4.6.3 Private Loan Test

The Private Loan Test is met if more than the lesser of 5% or $5 million of the proceeds of the issue is used to make or finance loans to nongovernmental persons. A loan is any transaction that is characterized as a loan under general federal income tax principles, and this tax analysis will be based on the substance of the transaction rather than the particular form. For example, a lease or a management contract might be considered a loan if federal tax ownership of the facility is transferred to the lessee or manager. Likewise, an output contract might be considered a loan if the agreement shifts significant burdens and benefits of ownership to the output purchaser.

Real property assessments and certain Mello Roos special taxes may be treated for federal income tax purposes as loans to the property owners. However, such “tax assessment loans” will not be treated as loans for purposes of the Private Loan Test as long as the loans arise from the imposition of a mandatory tax or other assessment of general application, are imposed for the purpose of financing essential governmental functions, and are applied on an equal basis to owners of property benefitting from the financed improvements. While tax assessment loans will not be treated as loans for purposes of the Private Loan Test, the payments made by property owners may cause the bonds to meet the Private Security or Payment Test. As a result, most special tax and assessment bonds are limited to financing projects that do not meet the Private Business Use Test (e.g., public infrastructure) in order to qualify as tax exempt.