---
kind: "range"
citation: "26 C.F.R. §§ 1.148-1–1.148-11"
title: "26"
from: "1.148-1"
to: "1.148-11"
count: 11
url: "https://uscodex.org/cfr/26/1.148-1..1.148-11"
---

# §1.148-1. Definitions and elections.

- (a) **In general.** The definitions in this section and the definitions under [section 150](/cfr/26/150.md) apply for purposes of [section 148](/cfr/26/148.md) and [§§ 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md).
- (b) **Certain definitions.** The following definitions apply:

  Accounting method means both the overall method used to account for gross proceeds of an issue (e.g., the cash method or a modified accrual method) and the method used to account for or allocate any particular item within that overall accounting method (e.g., accounting for investments, expenditures, allocations to and from different sources, and particular items of the foregoing).

  Annuity contract means annuity contract as defined in [section 72](/cfr/26/72.md).

  Available amount means available amount as defined in [§ 1.148-6(d)(3)(iii)](/cfr/26/1.148-6.md?p=d-3-iii).

  Bona fide debt service fund means a fund, which may include proceeds of an issue, that—

  - (1) Is used primarily to achieve a proper matching of revenues with principal and interest payments within each bond year; and
  - (2) Is depleted at least once each bond year, except for a reasonable carryover amount not to exceed the greater of:
    - (i) the earnings on the fund for the immediately preceding bond year; or
    - (ii) one-twelfth of the principal and interest payments on the issue for the immediately preceding bond year.

      Bond year means, in reference to an issue, each 1-year period that ends on the day selected by the issuer. The first and last bond years may be short periods. If no day is selected by the issuer before the earlier of the final maturity date of the issue or the date that is 5 years after the issue date, bond years end on each anniversary of the issue date and on the final maturity date.

      Capital project or capital projects means all capital expenditures, plus related working capital expenditures to which the de minimis rule under [§ 1.148-6(d)(3)(ii)(A)](/cfr/26/1.148-6.md?p=d-3-ii-A) applies, that carry out the governmental purposes of an issue. For example, a capital project may include capital expenditures for one or more buildings, plus related start-up operating costs.

      Commingled fund means any fund or account containing both gross proceeds of an issue and amounts in excess of $25,000 that are not gross proceeds of that issue if the amounts in the fund or account are invested and accounted for collectively, without regard to the source of funds deposited in the fund or account. An open-end regulated investment company under [section 851](/cfr/26/851.md), however, is not a commingled fund.

      Computation date means each date on which the rebate amount for an issue is computed under [§ 1.148-3(e)](/cfr/26/1.148-3.md?p=e).

      Computation period means the period between computation dates. The first computation period begins on the issue date and ends on the first computation date. Each succeeding computation period begins on the date immediately following the computation date and ends on the next computation date.

      Consistently applied means applied uniformly within a fiscal period and between fiscal periods to account for gross proceeds of an issue and any amounts that are in a commingled fund.

      De minimis amount means—

  - (1) In reference to original issue discount (as defined in [section 1273(a)(1)](/cfr/26/1273.md?p=a-1)) or premium on an obligation—
    - (i) An amount that does not exceed 2 percent multiplied by the stated redemption price at maturity; plus
    - (ii) Any original issue premium that is attributable exclusively to reasonable underwriters' compensation; and
  - (2) In reference to market discount (as defined in [section 1278(a)(2)(A)](/cfr/26/1278.md?p=a-2-A)) or premium on an obligation, an amount that does not exceed 2 percent multiplied by the stated redemption price at maturity.

    Economic accrual method (also known as the constant interest method or actuarial method) means the method of computing yield that is based on the compounding of interest at the end of each compounding period.

    Fair market value means fair market value as defined in [§ 1.148-5(d)(6)](/cfr/26/1.148-5.md?p=d-6).

    Fixed rate investment means any investment whose yield is fixed and determinable on the issue date.

    Fixed yield bond means any bond whose yield is fixed and determinable on the issue date using the assumptions and rules provided in [§ 1.148-4(b)](/cfr/26/1.148-4.md?p=b).

    Fixed yield issue means any issue if each bond that is part of the issue is a fixed yield bond.

    Gross proceeds means any proceeds and replacement proceeds of an issue.

    Guaranteed investment contract includes any nonpurpose investment that has specifically negotiated withdrawal or reinvestment provisions and a specifically negotiated interest rate, and also includes any agreement to supply investments on two or more future dates (e.g., a forward supply contract).

    Higher yielding investments means higher yielding investments as defined in [section 148(b)(1)](/cfr/26/148.md?p=b-1).

    Investment means any investment property as defined in sections [148(b)(2)](/cfr/26/148.md?p=b-2) and [148(b)(3)](/cfr/26/148.md?p=b-3), and any other tax-exempt bond.

    Investment proceeds means any amounts actually or constructively received from investing proceeds of an issue.

    Investment-type property is defined in [paragraph (e)](#e) of this section.

    Issue price means issue price as defined in [paragraph (f)](#f) of this section.

    Issuer generally means the entity that actually issues the issue, and, unless the context or a provision clearly requires otherwise, each conduit borrower of the issue. For example, rules imposed on issuers to account for gross proceeds of an issue apply to a conduit borrower to account for any gross proceeds received under a purpose investment. Provisions regarding elections, filings, liability for the rebate amount, and certifications of reasonable expectations apply only to the actual issuer.

    Multipurpose issue means an issue the proceeds of which are used for two or more separate purposes determined in accordance with [§ 1.148-9(h)](/cfr/26/1.148-9.md?p=h).

    Net sale proceeds means sale proceeds, less the portion of those sale proceeds invested in a reasonably required reserve or replacement fund under [section 148(d)](/cfr/26/148.md?p=d) and as part of a minor portion under [section 148(e)](/cfr/26/148.md?p=e).

    Nonpurpose investment means any investment property, as defined in [section 148(b)](/cfr/26/148.md?p=b), that is not a purpose investment.

