WASHINGTON - The lease financing of a state or local prison will remain tax-exempt even if more than 10% of the facility is used to house federal prisoners, the Internal Revenue Service has ruled.

The IRS letter ruling, which was recently published without identifying the parties involved, was based on the fact that federal prisoners were taken only on a first-come, first-serve basis and at the same costs as other prisoners, several bond lawyers said.

Most lawyers said the ruling was favorable for the municipal bond industry. But while some lawyers said it represents a liberalized stance by the IRS, others said it does not significantly depart from the position that the IRS took in a pre-1986 letter ruling.

David A. Caprera, a lawyer with Kutak Rock in Denver, said the letter ruling is postive and helpful because, "There has been a concern over the years that the federal use of state and county jails may bring into question the tax-exempt status of the bonds used to finance those jails.

The concern stems from the federal government being treated as a private party under the tax laws. Bond-related tax law provisions state that bonds are private-activity bonds and are not tax-exempt unless they fall within specific categories, if more than 10% of the proceeds are used for private parties, and more than 10% of the debt service is derived from, or secured by, private payments.

But the IRS concluded in the recent letter ruling that even though the local prison expected that more than 10% of its beds would be filled with federal prisoners, this would not constitute private use because the federal government would not be treated any differently from the state or county governments that were also housing prisoners there.

The letter ruling said the federal government did not have an ownership interest in the prison nor a lease, management contract, or incentive pay contract that would give it a private interest in the facility. The IRS said the federal government was being offered prison beds only to the extent they were available and on a first-come, first-serve basis. The federal government also was being charged similar rates as state and local governments. It was being charged slightly more, but only because it had requested additional services for its prisoners, the letter ruling says.

Frederic L. Ballard Jr., a lawyer with Ballard Spahr Andrews & Ingersoll in Washington, said the letter ruling "is certainly favorable," but is "not a surprising result" because the IRS has tended to take the view that even if a private party is using a bond-financed facility, that use is not considered private use if it is no different from any other use of the facility.

William Conner, a lawyer with Squires, Sanders & Dempsey in Cleveland, said while the ruling is "a very common sense approach by the IRS, " it is "not a major leap forward" because a previous letter ruling that dealt with military personnel using a nearby bond-financed laundromat reached a similar conclusion.

The letter ruling had been sought by a bond-issuing authority. The authority had acquired, improved, and equipped the prison through a tax-exempt lease financing. The prison was built to house medium-security male inmates. A feasibility study had concluded that the prison's services could be marketed to the District of Columbia, the 50 states, and some 3,000 county sentencing authorities as well as the federal government. But the authority wanted assurances from the IRS that taking federal prisoners would not affect the tax-exempt status of the lease.

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