This responds to the letter from your authorized representative requesting a ruling that, following transfer of partial title by deed in lieu of foreclosure, sale of a portion of the Projects financed with tax-exempt bond proceeds, and redemption of a proportionate amount of the Bonds, substantially all of the net proceeds of the Bonds will be used for residential rental projects that comply with the requirements of former section 103(b)(4) of the Internal Revenue Code.

The following facts and representations have been made. The Agency is an authority of the State created to provide, among other things, residential rental projects for low and moderate income individuals and families by making loans to the owners of housing developments who supply a portion of residential units to such individuals and families at rentals they can afford.

The Projects, referring collectively to 34 separate projects, numbered 1 through 34, consist of 82 three and four story townhouse buildings. Projects numbered 1 through 33 were renovated as residential renta projects with the proceeds of the Bonds. Project no. 34 was separately financed as commercial property.

After issuance of the Bonds in November 1985, the Agency deposited a portion of the proceeds of the Bonds in a debt service reserve fund for the Bonds or used it to pay interest accrued on the Bonds to the issue date of the Bonds. The remainder of the proceeds of the Bonds was used to make a building loan and a project loan (mortgage loan) to the Partnership to finance a portion of the cost of rehabilitation of the multifamily residential rental Projects nos. 1 through 33 for individuals and families of low and moderate income. The low-income set asides for the Projects were designed to comply with the requirements of former section 103(b)(4)(A) of the Code. The Bonds are secured by the mortgage loan, the debt service reserve fund, and a direct pay letter of credit issued by a bank.

In November 1989, the trustee drew on the letter of credit to pay the interest and sinking fund payment then due. The Partnership failed to repay at the prescribed time the amount drawn on the letter of credit and therefore defaulted on its scheduled mortgage loan payments. A continuing cash flow deficit, occuring most severely at Projects nos. 27 through 33, caused the defaults. These 7 projects were experiencing a high vacancy and turnover rate as a result of drug-related crime in their vicinity.

The Agency has avoided default on the Bonds by transferring amounts from the debt service reserve fund to make up for shortfalls in the amount required to reimburse the bank for the draw on the letter of credit. However, the Partnership's default will result in foreclosure of the mortgage loan, immediate mandatory redemption of all the Bonds, and the loss through sale of the entire low and moderate income residential rental housing provided by these Projects.

The Agency, the bank, and the Partnership are attempting to avoid sale of all of the Projects and to preserve as much of the Projects as possible as low and moderate income residential rental projects. The following workout plan has been developed. The Agency will begin foreclosure proceedings on the mortgage but will terminate the proceedings and accept a deed in lieu of foreclosure on Projects nos. 27 through 33 (and on Project no. 34 not financed with the Bonds). The Agency will sell Project nos. 27 through 34 and reinstate the mortgage, with the permission of the bank, on Projects nos. 1 through 26. The ownership interests in Projects nos. 27 through 34 will be conveyed to a person or persons other than the Partnerhsip or a related person as defined in section 1.10310(e) of the Income Tax Regulations. The workout plan is intended to enable the Projects to be self supporting. Furthermore, the low-income set aside percentage after the contemplated disposition of Projects nos. 27 through 33 will equal or exceed 20 percent of the original number of units in Projects 1 through 33.

As soon as the amounts from the disposition of Projects nos. 27 through 33 (defined as recovery payments in the bond resolution) are received by the Agency, the Agency will notify the trustee that, pursuant to section 206(2) of the series resolution, there is to be redeemed at par an amount of Bonds from recovery payments equal to the maximum multiple of $5,000 which is less than the amount received from the disposition. This amount of bonds will be at least equal to a fraction, consisting of the amount of proceeds allocable to the Projects sold divided by the amount of proceeds spent on Projects nos. 1 through 33 and applied against the face amount of the bond issue.

The Agency will furhter instruct the trustee to immediately publish the notice required by section 306 of the bond resolution for such redemption, setting the redemption date for 30 days after such notice. The portion of the recovery payments that is not an even multiple of $5,000 cannot be used to promptly call Bonds. Accordingly, any residual portion will be held in the sinking fund account of the debt service fund and will be applied on the next scheduled mandatory redemption date to reimburse the bank for amounts drawn under the letter of credit to redeem Bonds on such date. In the event that additional funds (mortgage advance amoritzation payments) are required to assure the redemption of the full amount of Bonds allocable to Projects 27 through 33, such payments, together with the portion of the recovery payments which are not an even multiple of $5,000 will be applied in accordance with the requirements of Rev. Proc. 79-5, 1979-1 C.B. 485, and Rev. Proc. 81-22, 1981-1 C.B. 692.

All recovery payments and all mortgage advance amortization payments, if any, needed to assure redemption in full of Bonds allocable to Projects nos. 27 through 33 will be ivnested prior to the redemption of the Bonds to produce a yield not greater than the yield on the Bonds.

Former section 103(a)(1) of the Internal Revenue Code of 1954 provides in general that gross income does not include interest on state or local bonds. Former section 103(b)(1) provides that except as otherwise stated, the interest on any industrial development bond shall not be excludable from gross income. former section 103(b)(2) provides that the term "industrial development bond" means any obligation (A) which is issued as part of an issue all or a major portion of the proceeds of which are to [be] used directly or indirectly in any trade or business carried on by any person who is not an exempt person, and (B) the payment of the principal or interest on which is, inwhole or in major part (i) secured by any interest in property used or to be used in a trade or business or in payments in respect of such property, or (ii) to be derived from payments in respect of property, or borrowed money, used or to be used in a trade or business.

Former section 103(b)(4)(A) of the Code provides, in part, that the inclusion of interest on industrial development bonds does not apply to any obligation which is issued as part of an issue substantially all of the proceeds of which are to be used to provide projects for residential rental property if at all times during the qualified project period 20 percent or more of the units in each project are to be occupied by individuals of low or moderate income.

Section 1.103-8(b)(6)(iii)(a) of the Income Tax Regulations provides that the various qualifying requirements for residentail rental project bonds cease to apply in the event of involuntary noncompliance caused by fire, seizure, requisition, foreclosure, transfer of title by deed in lieu of foreclosure, change in a Federal law or an action of a Federal agency after the date of issue which prevents an issuer from enforcing the requirements of section 1.103-8(b), or condemnation or similar event but only if, within a reasonable period, either the obligation used to provide such project is retired or amounts received as a consequence of such event are used to provide a project which meets the requirements of section 103(b)(4)(A) and section 1.103-8(b).

Section 1.103-8(b)(6)(iii)(a) of the regulations may be read to imply that, in the case of an obligation whose proceeds were used to fund several projects without identifying which bonds would fund each particular project, the entire issue of obligations must be redeemed upon involuntary noncompliance of any single project. Neither the statute nor the legislative history, however, require this reading.

In the present situation, the Partnership intends to continue to provide, on a reduced scale, Projects that would meet the requirements of former section 103(b)(4)(A) of the Code. Absent this workout agreement, the Projects would be transferred by deed in lieu of foreclosure and sold, and the low-income requirement would be removed. We believe that, under the facts presented, permitting the sale of the 7 bond financed Projects and the redemption of a proportionate amount of the Bonds is consistent with the purposes underlying former section 103(b)(4)(A) and section 1.103-8(b)(6)(iii)(a) of the Regulations.

Based on the facts and representations, we conclude that the sale of the Bond-financed projects and partial redemption of the Bonds do not require recharacterization of the Bonds as taxable bonds.

Except as specifically ruled above, no opinion is expressed concerning the tax consequences of the transaction.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Internal Revenue Code provides that it may not be used or cited as precedent.

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