Reform Act Cuts Into Tax-Free Bond Issues : Redevelopment Agencies Will Have to Lean More on Municipals Without Exemptions

The federal tax reform law has severely tightened the restrictions on California’s local redevelopment agencies, which means that most redevelopment bonds will probably no longer be tax-exempt.

Instead, local governments will have to rely heavily on taxable bonds for many projects--and, for the first time, stand in line, along with those seeking industrial development bonds, for authority to issue tax-exempt bonds.

Experts who attended a recent conference in Los Angeles say that the outcome could have been even more harmful to urban anti-blight programs if the state’s redevelopment agencies had not lobbied vigorously in Washington.

“If it hadn’t been for the redevelopment agencies pushing their case, there would have been nothing left but taxables,” said Tony Edwards, a lawyer with Morrison & Foerster’s Washington office, who led the redevelopment lobbying campaign. “Not too many heavyweights on the tax-writing committees are from states that use redevelopment bonds.”

Popular Financing Tool

Redevelopment bonds have been a popular financing tool in California since the passage of Proposition 13 eight years ago. They have frequently confused federal tax writers because, though they are similar to the often-abused industrial development bonds, they are secured, not by a private business’s commitments, but by incremental increases in sales or property tax within the redevelopment area.

One of the reasons for their popularity has been that, unlike IDBs, redevelopment bonds have not been subject to a congressionally imposed limit on their use.

“Up to now, cities (engaged in redevelopment) have been able to develop a program of facilities the market wanted or a community desired without considering any tax consequences,” said Calvin E. Hollis, a principal at Katz Hollis Coren & Associates Inc., a Los Angeles-based redevelopment consulting firm that sponsored the conference at the Biltmore Hotel.

However, the tax reform bill has changed all that. Generally, bonds used for facilities owned and operated by government agencies are still tax-exempt.

Tighter Restrictions

But redevelopment bonds will not be tax-exempt unless they meet strict requirements on the involvement of private developers. For any bond to be tax-exempt under the new bill, no more than 10% of its proceeds can be used by private businesses (down from 25%) and no more than 10% of its bond payments may be secured by private businesses. (Alternatively, no more than 5% of its proceeds may be loaned to private individuals.)

Additionally, for redevelopment bonds to be tax-exempt, no more than 20% of a local jurisdiction’s assessed value may be included in the redevelopment area; bond proceeds in small redevelopment areas must be spread among more than one user, and no more than 25% of the bond’s proceeds can be used for such “private” purposes as recreational facilities, health clubs and automobile shopping centers.

Meanwhile, at least two redevelopment agencies in Southern California already have issued taxable bonds, both for the so-called “auto malls” which are specifically prohibited from being financed by tax-exempts under the tax bill.

Monrovia has issued a taxable bond in the $12-million to $15-million range, secured by sales tax, while Cathedral City has issued a bond of about $4 million. Of course, taxable bonds for purposes other than redevelopment are becoming popular among California’s public entities; John Gibson, vice president of Drexel Burnham, said his firm has issued $1.5 billion in taxable bonds for the public sector.

‘Not a Panacea’

“You can recommend it for a unique set of circumstances,” Gibson said--particularly middle-sized projects. But, he warned, “it is not a panacea.”

Hollis said one way to use the taxable bond is to treat it just as if it were a loan from a local bank--though he admitted the knowledge gap could pose a problem. He described the experience of one redevelopment agency that took this route, seeking a $2-million loan to expand a conference center.

“We ended up with a real estate loan officer who wanted to get an appraisal,” Hollis said. “It took us two weeks to make him understand that there was nothing to appraise. It’s very difficult to get the public finance arm of a bank to talk to the real estate arm of the bank and say, ‘It’s OK, these deals work.’ ”