WASHINGTON -- The Internal Revenue Service has ruled that a non-profit medical center can sell its nursing homes to a private owner without endangering the tax-exempt status of bonds used to finance the nursing homes because the bonds are being retired as quickly as possible.
The medical center in question and its affiliated hospital were not identified in the private letter ruling, number 9438008, which was published last month.
Bond lawyers said the ruling is helpful because it offers additional evidence that the IRS is willing to bless change-in-use situations which, like the one in question, fall outside of safe harbors that the IRS created under Revenue Procedure 93-17.
The IRS, however, offered its usual cautionary statement in the ruling that its conclusions should not be regarded as precedent setting.
Several years ago the hospital and medical center together participated in a tax-exempt bond issue, a portion of which was used to refinance an existing taxable issue for two nursing homes owned by the medical center.
Shortly after the bonds were issued, decreasing patient admissions and other unforeseen circumstances caused the center and hospital to suffer severe financial losses. To remedy the situation, the center decided to sell the two nursing homes, and has found a buyer: A private owner and operator of nursing home facilities.
But under the tax law, selling to a private buyer could presumably create a problem because 501(c)(3) bonds and other qualified private-activity bonds cannot be tax-exempt unless at least 95% of the proceeds are used for the intended purpose that qualifies for tax-exempt financing.
In February 1993, the IRS published Revenue Procedure 93-17, under which issuers and borrowers who meet certain criteria may convert their bond-financed facilities to private use without undermining the tax-exempt status of the bonds.
One of the key criteria in the 1993 revenue procedure was that the bond issue must be outstanding, and the facility in service, for at least five years. The sale described in the private letter ruling falls outside of the safe harbors created in the 1993 revenue procedure because the sale is occurring within five years.
Even so, the IRS concluded that the"' bonds would not lose their tax-exempt status because within 90 days after the sale the hospital and medical center will use the proceeds from the sale to tender, at a premium, for the portion of the outstanding issue that represents the refinancing of the nursing homes.
The premium will be designed so that all of the sale proceeds will be used within six months of the sale to purchase as many bonds as possible. If the tender does not retrieve' all the outstanding bonds, the issuer will place the rest of the sale proceeds in an escrow to the first call date to retire the additional bonds.
This appears to be only the second significant letter ruling covering change-in-use situations that occur outside of the safe harbor guidelines set up under the 1993 revenue procedure, lawyers said. In the first ruling, released last February, the IRS permitted a hospital to convert its rehabilitation facility to private use if the hospital retired some of the tax-exempt bonds that had been used three years before to finance the facility and commonly used areas of the hospital.
Bond lawyers have been anxious for guidance in this area because shortly after the 1993 revenue procedure was issued, IRS officials conceded that the safe harbor guidelines did not cover all change-in-use situations. The officials encouraged lawyers and issuers to seek letter rulings for questions that the revenue procedure did not address.
Last month's letter ruling is helpful because it "confirms the stated position of the service they're willing to work with people who have situations that fall outside the express provisions of the 93-17 safe harbors," said R. Todd Greenwalt, a lawyer with Vinson & Elkins in Houston. "But you still have to make some reasonable effort to. minimize the amount of time that tax-exempt bonds are outstanding with respect to property that's no longer used in a qualified manner."
Greenwalt and other lawyers noted the ruling also sheds a bit more light on what the IRS will permit outside the safe harbor. The ruling released in February offered the first indication that the IRS would accept a tender offer as a remedy. This new ruling indicates that a tender offer that fails to capture all outstanding bonds can be supplemented with a partial defeasance to the first call date.
The new ruling "makes it clear that as long as you make a good-faith attempt" to get all the bonds in the tender offer, failure to do so "is not fatal," said Lauren McNulty, a lawyer with Gardner, Carton & Douglas in Chicago.