    Payment means a payment as defined in [§ 1.148-3(d)](/cfr/26/1.148-3.md?p=d) for purposes of computing the rebate amount, and a payment as defined in [§ 1.148-5(b)](/cfr/26/1.148-5.md?p=b) for purposes of computing the yield on an investment.

    Plain par bond means a qualified tender bond or a bond—

  - (1) Issued with not more than a de minimis amount of original issue discount or premium;
  - (2) Issued for a price that does not include accrued interest other than pre-issuance accrued interest;
  - (3) That bears interest from the issue date at a single, stated, fixed rate or that is a variable rate debt instrument under [section 1275](/cfr/26/1275.md), in each case with interest unconditionally payable at least annually; and
  - (4) That has a lowest stated redemption price that is not less than its outstanding stated principal amount.

    Plain par investment means an investment that is an obligation—

  - (1) Issued with not more than a de minimis amount of original issue discount or premium, or, if acquired on a date other than the issue date, acquired with not more than a de minimis amount of market discount or premium;
  - (2) Issued for a price that does not include accrued interest other than pre-issuance accrued interest;
  - (3) That bears interest from the issue date at a single, stated, fixed rate or that is a variable rate debt instrument under [section 1275](/cfr/26/1275.md), in each case with interest unconditionally payable at least annually; and
  - (4) That has a lowest stated redemption price that is not less than its outstanding stated principal amount.

    Pre-issuance accrued interest means amounts representing interest that accrued on an obligation for a period not greater than one year before its issue date but only if those amounts are paid within one year after the issue date.

    Proceeds means any sale proceeds, investment proceeds, and transferred proceeds of an issue. Proceeds do not include, however, amounts actually or constructively received with respect to a purpose investment that are properly allocable to the immaterially higher yield under [§ 1.148-2(d)](/cfr/26/1.148-2.md?p=d) or [section 143(g)](/cfr/26/143.md?p=g) or to qualified administrative costs recoverable under [§ 1.148-5(e)](/cfr/26/1.148-5.md?p=e).

    Program investment means a purpose investment that is part of a governmental program in which—

  - (1) The program involves the origination or acquisition of purpose investments;
  - (2) At least 95 percent (90 percent for qualified student loans under [section 144(b)(1)(A)](/cfr/26/144.md?p=b-1-A)) of the cost of the purpose investments acquired under the program represents one or more loans to a substantial number of persons representing the general public, States or political subdivisions, 501(c)(3) organizations, persons who provide housing and related facilities, or any combination of the foregoing;
  - (3) At least 95 percent of the receipts from the purpose investments are used to pay principal, interest, or redemption prices on issues that financed the program, to pay or reimburse administrative costs of those issues or of the program, to pay or reimburse anticipated future losses directly related to the program, to finance additional purpose investments for the same general purposes of the program, or to redeem and retire governmental obligations at the next earliest possible date of redemption;
  - (4) The program documents prohibit any obligor on a purpose investment financed by the program or any related party to that obligor from purchasing bonds of an issue that finance the program in an amount related to the amount of the purpose investment acquired from that obligor; and
  - (5) **The issuer has not waived the right to treat the investment as a program investment.** Purpose investment means an investment that is acquired to carry out the governmental purpose of an issue.

    Qualified administrative costs means qualified administrative costs as defined in [§ 1.148-5(e)](/cfr/26/1.148-5.md?p=e).

    Qualified guarantee means a qualified guarantee as defined in [§ 1.148-4(f)](/cfr/26/1.148-4.md?p=f).

    Qualified hedge means a qualified hedge as defined in [§ 1.148-4(h)(2)](/cfr/26/1.148-4.md?p=h-2).

    Reasonable expectations or reasonableness. An issuer's expectations or actions are reasonable only if a prudent person in the same circumstances as the issuer would have those same expectations or take those same actions, based on all the objective facts and circumstances. Factors relevant to a determination of reasonableness include the issuer's history of conduct concerning stated expectations made in connection with the issuance of obligations, the level of inquiry by the issuer into factual matters, and the existence of covenants, enforceable by bondholders, that require implementation of specific expectations. For a conduit financing issue, factors relevant to a determination of reasonableness include the reasonable expectations of the conduit borrower, but only if, under the circumstances, it is reasonable and prudent for the issuer to rely on those expectations.

    Rebate amount means 100 percent of the amount owed to the United States under [section 148(f)(2)](/cfr/26/148.md?p=f-2), as further described in [§ 1.148-3](/cfr/26/1.148-3.md).

    Receipt means a receipt as defined in [§ 1.148-3(d)](/cfr/26/1.148-3.md?p=d) for purposes of computing the rebate amount, and a receipt as defined in [§ 1.148-5(b)](/cfr/26/1.148-5.md?p=b) for purposes of computing yield on an investment.

    Refunding escrow means one or more funds established as part of a single transaction or a series of related transactions, containing proceeds of a refunding issue and any other amounts to provide for payment of principal or interest on one or more prior issues. For this purpose, funds are generally not so established solely because of—

  - (1) The deposit of proceeds of an issue and replacement proceeds of the prior issue in an escrow more than 6 months apart, or
  - (2) **The deposit of proceeds of completely separate issues in an escrow.** Replacement proceeds is defined in [paragraph (c)](#c) of this section.

    Restricted working capital expenditures means working capital expenditures that are subject to the proceeds-spent-last rule in [§ 1.148-6(d)(3)(i)](/cfr/26/1.148-6.md?p=d-3-i) and are ineligible for any exception to that rule.

    Sale proceeds means any amounts actually or constructively received from the sale of the issue, including amounts used to pay underwriters' discount or compensation and accrued interest other than pre-issuance accrued interest. Sale proceeds also include, but are not limited to, amounts derived from the sale of a right that is associated with a bond, and that is described in [§ 1.148-4(b)(4)](/cfr/26/1.148-4.md?p=b-4). See also [§ 1.148-4(h)(5)](/cfr/26/1.148-4.md?p=h-5) treating amounts received upon the termination of certain hedges as sale proceeds.

