeds can be used for costs of issuance) are to be used for "qualified economic development purposes" or to fund a reasonably required reserve.
• "Qualified economic development purpose" consists of expenditures for the purposes of promoting development or other economic activity in a recovery zone including: (i) capital expenditures paid or incurred with respect to property located in a recovery zone; (ii) expenditures for public infrastructure and construction of public facilities; and (iii) expenditures for job training and educational programs.
• Davis Bacon wage rate rules apply to projects funded with the proceeds of RZEDBs.

Recovery Zone Facility Bonds

• The ARRA also created a new recovery zone bond (RZFBs) which are an additional category of tax-exempt private activity bonds which provide private businesses access to low interest tax-exempt financing.
• At least 95 percent of the proceeds of RZFBs must be used to finance "recovery zone property" which is defined as depreciable property meeting certain requirements:
  • Such property must be constructed, renovated or acquired by a taxpayer after the date of designation of a recovery zone. Rules would appear to permit a "turnkey" purchase of newly constructed property, a purchase of equipment for an existing facility or the purchase of existing equipment from outside the recovery zone for use in the recovery zone; and
  • Such property must be used for a qualified business which excludes rental of residential property (mixed use property does qualify as long as 20 percent or more of the gross rental income is from commercial activity rather than residential rental) and certain other types of businesses (e.g., golf courses, gambling establishments).
• RZFBs are issued by local governmental units which in turn loan the proceeds to private businesses. Prior to this new bonding authority, tax-exempt bond financing for private businesses was limited to new manufacturing facilities.