rp-18-26.pdf

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26 CFR 601.601 Rules and regulations.
(Also, §§54, 54A, 54AA, 141, 142, 1397E, 1400N, 1400U-2, 6431; 1.141-12, & 1.142-2)

Rev. Proc. 2018-26

SECTION 1. PURPOSE
This revenue procedure provides certain remedial actions that issuers of State
and local tax-exempt bonds and other tax-advantaged bonds (as defined in § 1.150-1(b)
of the Income Tax Regulations) may take to preserve the tax-advantaged status of the
bonds when nonqualified uses (as defined in section 4.04 of this revenue procedure) of
the bond proceeds occur.
SECTION 2. BACKGROUND
.01 Various provisions of the Internal Revenue Code (the “Code”) provide tax
benefits to facilitate lower borrowing costs for State and local governments and other
qualified issuers if certain requirements are met. These benefits are in the form of a tax
exemption under § 103 on the interest paid to holders of eligible State and local bonds
(“tax-exempt bonds”), refundable tax credits under § 6431 payable to issuers of certain
qualified bonds (“direct pay bonds”), or tax credits under § 54A and similar provisions to
holders of qualified tax credit bonds (“tax credit bonds”).
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Eligibility requirements for
these tax benefits include prescribed uses of the proceeds of the bonds.

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Public Law No. 115-97, § 13404, 131 Stat. 2138 (2017), repealed the Code provisions related to tax
credit bonds and direct pay bonds effective for bonds issued after December 31, 2017. References in
this revenue procedure to these Code sections refer to those sections as in effect prior to repeal.

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.02 For some types of tax-advantaged bonds, existing regulations provide
remedial actions to cure certain nonqualified uses. For example, for tax-exempt
governmental bonds (as defined in § 1.150-1(b)), § 1.141-12 provides remedial actions
(including bond redemption or defeasance, alternative qualified use of disposition
proceeds, and alternative qualified use of facilities) to cure violations of the private
business use and private loan restrictions under § 141. Similarly, for certain types of
tax-exempt private activity bonds (as defined in § 141), § 1.142-2 provides remedial
actions (including bond redemption or defeasance) to cure violations of particular
requirements for qualified private activity bonds under §§ 142, 144, and 147. In
addition, for qualified zone academy bonds (“QZABs”) as defined in § 1397E,
§ 1.1397E-1(h)(8) provides remedial actions (including bond redemption or defeasance
and alternative qualified use of disposition proceeds) to cure violations of requirements
for QZABs under § 1397E.
.03 The existing remedial actions for tax-exempt governmental bonds do not
include a remedial action to cure the nonqualified uses that generally result from longer-
term leases of financed property to private businesses, other than the remedial action of
bond redemption or defeasance. Taxpayers have recommended adding a remedial
action for this purpose similar to the existing remedial action that allows curing
nonqualified uses that result from sales of financed property to private businesses
through alternative qualified uses of the disposition proceeds of those sales. Section
1.141-12(h) permits the Commissioner, by publication in the Internal Revenue Bulletin,
to provide additional remedial actions for purposes of the private business use and

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private loan restrictions. Section 5 of this revenue procedure provides such a remedial
action.
.04 For direct pay bonds, no existing remedial action allows adjustment of the
refundable Federal tax credit for nonqualified uses. Such a remedial action would
provide a simple and administrable method of preserving the tax-advantaged status of
direct pay bonds. Section 6 of this revenue procedure provides this remedial action.
.05 Finally, for certain types of tax credit bonds and for direct pay bonds, none of
the existing remedial actions described in section 2.02 of this revenue procedure are
available. Extending the availability of existing remedial actions to these types of bonds
would allow issuers similarly to cure nonqualified uses of these bonds. Section 7 of this
revenue procedure provides remedial actions for these bonds.
SECTION 3. SCOPE
This revenue procedure applies to tax-advantaged bonds to allow issuers to take
certain remedial actions to protect the tax-advantaged status of the bonds when
nonqualified uses of bond proceeds occur if the requirements of particular remedial
actions under this revenue procedure are met.
SECTION 4. DEFINITIONS
The definitions in this section 4 apply for purposes of this revenue procedure.
.01 Applicable Code section means the Code section that sets forth the
qualification requirements for a particular type of bond.
.02 Defeasance escrow means an irrevocable escrow established to redeem
nonqualified bonds on the earliest call date after the date on which a nonqualified use
occurs in an amount that, together with investment earnings, is sufficient to pay all the