    Stated redemption price means the redemption price of an obligation under the terms of that obligation, including any call premium.

    Transferred proceeds means transferred proceeds as defined in [§ 1.148-9](/cfr/26/1.148-9.md) (or the applicable corresponding provision of prior law).

    Unconditionally payable means payable under terms in which—

  - (1) Late payment or nonpayment results in a significant penalty to the borrower or reasonable remedies to the lender, and
  - (2) It is reasonably certain on the issue date that the payment will actually be made.

    Value means value determined under [§ 1.148-4(e)](/cfr/26/1.148-4.md?p=e) for a bond, and value determined under [§ 1.148-5(d)](/cfr/26/1.148-5.md?p=d) for an investment.

    Variable yield bond means any bond that is not a fixed yield bond.

    Variable yield issue means any issue that is not a fixed yield issue.

    Yield means yield computed under [§ 1.148-4](/cfr/26/1.148-4.md) for an issue, and yield computed under [§ 1.148-5](/cfr/26/1.148-5.md) for an investment.

    Yield restricted means required to be invested at a yield that is not materially higher than the yield on the issue under [section 148(a)](/cfr/26/148.md?p=a) and [§ 1.148-2](/cfr/26/1.148-2.md).

- (c) **Definition of replacement proceeds—**
  - (1) **In general.** Amounts are replacement proceeds of an issue if the amounts have a sufficiently direct nexus to the issue or to the governmental purpose of the issue to conclude that the amounts would have been used for that governmental purpose if the proceeds of the issue were not used or to be used for that governmental purpose. For this purpose, governmental purposes include the expected use of amounts for the payment of debt service on a particular date. The mere availability or preliminary earmarking of amounts for a governmental purpose, however, does not in itself establish a sufficient nexus to cause those amounts to be replacement proceeds. Replacement proceeds include, but are not limited to, sinking funds, pledged funds, and other replacement proceeds described in [paragraph (c)(4)](#c-4) of this section, to the extent that those funds or amounts are held by or derived from a substantial beneficiary of the issue. A substantial beneficiary of an issue includes the issuer and any related party to the issuer, and, if the issuer is not a state, the state in which the issuer is located. A person is not a substantial beneficiary of an issue solely because it is a guarantor under a qualified guarantee.
  - (2) **Sinking fund. Sinking fund—** includes a debt service fund, redemption fund, reserve fund, replacement fund, or any similar fund, to the extent reasonably expected to be used directly or indirectly to pay principal or interest on the issue.
  - (3) **Pledged fund—**
    - (i) **In general.** A pledged fund is any amount that is directly or indirectly pledged to pay principal or interest on the issue. A pledge need not be cast in any particular form but, in substance, must provide reasonable assurance that the amount will be available to pay principal or interest on the issue, even if the issuer encounters financial difficulties. A pledge to a guarantor of an issue is an indirect pledge to secure payment of principal or interest on the issue. A pledge of more than 50 percent of the outstanding stock of a corporation that is a conduit borrower of the issue is not treated as a pledge for this purpose, unless the corporation is formed or availed of to avoid the creation of replacement proceeds.
    - (ii) **Negative pledges.** An amount is treated as pledged to pay principal or interest on an issue if it is held under an agreement to maintain the amount at a particular level for the direct or indirect benefit of the bondholders or a guarantor of the bonds. An amount is not treated as pledged under this [paragraph (c)(3)(ii)](#c-3-ii), however, if—
      - (A) The issuer or a substantial beneficiary may grant rights in the amount that are superior to the rights of the bondholders or the guarantor; or
      - (B) The amount does not exceed reasonable needs for which it is maintained, the required level is tested no more frequently than every 6 months, and the amount may be spent without any substantial restriction other than a requirement to replenish the amount by the next testing date.
  - (4) **Other replacement proceeds—**
    - (i) **Bonds outstanding longer than necessary—**
      - (A) **In general.** Replacement proceeds arise to the extent that the issuer reasonably expects as of the issue date that—

        (1) The term of an issue will be longer than is reasonably necessary for the governmental purposes of the issue, and

        (2) There will be available amounts during the period that the issue remains outstanding longer than necessary. Whether an issue is outstanding longer than necessary is determined under [§ 1.148-10](/cfr/26/1.148-10.md). Replacement proceeds are created under this [paragraph (c)(4)(i)(A)](#c-4-i-A) at the beginning of each fiscal year during which an issue remains outstanding longer than necessary in an amount equal to available amounts of the issuer as of that date.

      - (B) **Safe harbor against creation of replacement proceeds.** As a safe harbor, replacement proceeds do not arise under [paragraph (c)(4)(i)(A)](#c-4-i-A) of this section—

        (1) For the portion of an issue that is to be used to finance working capital expenditures, if that portion is not outstanding longer than the temporary period under [§ 1.148-2(e)(3)](/cfr/26/1.148-2.md?p=e-3) for which the proceeds qualify;

        (2) For the portion of an issue (including a refunding issue) that is to be used to finance or refinance capital projects, if that portion has a weighted average maturity that does not exceed 120 percent of the average reasonably expected economic life of the financed capital projects, determined in the same manner as under [section 147(b)](/cfr/26/147.md?p=b);

        (3) For the portion of an issue that is a refunding issue, if that portion has a weighted average maturity that does not exceed the remaining weighted average maturity of the prior issue, and the issue of which the prior issue is a part satisfies [paragraph (c)(4)(i)(B)](#c-4-i-B) (1) or (2) of this section; or

        (4) For the portion of an issue (including a refunding issue) that is to be used to finance working capital expenditures, if that portion satisfies [paragraph (c)(4)(ii)](#c-4-ii) of this section.

