IRS Decision on Florida CDD: Commercial Is Out; Residential May Be In

June 11, 2013

By: Jason W. Johnson, Michael Ryan and Miranda F. Fitzgerald

Community Development Districts are creatures of state law.  They are quasi-governmental entities typically created for the purposes of issuing tax exempt bonds in order to finance the construction of real estate development infrastructure.  Approximately 600 CDD’s currently exist in Florida.  Collectively, those CDD’s have issued approximately $6.5B in tax exempt bonds.

The Village Center Community Development District (“Village Center CDD”), the heart of a Central Florida active adult community commonly known as “The Villages”, sought a ruling from the Internal Revenue Service—by way of a Technical Advice Memorandum—that it was a political subdivision within the meaning of Section 103-1(b) of the Income Tax Regulations.  The May 9, 2013 TAM ruling** (TAM-127670-12) is important because if the Village Center CDD is a political subdivision within the meaning of Section 103-1(b) of the Income Tax Regulations, then it is a qualified issuer of tax exempt bonds and the interest it paid on the bonds is not taxable income to the bondholders.   If, however, the entity is not a political subdivision, then the bonds that were issued by the Village Center CDD were not tax exempt and the bondholders will have to pay the income taxes on interest income they received with respect to the $426,200,000 worth of recreational and utility bonds it issued during the applicable review period. Presumably the taxpaying bondholders would look to the Village Center CDD—and the Village Center CDD potentially to the developer landowners—to cover this expense.

CDD’s are governed by Boards of Supervisors.  In residential or mixed residential/non-residential CDD’s, appointees of the  developer landowners may initially serve on these boards, but Florida law requires that eventually governance of the CDD  will be turned over to residents by way of election of board members by residents, once an ownership threshold is reached.  In a non-residential CDD, there are very often no residents and in that case Florida law contemplates that the landowners (not residents) will continue to appoint the CDD board members.

The IRS ruled that the Village Center CDD was not a political subdivision when the bonds were issued.  The decision centers around one issue: that from the actions of the Village Center CDD and the developer, it appeared that the Village Center CDD was organized and operated in a manner intended to perpetuate private control, and to indefinitely avoid responsibility to a public electorate.  In the case of the Village Center CDD, control of the entity has not been turned over to residents in the 20 years of the CDD’s existence, despite the developer selling 44,000 homes in The Villages.  The IRS found that the developer intentionally structured the Village Center CDD so as to ensure that control would never be turned over to anyone other than the developer’s insiders.  The Village Center CDD’s actions included petitioning the town of Lady Lake, Florida to change the boundaries of the CDD to remove land upon which future residential development was to occur, thereby ensuring that the residential threshold requiring election of the Board of Supervisors by residents would never be reached.

While the Internal Revenue Code provides that the TAM may not be used or cited as precedent, its rationale should be considered as a guiding force by other developers considering the formation of a non-residential CDD, and for developer-controlled Boards of Supervisors of existing non-residential CDD’s.  The tax implications that could result from a determination by the IRS that a non-residential CDD is not a qualified issuer of tax exempt bonds could seriously affect the ability of landowner-controlled non-residential CDD’s to issue and sell their bonds as tax exempt, as well as the financial future of existing non-residential CDD’s whose bondholders may find themselves in a similar predicament to the holders of the Village Center CDD bonds.

On the bright side, the TAM would appear to give a green light for tax exempt bond issues by residential CDD’s, even if initially landowner controlled, in light of the language of the TAM emphasizing the intent of the Village Center CDD to perpetually be landowner-controlled.

**Please click on the attachment below for a copy of the TAM ruling.  

If you have questions regarding the IRS Decision on Florida CDD, please contact the authors above or any member of our firm's Distressed Real Estate Solutions Group.

PDF FileTAM Ruling