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principal of, interest on, and call premium, if any, on the nonqualified bonds from the
date the escrow is established to that call date. No amount in a defeasance escrow
may be invested in an investment the obligor of which is a user (or a related party (as
defined in § 1.150-1(b)) to a user) of proceeds of the bonds. All purchases or sales of
investments in a defeasance escrow must be made at the fair market value of the
investment within the meaning of § 1.148-5(d)(6).
.03 Disposition proceeds means, except as otherwise provided in this section
4.03, disposition proceeds (as defined in § 1.141-12(c)(1)), plus investment earnings on
those amounts. For property financed with different sources of funding, disposition
proceeds are allocated among the sources under § 1.141-12(c)(3). For purposes of
section 5 of this revenue procedure, the definition of disposition proceeds in § 1.141-
12(c)(1) applies.
.04 Nonqualified use means a failure to spend proceeds of tax-advantaged
bonds within any required expenditure period specified in the applicable Code section
and any use of expended proceeds of tax-advantaged bonds for a purpose other than a
qualified use (as defined in section 4.06 of this revenue procedure). A nonqualified use
under § 141 occurs on the date of the deliberate action (as defined in § 1.141-2(d)(3)).
For dates on which other nonqualified uses occur, see section 7.03 of this revenue
procedure.
.05 Nonqualified bonds means the portion of the outstanding bonds in an amount
that, if the remaining bonds were issued on the date on which nonqualified use of
proceeds occurs, the proceeds of the remaining bonds would be used in a timely

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manner for a qualified use. Allocations of nonqualified bonds are made in accordance
with § 1.142-2(e).
.06 Qualified use means a use required or permitted by the applicable Code
section. For example, qualified uses include a qualified purpose under § 54A(d)(2)(C)
for tax credit bonds under § 54A, capital expenditures for direct pay build America
bonds under § 54AA(g), and a prescribed amount of governmental use for tax-exempt
governmental bonds under § 141 and build America bonds under § 54AA.
SECTION 5. REMEDIAL ACTION FOR ELIGIBLE LEASES OF PROPERTY
FINANCED WITH TAX-ADVANTAGED BONDS SUBJECT TO § 141 OR § 145(a)

.01 Modified alternative use of disposition proceeds remedy for eligible leases.
In the case of a deliberate action (as defined in § 1.141-2(d)(3)) that consists of an
eligible lease (as defined in section 5.02 of this revenue procedure) to a
nongovernmental person (as defined in § 1.141-1(b)) of property financed with tax-
advantaged bonds subject to the private activity bond restrictions under § 141 or
§ 145(a), provided the requirements of § 1.141-12(a) are met, the issuer may cure the
nonqualified use resulting from the lease by applying the alternative use of disposition
proceeds remedial action under § 1.141-12(e) in the same manner as to a disposition
with the following modifications--
(1) Treating the eligible lease as a disposition for which the consideration is
exclusively cash;
(2) Treating funds (excluding proceeds of tax-advantaged bonds) in an amount
equal to the lease amount (as defined in section 5.03 of this revenue
procedure) as disposition proceeds;
(3) Treating the leased property as transferred property; and

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(4) Allocating proceeds of the issue that, under § 1.141-12(c)(2), are allocable
to the funds treated as disposition proceeds, to those funds during the term
of the lease only (and to the leased property thereafter).
.02 Eligible lease. A lease is an eligible lease if--
(1) The consideration for the lease consists exclusively of cash lease payments
(regardless of when paid) that are not financed with proceeds of another
issue of tax-advantaged bonds; and
(2) The term of the lease--
(a) Is at least equal to the lesser of 20 years or 75 percent of the weighted
average reasonably expected economic life of the leased property
(determined in the same manner as under section 147(b)) as of the start
of the term of the lease; or
(b) Runs through the end of the measurement period (as defined in § 1.141-
3(g)(2)) during which the private business use restrictions are measured
for compliance under section 141.
.03 Lease amount. The lease amount is an amount equal to the present value
of all of the lease payments required to be made under the lease. For this purpose,
present value is determined as of the start of the term of the lease by using the yield on
the issue as of the start of the term of the lease as the discount rate.
SECTION 6. REMEDIAL ACTION FOR DIRECT PAY BONDS TO REDUCE THE
REFUNDABLE FEDERAL TAX CREDIT

In the case of direct pay bonds, an issuer may cure a nonqualified use by
reducing the amount of the refundable Federal tax credit to eliminate the amount
allocable to the nonqualified bonds. Further, the issuer must treat any disposition

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proceeds as described in section 7.02(3) of this revenue procedure. To effect this
remedial action, beginning with the first Form 8038-CP (Return for Credit Payment to
Issuers of Qualified Bonds) or successor form filed for any interest payment date for the
bonds after the nonqualified use occurs, the issuer, in reporting the amount of the
interest payable, must exclude the portion of that interest allocable to the nonqualified
bonds
that accrues on or after the date of the nonqualified use. For the first such Form
8038-CP (or successor form), the issuer must print or type across the top of the form
“Remedial Action under Section 6 of Rev. Proc. 2018-26” and attach the required
explanation for the difference in scheduled credit payment. The explanation must state
that a nonqualified use occurred and the date of the nonqualified use and include a
revised debt service schedule reflecting the exclusion of amounts allocable to the
nonqualified bonds beginning with the date of the nonqualified use.
SECTION 7. CERTAIN GENERAL REMEDIAL ACTIONS FOR TAX-ADVANTAGED
BONDS