    - (ii) **Safe harbor for longer-term working capital financings.** A portion of an issue used to finance working capital expenditures satisfies this [paragraph (c)(4)(ii)](#c-4-ii) if the issuer meets the requirements of [paragraphs (c)(4)(ii)(A) through (E)](#c-4-ii-A..c-4-ii-E) of this section.
      - (A) **Determine first testing year.** On the issue date, the issuer must determine the first fiscal year following the applicable temporary period under [§ 1.148-2(e)](/cfr/26/1.148-2.md?p=e) in which it reasonably expects to have available amounts (first testing year), but in no event can the first day of the first testing year be later than five years after the issue date.
      - (B) **Application of available amount to reduce burden on tax-exempt bond market.** Beginning with the first testing year and for each subsequent fiscal year for which the portion of the issue that is the subject of this safe harbor remains outstanding, the issuer must determine the available amount as of the first day of each fiscal year. Then, except as provided in [paragraph (c)(4)(ii)(D)](#c-4-ii-D) of this section, within the first 90 days of that fiscal year, the issuer must apply that amount (or if less, the available amount on the date of the required redemption or investment) to redeem or to invest in eligible tax-exempt bonds (as defined in [paragraph (c)(4)(ii)(E)](#c-4-ii-E) of this section). For this purpose, available amounts in a bona fide debt service fund are not treated as available amounts.
      - (C) **Continuous investment requirement.** Except as provided in this [paragraph (c)(4)(ii)(C)](#c-4-ii-C), any amounts invested in eligible tax-exempt bonds under [paragraph (c)(4)(ii)(B)](#c-4-ii-B) of this section must be invested continuously in such tax-exempt bonds to the extent provided in [paragraph (c)(4)(ii)(D)](#c-4-ii-D) of this section.

        (1) Exception for reinvestment period. Amounts previously invested in eligible tax-exempt bonds under [paragraph (c)(4)(ii)(B)](#c-4-ii-B) of this section that are held for not more than 30 days in a fiscal year pending reinvestment in eligible tax-exempt bonds are treated as invested in eligible tax-exempt bonds.

        (2) Limited use of invested amounts. An issuer may spend amounts previously invested in eligible tax-exempt bonds under [paragraph (c)(4)(ii)(B)](#c-4-ii-B) of this section within 30 days of the date on which they cease to be so invested to make expenditures for a governmental purpose on any date on which the issuer has no other available amounts for such purpose, or to redeem eligible tax-exempt bonds.

      - (D) **Cap on applied or invested amounts.** The maximum amount that an issuer is required to apply under [paragraph (c)(4)(ii)(B)](#c-4-ii-B) of this section or to invest continuously under [paragraph (c)(4)(ii)(C)](#c-4-ii-C) of this section with respect to the portion of an issue that is the subject of this safe harbor is the outstanding principal amount of such portion. For purposes of this cap, an issuer receives credit towards its requirement to invest available amounts in eligible tax-exempt bonds for amounts previously invested under [paragraph (c)(4)(ii)(B)](#c-4-ii-B) of this section that remain continuously invested under [paragraph (c)(4)(ii)(C)](#c-4-ii-C) of this section.
      - (E) **Definition of eligible tax-exempt bonds.** For purposes of [paragraph (c)(4)(ii)](#c-4-ii) of this section, eligible tax-exempt bonds means any of the following:

        (1) A bond the interest on which is excludable from gross income under [section 103](/cfr/26/103.md) and that is not a specified private activity bond (as defined in [section 57(a)(5)(C)](/cfr/26/57.md?p=a-5-C)) subject to the alternative minimum tax;

        (2) An interest in a regulated investment company to the extent that at least 95 percent of the income to the holder of the interest is interest on a bond that is excludable from gross income under [section 103](/cfr/26/103.md) and that is not interest on a specified private activity bond (as defined in [section 57(a)(5)(C)](/cfr/26/57.md?p=a-5-C)) subject to the alternative minimum tax; or

        (3) A certificate of indebtedness issued by the United States Treasury pursuant to the Demand Deposit State and Local Government Series program described in [31 CFR part 344](/cfr/31/part344.md).

- (d) **Elections.** Except as otherwise provided, any required elections must be made in writing, and, once made, may not be revoked without the permission of the Commissioner.
- (e) **Investment-type property—**
  - (1) **In general.** Except as otherwise provided in this [paragraph (e)](#e), investment-type property includes any property, other than property described in section [148(b)(2)(A)](/cfr/26/148.md?p=b-2-A), [(B)](/cfr/26/148.md?p=b-2-B), [(C)](/cfr/26/148.md?p=b-2-C), or [(E)](/cfr/26/148.md?p=b-2-E), that is held principally as a passive vehicle for the production of income. For this purpose, production of income includes any benefit based on the time value of money.
  - (2) **Prepayments—**
    - (i) **In general—**
      - (A) **Generally.** Except as otherwise provided in this [paragraph (e)(2)](#e-2), a prepayment for property or services, including a prepayment for property or services that is made after the date that the contract to buy the property or services is entered into, also gives rise to investment-type property if a principal purpose for prepaying is to receive an investment return from the time the prepayment is made until the time payment otherwise would be made. A prepayment does not give rise to investment-type property if—

        (1) Prepayments on substantially the same terms are made by a substantial percentage of persons who are similarly situated to the issuer but who are not beneficiaries of tax-exempt financing;

        (2) The prepayment is made within 90 days of the reasonably expected date of delivery to the issuer of all of the property or services for which the prepayment is made; or

        (3) The prepayment meets the requirements of paragraph [(e)(2)(iii)(A)](#e-2-iii-A) or [(B)](#e-2-iii-B) of this section.

