Tax Exemption for Mello-Roos Bonds Backed : Housing: Federal proposal to strip the benefit would ‘chill’ county growth, public officials warn. IRS declines comment until after upcoming hearings.

A federal proposal to strip the tax exemption enjoyed by investors who buy California’s Mello-Roos bonds would “chill” county economic growth, public officials said Tuesday.

“I think there are a lot of problems with Mello-Roos--I don’t think of it as a panacea at all--but it’s all we have right now to build infrastructure,” said Orange County Supervisor Marian Bergeson.

The bonds--sold by municipalities, used by developers and repaid by home buyers--are designed to get around the restrictions of Proposition 13’s property tax limit.

But the Internal Revenue Service, concerned that the public money being raised is enriching private enterprise, is threatening to change current regulations to do away with tax exemption for investors who purchase Mello-Roos bonds in the future.

Since the law became effective in 1982, more than $5 billion in Mello-Roos bonds have been sold essentially as tax-free municipal bonds to build such basic community needs as schools, roads and sewers.

“Bond elections have not been successful in recent years, so without (Mello-Roos), these things are simply not going to be built,” Bergeson said.

The Internal Revenue Service will begin hearings in June to decide the fate of the tax exemption, and has declined to comment on the issue until after that public hearing process.

A special county counsel has been assigned to investigate the potential effects of losing the tax exemption and to prepare a response to the federal proposal, a county official said Tuesday.

There are more than four dozen Mello-Roos districts in Orange County, 17 of them in unincorporated areas administered by county government. The lion’s share of the remaining districts are operated by school districts.

Mello-Roos bonds would lose much of their luster with investors if buyers had to pay taxes on the interest, said Michael Fine, fiscal services director for Newport-Mesa Unified School District.

“I think they’d still be attractive but to different investors and for different reasons,” said Fine, whose school district has one Mello-Roos district operating and wants to expand it for a new elementary school in the Corona del Mar area.

“We’ll still sell them, but we’ll have to pay (a higher interest rate to attract investors), and the costs will go on to those homeowners in the district,” he said.

Federal tax authorities, Fine asserts, are exaggerating the boon that the tax exemption grants to developers.

“The question here is who is the real beneficiary,” he said. “Initially, it is the owner and developer, because they sold their land and put money in their pocket. But, ultimately, I think its the homeowner who lives in a place with curbs and street lights and a school down the street.”

In the past six years, the Capistrano Unified School District has raised $65 million via Mello-Roos bonds to build five schools and set aside money for a sixth. The district’s facilities planning director, David A. Doomey, said the 37-school agency would be hard-pressed to duplicate such results with bonds that weren’t tax free.

“It will cost taxpayers more to get less,” Doomey said.

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Typically, Mello-Roos districts are created when a developer puts up land as collateral for the bonds, which a city or school district then sells to investors. The money is turned over to the developer to pay for improvements, and buyers of the new homes repay the bonds through additional levies on their property tax bills.

Residents in the districts often complain that they were blindsided by the steep cost of the bonds, and charge that the arrangement allows developers to lower the price of houses by disguising costs as a tax.

Residents also say the tax payments can jump as much as 4% a year because not all of the bonds for the districts are always sold at once.

But for cash-strapped cities, the Mello-Roos bonds are only viable options open to cities and school districts, and public officials are concerned that they won’t be able to sell much of them if the bonds lose their tax-exempt status.

“These are options being closed on future growth,” Bergeson said. “The whole vitality of the county would be at stake. It would chill growth, both economic and residential.”

Times correspondent Andrea Adelson contributed to this report.