.01 In general. In the case of tax-credit bonds or direct pay bonds, except as
otherwise provided in section 7.06 of this revenue procedure, an issuer may cure a
nonqualified use by taking a remedial action of redemption or defeasance of
nonqualified bonds under section 7.02 of this revenue procedure or alternative use of
disposition proceeds under section 7.05 of this revenue procedure. In the case of tax-
exempt bonds, issuers may apply section 7.02(2) of this revenue procedure to
defeasance escrows established under § 1.141-12(d) or § 1.142-2(c).
.02 Redemption or defeasance of nonqualified bonds. The requirements for
redemption or defeasance of nonqualified bonds under this section 7.02 are met if--

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(1) Amount and timing of redemption or defeasance. Within 90 days after the
date on which the nonqualified use occurs, the issuer redeems the nonqualified bonds
of the issue or establishes a defeasance escrow for any nonqualified bonds that are not
so redeemed; and
(2) Yield restriction or rebate requirement. The issuer either restricts the
investments in the defeasance escrow to investments that are not higher yielding
investments (as defined in § 148(b)) or the issuer makes rebate payments to the United
States, at the same time and in the same manner as arbitrage rebate amounts are
required to be paid, in amounts equal to any earnings on investments in the defeasance
escrow that are higher than the yield on the issue with respect to which the defeasance
escrow was established. For this purpose, the first computation period begins on the
date on which the defeasance escrow is established. Further, for purposes of this
section 7.02(2), § 148 and the regulations thereunder (as modified by the applicable
Code section and this section 7.02(2)) apply, and compliance with the rebate
requirement in this section 7.02(2) is treated as satisfying applicable arbitrage
investment restrictions under § 148 for the defeasance escrow.
(3) Treatment of disposition proceeds. The issuer treats the disposition proceeds
as gross proceeds for purposes of § 148 as modified by the applicable Code section
(the arbitrage requirements) and as proceeds for purposes of the applicable Code
section. For purposes of applying the temporary period and spending exceptions to the
arbitrage requirements, the issuer may treat the date of the receipt of the disposition
proceeds as if it were the issue date of the nonqualified bonds and disregard the receipt

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of disposition proceeds for the spending exceptions under § 1.148-7 for which the
requirements were met before the receipt of the disposition proceeds.
.03 When a nonqualified use occurs. For unspent proceeds of bonds, a
nonqualified use occurs on the earlier of the first date on which the issuer fails to have a
reasonable expectation to spend the proceeds for a qualified use (within the required
expenditure period, if any) or the last day of the required expenditure period, if any. For
proceeds of bonds that have been spent, a nonqualified use occurs on the first date on
which an action causes proceeds to be used for other than a qualified use.
.04 Reissuance. For purposes of determining whether the establishment of a
defeasance escrow under section 7.02 of this revenue procedure results in an
exchange under § 1.1001-1(a), the defeased bonds are treated as tax-exempt bonds for
purposes of § 1.1001-3(e)(5)(ii)(B)(1).
.05 Alternative use of disposition proceeds. The requirements for alternative use
of disposition proceeds under this section 7.05 are met if--
(1) Disposition for cash. The nonqualified use consists of a disposition for which
the consideration is exclusively cash;
(2) Reasonably expected use of disposition proceeds. The issuer reasonably
expects to spend the disposition proceeds within two years after the date of the
disposition on alternative qualified uses or, to the extent the issuer does not expect to
so spend the disposition proceeds, the issuer takes a remedial action under section
7.02 of this revenue procedure for such disposition proceeds within 90 days after the
date of disposition;

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(3) Unspent disposition proceeds. If the issuer fails to spend all of the disposition
proceeds that it reasonably expected to spend within the prescribed two-year period in
the manner described in section 7.05(2) of this revenue procedure, the issuer takes a
remedial action under section 7.02 of this revenue procedure for the remaining
disposition proceeds within 90 days after the end of that two-year period; and
(4) Treatment of disposition proceeds. The issuer treats the disposition proceeds
as described in section 7.02(3) of this revenue procedure.
.06 Certain special rules on applicability. For QZABs under § 1397E, the
remedial actions under § 1.1397E-1(h)(8) apply in lieu of this section 7. For tax-
advantaged bonds subject to § 141, the remedial action provisions under § 1.141-12
apply in lieu of this section 7 for purposes of curing violations of the private business
use and private loan restrictions; however, for defeasance escrows established under
§ 1.141-12(d), section 7.04 of this revenue procedure applies and issuers may apply
section 7.02(2) of this revenue procedure.
SECTION 8. EFFECTIVE DATE
This revenue procedure applies to a nonqualified use that occurs on or after April
11, 2018, and may be applied to a nonqualified use that occurs before April 11, 2018.
SECTION 9. DRAFTING INFORMATION
The principal authors of this revenue procedure are Timothy L. Jones, Johanna
Som de Cerff, and Zoran Stojanovic of the Office of Associate Chief Counsel (Financial
Institutions & Products). For further information regarding this revenue procedure,
contact Zoran Stojanovic at 202-317-6980 (not a toll-free call).