      - (B) **Example.** The following example illustrates an application of this [paragraph (e)(2)(i)](#e-2-i):
    - (ii) **Customary prepayments.** The determination of whether a prepayment satisfies paragraph (e)(2)(i)(A)(1) of this section is generally made based on all the facts and circumstances. In addition, a prepayment is deemed to satisfy paragraph (e)(2)(i)(A)(1) of this section if—
      - (A) **The prepayment is made for—** (1) Maintenance, repair, or an extended warranty with respect to personal property (for example, automobiles or electronic equipment); or

        (2) Updates or maintenance or support services with respect to computer software; and

      - (B) The same maintenance, repair, extended warranty, updates or maintenance or support services, as applicable, are regularly provided to nongovernmental persons on the same terms.
    - (iii) **Certain prepayments to acquire a supply of natural gas or electricity—**
      - (A) **Natural gas prepayments.** A prepayment meets the requirements of this [paragraph (e)(2)(iii)(A)](#e-2-iii-A) if—

        (1) It is made by or for one or more utilities that are owned by a governmental person, as defined in [§ 1.141-1(b)](/cfr/26/1.141-1.md?p=b) (each of which is referred to in this [paragraph (e)(2)(iii)(A)](#e-2-iii-A) as the issuing municipal utility), to purchase a supply of natural gas; and

        (2) At least 90 percent of the prepaid natural gas financed by the issue is used for a qualifying use. Natural gas is used for a qualifying use if it is to be—

        (i) Furnished to retail gas customers of the issuing municipal utility who are located in the natural gas service area of the issuing municipal utility, provided, however, that gas used to produce electricity for sale shall not be included under this paragraph (e)(2)(iii)(A)(2)(i);

        (ii) Used by the issuing municipal utility to produce electricity that will be furnished to retail electric customers of the issuing municipal utility who are located in the electricity service area of the issuing municipal utility;

        (iii) Used by the issuing municipal utility to produce electricity that will be sold to a utility that is owned by a governmental person and furnished to retail electric customers of the purchaser who are located in the electricity service area of the purchaser;

        (iv) Sold to a utility that is owned by a governmental person if the requirements of paragraph (e)(2)(iii)(A)(2)(i), (ii) or (iii) of this section are satisfied by the purchaser (treating the purchaser as the issuing municipal utility); or

        (v) Used to fuel the pipeline transportation of the prepaid gas supply acquired in accordance with this [paragraph (e)(2)(iii)(A)](#e-2-iii-A).

      - (B) **Electricity prepayments.** A prepayment meets the requirements of this [paragraph (e)(2)(iii)(B)](#e-2-iii-B) if—

        (1) It is made by or for one or more utilities that are owned by a governmental person (each of which is referred to in this [paragraph (e)(2)(iii)(B)](#e-2-iii-B) as the issuing municipal utility) to purchase a supply of electricity; and

        (2) At least 90 percent of the prepaid electricity financed by the issue is used for a qualifying use. Electricity is used for a qualifying use if it is to be—

        (i) Furnished to retail electric customers of the issuing municipal utility who are located in the electricity service area of the issuing municipal utility; or

        (ii) Sold to a utility that is owned by a governmental person and furnished to retail electric customers of the purchaser who are located in the electricity service area of the purchaser.

      - (C) **Service area.** For purposes of this [paragraph (e)(2)(iii)](#e-2-iii), the service area of a utility owned by a governmental person consists of—

        (1) Any area throughout which the utility provided, at all times during the 5-year period ending on the issue date—

        (i) In the case of a natural gas utility, natural gas transmission or distribution service; and

        (ii) In the case of an electric utility, electricity distribution service; and

        (2) Any area recognized as the service area of the utility under state or Federal law.

      - (D) **Retail customer.** For purposes of this [paragraph (e)(2)(iii)](#e-2-iii), a retail customer is a customer that purchases natural gas or electricity, as applicable, other than for resale.
      - (E) **Commodity swaps.** A prepayment does not fail to meet the requirements of this [paragraph (e)(2)(iii)](#e-2-iii) by reason of any commodity swap contract that may be entered into between the issuer and an unrelated party (other than the gas or electricity supplier), or between the gas or electricity supplier and an unrelated party (other than the issuer), so long as each swap contract is an independent contract. A swap contract is an independent contract if the obligation of each party to perform under the swap contract is not dependent on performance by any person (other than the other party to the swap contract) under another contract (for example, a gas or electricity supply contract or another swap contract); provided, however, that a commodity swap contract will not fail to be an independent contract solely because the swap contract may terminate in the event of a failure of a gas or electricity supplier to deliver gas or electricity for which the swap contract is a hedge.
      - (F) **Remedial action.** Issuers may apply principles similar to the rules of [§ 1.141-12](/cfr/26/1.141-12.md), including [§ 1.141-12(d)](/cfr/26/1.141-12.md?p=d) (relating to redemption or defeasance of nonqualified bonds) and [§ 1.141-12(e)](/cfr/26/1.141-12.md?p=e) (relating to alternative use of disposition proceeds), to cure a violation of paragraph (e)(2)(iii)(A)(2) or (e)(2)(iii)(B)(2) of this section. For this purpose, the amount of nonqualified bonds is determined in the same manner as for output contracts taken into account under the private business tests, including the principles of [§ 1.141-7(d)](/cfr/26/1.141-7.md?p=d), treating nonqualified sales of gas or electricity under this [paragraph (e)(2)(iii)](#e-2-iii) as satisfying the benefits and burdens test under [§ 1.141-7(c)(1)](/cfr/26/1.141-7.md?p=c-1).
    - (iv) **Additional prepayments as permitted by the Commissioner.** The Commissioner may, by published guidance, set forth additional circumstances in which a prepayment does not give rise to investment-type property.
  - (3) **Certain hedges.** Investment-type property also includes the investment element of a contract that is a hedge (within the meaning of [§ 1.148-4(h)(2)(i)(A)](/cfr/26/1.148-4.md?p=h-2-i-A)) and that contains a significant investment element because a payment by the issuer relates to a conditional or unconditional obligation by the hedge provider to make a payment on a later date. See [§ 1.148-4(h)(2)(ii)](/cfr/26/1.148-4.md?p=h-2-ii) relating to hedges with a significant investment element.
  - (4) **Exception for certain capital projects.** Investment-type property does not include real property or tangible personal property (for example, land, buildings, and equipment) that is used in furtherance of the public purposes for which the tax-exempt bonds are issued. For example, investment-type property does not include a courthouse financed with governmental bonds or an eligible exempt facility under [section 142](/cfr/26/142.md), such as a public road, financed with private activity bonds.
- (f) **Definition of issue price—**
  - (1) **In general.** Except as otherwise provided in this [paragraph (f)](#f), “issue price” is defined in sections [1273](/cfr/26/1273.md) and [1274](/cfr/26/1274.md) and the regulations under those sections.
  - (2) **Bonds issued for money—**
    - (i) **General rule.** Except as otherwise provided in this [paragraph (f)(2)](#f-2), the issue price of bonds issued for money is the first price at which a substantial amount of the bonds is sold to the public. If a bond is issued for money in a private placement to a single buyer that is not an underwriter or a related party (as defined in [§ 1.150-1(b)](/cfr/26/1.150-1.md?p=b)) to an underwriter, the issue price of the bond is the price paid by that buyer. Issue price is not reduced by any issuance costs (as defined in [§ 1.150-1(b)](/cfr/26/1.150-1.md?p=b)).
    - (ii) **Special rule for use of initial offering price to the public.** The issuer may treat the initial offering price to the public as of the sale date as the issue price of the bonds if the requirements of paragraphs [(f)(2)(ii)(A)](#f-2-ii-A) and [(B)](#f-2-ii-B) of this section are met.
      - (A) The underwriters offered the bonds to the public for purchase at a specified initial offering price on or before the sale date, and the lead underwriter in the underwriting syndicate or selling group (or, if applicable, the sole underwriter) provides, on or before the issue date, a certification to that effect to the issuer, together with reasonable supporting documentation for that certification, such as a copy of the pricing wire or equivalent communication.
      - (B) Each underwriter agrees in writing that it will neither offer nor sell the bonds to any person at a price that is higher than the initial offering price to the public during the period starting on the sale date and ending on the earlier of the following:

