WASHINGTON -- The U.S. Tax Court has rescheduled until next February the trial of the first bondholder challenge to the Internal Revenue Service's efforts to tax the interest earned from black box bond issues.
The trial involving $17.5 million of Whitewater Garden multifamily housing bonds was originally scheduled to begin next month in Los Angeles.
It is expected to be precedent setting because the outcome probably will determine whether other bondholders faced with having to pay back taxes on black box issues also can sue the IRS in the tax court. An IRS win would discourage lawsuits; a loss would encourage them.
Harbor Bancorp and Subsidiaries of Long Beach, Calif., brought the suit against the IRS last year after the agency tried to collect $19,763 of back taxes on the interest the bank earned from $250,000 of Whitewater Garden bonds it held from 1988 through 1990.
The IRS revoked the tax-exempt status of the $17.5 million bond issue, which was issued by the Riverside County, Calif.. Housing Authority, after contending that the bonds violated the arbitrage rebate requirements of the tax law.
Tax Court Judge Larry L. Nameroff, who had planned to begin hearing the case next month, recently struck it from his calendar so that it could be reassigned to a more senior judge, sources said.
The case was then assigned to Judge Julian Jacobs, who also hears cases in Los Angeles, they said. On Feb. 7, Jacobs is scheduled to set an exact date for the trial. and sources said is it likely to begin sometime before Feb. 21.
The dispute over the Whitewater Garden bonds revolves around their issue date. The IRS contends that while the transaction was closed on Dec. 31, 1985, the bonds were not actually issued until February 1986.
Matthews & Wright Inc., an underwriting firm that was forced out of the municipal bond business, closed the Whitewater Garden bond deal and roughly two dozen other bona transactions without cash in late 1985 to beat arbitrage rebate requirements that went into effect for housing bonds issued after Dec. 31, 1985.
The bonds were "purchased" with a check from an undercapitalized credit union and temporarily warehoused with an unlicensed offshore shell bank. They were not sold to public investors for cash until February 1986.
Riverside County Housing Authority officials have contended they did not know about the cash-less closing scheme.
The bonds were issued to finance the Whitewater Gardens apartment project. But the project was never built because of the black box structure of the transaction.
In black box transactions, which earn their name from their complexity, the bond proceeds are supposed to be used for the project and the mortgage note is supposed to be sold to third-party investors to provide funds for credit enhancement. But in many such deals done in the mid-1980s, the mortgage notes were never sold and the bond proceeds were used for credit enhancement rather than for the projects.