        (1) The close of the fifth (5th) business day after the sale date; or

        (2) The date on which the underwriters have sold a substantial amount of the bonds to the public at a price that is no higher than the initial offering price to the public.

    - (iii) **Special rule for competitive sales.** For bonds issued for money in a competitive sale, an issuer may treat the reasonably expected initial offering price to the public as of the sale date as the issue price of the bonds if the issuer obtains from the winning bidder a certification of the bonds' reasonably expected initial offering price to the public as of the sale date upon which the price in the winning bid is based.
    - (iv) **Choice of rule for determining issue price.** If more than one rule for determining the issue price of the bonds is available under this [paragraph (f)(2)](#f-2), at any time on or before the issue date, the issuer may select the rule it will use to determine the issue price of the bonds. On or before the issue date of the bonds, the issuer must identify the rule selected in its books and records maintained for the bonds.
  - (3) **Definitions.** For purposes of this [paragraph (f)](#f), the following definitions apply:
    - (i) Competitive sale means a sale of bonds by an issuer to an underwriter that is the winning bidder in a bidding process in which the issuer offers the bonds for sale to underwriters at specified written terms, if that process meets the following requirements:
      - (A) The issuer disseminates the notice of sale to potential underwriters in a manner that is reasonably designed to reach potential underwriters (for example, through electronic communication that is widely circulated to potential underwriters by a recognized publisher of municipal bond offering documents or by posting on an Internet-based Web site or other electronic medium that is regularly used for such purpose and is widely available to potential underwriters);
      - (B) All bidders have an equal opportunity to bid (within the meaning of [§ 1.148-5(d)(6)(iii)(A)(6)](/cfr/26/1.148-5.md?p=d-6-iii-A-6));
      - (C) The issuer receives bids from at least three underwriters of municipal bonds who have established industry reputations for underwriting new issuances of municipal bonds; and
      - (D) The issuer awards the sale to the bidder who submits a firm offer to purchase the bonds at the highest price (or lowest interest cost).
    - (ii) Public means any person (as defined in [section 7701(a)(1)](/cfr/26/7701.md?p=a-1)) other than an underwriter or a related party (as defined in [§ 1.150-1(b)](/cfr/26/1.150-1.md?p=b)) to an underwriter.
    - (iii) **Underwriter—** means:
      - (A) Any person (as defined in [section 7701(a)(1)](/cfr/26/7701.md?p=a-1)) that agrees pursuant to a written contract with the issuer (or with the lead underwriter to form an underwriting syndicate) to participate in the initial sale of the bonds to the public; and
      - (B) Any person that agrees pursuant to a written contract directly or indirectly with a person described in [paragraph (f)(3)(iii)(A)](#f-3-iii-A) of this section to participate in the initial sale of the bonds to the public (for example, a retail distribution agreement between a national lead underwriter and a regional firm under which the regional firm participates in the initial sale of the bonds to the public).
  - (4) **Other special rules.** For purposes of this [paragraph (f)](#f), the following special rules apply:
    - (i) **Separate determinations.** The issue price of bonds in an issue that do not have the same credit and payment terms is determined separately. The issuer need not apply the same rule to determine issue price for all of the bonds in the issue.
    - (ii) **Substantial amount.** Ten percent is a substantial amount.
    - (iii) **Bonds issued for property.** If a bond is issued for property, the adjusted applicable Federal rate, as determined under [section 1288](/cfr/26/1288.md) and [§ 1.1288-1](/cfr/26/1.1288-1.md), is used in lieu of the applicable Federal rate to determine the bond's issue price under [section 1274](/cfr/26/1274.md).

# §1.148-2. General arbitrage yield restriction rules.

- (a) **In general.** Under [section 148(a)](/cfr/26/148.md?p=a), the direct or indirect investment of the gross proceeds of an issue in higher yielding investments causes the bonds of the issue to be arbitrage bonds. The investment of proceeds in higher yielding investments, however, during a temporary period described in [paragraph (e)](#e) of this section, as part of a reasonably required reserve or replacement fund described in [paragraph (f)](#f) of this section, or as part of a minor portion described in [paragraph (g)](#g) of this section does not cause the bonds of the issue to be arbitrage bonds. Bonds are not arbitrage bonds under this section as a result of an inadvertent, insubstantial error.
- (b) **Reasonable expectations—**
  - (1) **In general.** Except as provided in [paragraph (c)](#c) of this section, the determination of whether an issue consists of arbitrage bonds under [section 148(a)](/cfr/26/148.md?p=a) is based on the issuer's reasonable expectations as of the issue date regarding the amount and use of the gross proceeds of the issue.
  - (2) **Certification of expectations—**
    - (i) **In general.** An officer of the issuer responsible for issuing the bonds must, in good faith, certify the issuer's expectations as of the issue date. The certification must state the facts and estimates that form the basis for the issuer's expectations. The certification is evidence of the issuer's expectations, but does not establish any conclusions of law or any presumptions regarding either the issuer's actual expectations or their reasonableness.
    - (ii) **Exceptions to certification requirement.** An issuer is not required to make a certification for an issue under [paragraph (b)(2)(i)](#b-2-i) of this section if—
      - (A) The issuer reasonably expects as of the issue date that there will be no unspent gross proceeds after the issue date, other than gross proceeds in a bona fide debt service fund (e.g., equipment lease financings in which the issuer purchases equipment in exchange for an installment payment note); or
      - (B) **The issue price of the issue does not exceed $1,000,000.**
- (c) **Intentional acts.** The taking of any deliberate, intentional action by the issuer or person acting on its behalf after the issue date in order to earn arbitrage causes the bonds of the issue to be arbitrage bonds if that action, had it been expected on the issue date, would have caused the bonds to be arbitrage bonds. An intent to violate the requirements of [section 148](/cfr/26/148.md) is not necessary for an action to be intentional.
- (d) **Materially higher yielding investments—**
  - (1) **In general.** The yield on investments is materially higher than the yield on the issue to which the investments are allocated if the yield on the investments over the term of the issue exceeds the yield on the issue by an amount in excess of the applicable definition of materially higher set forth in [paragraph (d)(2)](#d-2) of this section. If yield restricted investments in the same class are subject to different definitions of materially higher, the applicable definition of materially higher that produces the lowest permitted yield applies to all the investments in the class. The yield on the issue is determined under [§ 1.148-4](/cfr/26/1.148-4.md). The yield on investments is determined under [§ 1.148-5](/cfr/26/1.148-5.md).
  - (2) **Definitions of materially higher yield—**
    - (i) **General rule for purpose and nonpurpose investments.** For investments that are not otherwise described in this [paragraph (d)(2)](#d-2), materially higher means one-eighth of 1 percentage point.
    - (ii) **Refunding escrows and replacement proceeds.** For investments in a refunding escrow or for investments allocable to replacement proceeds, materially higher means one-thousandth of 1 percentage point.
    - (iii) **Program investments.** For program investments that are not described in [paragraph (d)(2)(iv)](#d-2-iv) of this section, materially higher means 1 and one-half percentage points.
    - (iv) **Student loans.** For qualified student loans that are program investments, materially higher means 2 percentage points.
    - (v) **Tax-exempt investments.** For investments that are tax-exempt bonds and are not investment property under [section 148(b)(3)](/cfr/26/148.md?p=b-3), no yield limitation applies.
  - (3) **Mortgage loans.** Qualified mortgage loans that satisfy the requirements of [section 143(g)](/cfr/26/143.md?p=g) are treated as meeting the requirements of this [paragraph (d)](#d).
- (e) **Temporary periods—**
  - (1) **In general.** During the temporary periods set forth in this [paragraph (e)](#e), the proceeds and replacement proceeds of an issue may be invested in higher yielding investments without causing bonds in the issue to be arbitrage bonds. This [paragraph (e)](#e) does not apply to refunding issues (see [§ 1.148-9](/cfr/26/1.148-9.md)).
  - (2) **General 3-year temporary period for capital projects and qualified mortgage loans—**
    - (i) **In general.** The net sale proceeds and investment proceeds of an issue reasonably expected to be allocated to expenditures for capital projects qualify for a temporary period of 3 years beginning on the issue date (the 3-year temporary period). The 3-year temporary period also applies to the proceeds of qualified mortgage bonds and qualified veterans' mortgage bonds by substituting qualified mortgage loans in each place that capital projects appears in this [paragraph (e)(2)](#e-2). The 3-year temporary period applies only if the issuer reasonably expects to satisfy the expenditure test, the time test, and the due diligence test. These rules apply separately to each conduit loan financed by an issue (other than qualified mortgage loans), with the expenditure and time tests measured from the issue date of the issue.
      - (A) **Expenditure test.** The expenditure test is met if at least 85 percent of the net sale proceeds of the issue are allocated to expenditures on the capital projects by the end of the 3-year temporary period.
      - (B) **Time test.** The time test is met if the issuer incurs within 6 months of the issue date a substantial binding obligation to a third party to expend at least 5 percent of the net sale proceeds of the issue on the capital projects. An obligation is not binding if it is subject to contingencies within the issuer's or a related party's control.
      - (C) **Due diligence test.** The due diligence test is met if completion of the capital projects and the allocation of the net sale proceeds of the issue to expenditures proceed with due diligence.
    - (ii) **5-year temporary period.** In the case of proceeds expected to be allocated to a capital project involving a substantial amount of construction expenditures (as defined in [§ 1.148-7](/cfr/26/1.148-7.md)), a 5-year temporary period applies in lieu of the 3-year temporary period if the issuer satisfies the requirements of [paragraph (e)(2)(i)](#e-2-i) of this section applied by substituting “5 years” in each place that “3 years” appears, and both the issuer and a licensed architect or engineer certify that the longer period is necessary to complete the capital project.
  - (3) **Temporary period for working capital expenditures—**
    - (i) **General rule.** The proceeds of an issue that are reasonably expected to be allocated to working capital expenditures within 13 months after the issue date qualify for a temporary period of 13 months beginning on the issue date. [Paragraph (e)(2)](#e-2) of this section contains additional temporary period rules for certain working capital expenditures that are treated as part of a capital project.
    - (ii) **Longer temporary period for certain tax anticipation issues.** If an issuer reasonably expects to use tax revenues arising from tax levies for a single fiscal year to redeem or retire an issue, and the issue matures by the earlier of 2 years after the issue date or 60 days after the last date for payment of those taxes without interest or penalty, the temporary period under [paragraph (e)(3)(i)](#e-3-i) of this section is extended until the maturity date of the issue.
  - (4) **Temporary period for pooled financings—**
    - (i) **In general.** Proceeds of a pooled financing issue reasonably expected to be used to finance purpose investments qualify for a temporary period of 6 months while held by the issuer before being loaned to a conduit borrower. Any otherwise available temporary period for proceeds held by a conduit borrower, however, is reduced by the period of time during which those proceeds were held by the issuer before being loaned. For example, if the proceeds of a pooled financing issue loaned to a conduit borrower would qualify for a 3-year temporary period, and the proceeds are held by the issuer for 5 months before being loaned to the conduit borrower, the proceeds qualify for only an additional 31-month temporary period after being loaned to the conduit borrower. Except as provided in [paragraph (e)(4)(iv)](#e-4-iv) of this section, this [paragraph (e)(4)](#e-4) does not apply to any qualified mortgage bond or qualified veterans' mortgage bond under [section 143](/cfr/26/143.md).
    - (ii) **Loan repayments—**
      - (A) **Amount held by the issuer.** The temporary period under this [paragraph (e)(4)](#e-4) for proceeds from the sale or repayment of any loan that are reasonably expected to be used to make or finance new loans is 3 months.
      - (B) **Amounts re-loaned to conduit borrowers.** Any temporary period for proceeds held by a conduit borrower under a new loan from amounts described in [paragraph (e)(4)(ii)(A)](#e-4-ii-A) of this section is determined by treating the date the new loan is made as the issue date and by reducing the temporary period by the period the amounts were held by the issuer following the last repayment.
    - (iii) **Construction issues.** If all or a portion of a pooled financing issue qualifies as a construction issue under [§ 1.148-7(b)(6)](/cfr/26/1.148-7.md?p=b-6), [paragraph (e)(4)(i)](#e-4-i) of this section is applied by substituting “2 years” for “6 months.”
    - (iv) **Amounts re-loaned for qualified mortgage loans.** The temporary period under this [paragraph (e)(4)](#e-4) for proceeds from the sale, prepayment, or repayment of any qualified mortgage loan that are reasonably expected to be used to make or finance new qualified mortgage loans is 3 years.
  - (5) **Temporary period for replacement proceeds—**
    - (i) **In general.** Except as otherwise provided, replacement proceeds qualify for a temporary period of 30 days beginning on the date that the amounts are first treated as replacement proceeds.
    - (ii) **Temporary period for bona fide debt service funds.** Amounts in a bona fide debt service fund for an issue qualify for a temporary period of 13 months. If only a portion of a fund qualifies as a bona fide debt service fund, only that portion qualifies for this temporary period.
  - (6) **Temporary period for investment proceeds.** Except as otherwise provided in this [paragraph (e)](#e), investment proceeds qualify for a temporary period of 1 year beginning on the date of receipt.
  - (7) **Other amounts.** Gross proceeds not otherwise eligible for a temporary period described in this [paragraph (e)](#e) qualify for a temporary period of 30 days beginning on the date of receipt.
- (f) **Reserve or replacement funds—**
  - (1) **General 10 percent limitation on funding with sale proceeds.** An issue consists of arbitrage bonds if sale proceeds of the issue in excess of 10 percent of the stated principal amount of the issue are used to finance any reserve or replacement fund, without regard to whether those sale proceeds are invested in higher yielding investments. If an issue has more than a de minimis amount of original issue discount or premium, the issue price (net of pre-issuance accrued interest) is used to measure the 10-percent limitation in lieu of stated principal amount. This rule does not limit the use of amounts other than sale proceeds of an issue to fund a reserve or replacement fund.
  - (2) **Exception from yield restriction for reasonably required reserve or replacement funds—**
    - (i) **In general.** The investment of amounts that are part of a reasonably required reserve or replacement fund in higher yielding investments will not cause an issue to consist of arbitrage bonds. A reasonably required reserve or replacement fund may consist of all or a portion of one or more funds, however labelled, derived from one or more sources. Amounts in a reserve or replacement fund in excess of the amount that is reasonably required are not part of a reasonably required reserve or replacement fund.
    - (ii) **Size limitation.** The amount of gross proceeds of an issue that qualifies as a reasonably required reserve or replacement fund may not exceed an amount equal to the least of 10 percent of the stated principal amount of the issue, the maximum annual principal and interest requirements on the issue, or 125 percent of the average annual principal and interest requirements on the issue. If an issue has more than a de minimis amount of original issue discount or premium, the issue price of the issue (net of pre-issuance accrued interest) is used to measure the 10 percent limitation in lieu of its stated principal amount. For a reserve or replacement fund that secures more than one issue (e.g. a parity reserve fund), the size limitation may be measured on an aggregate basis.
    - (iii) **Valuation of investments.** Investments in a reasonably required reserve or replacement fund may be valued in any reasonable, consistently applied manner that is permitted under [§ 1.148-5](/cfr/26/1.148-5.md).
    - (iv) **150 percent debt service limitation on investment in nonpurpose investments for certain private activity bonds.** [Section 148(d)(3)](/cfr/26/148.md?p=d-3) contains additional limits on the amount of gross proceeds of an issue of private activity bonds, other than qualified 501(c)(3) bonds, that may be invested in higher yielding nonpurpose investments without causing the bonds to be arbitrage bonds. For purposes of these rules, initial temporary period means the temporary periods under paragraphs [(e)(2)](#e-2), [(e)(3)](#e-3), and [(e)(4)](#e-4) of this section and under § [1.148-9(d)(2)(i)](/cfr/26/1.148-9.md?p=d-2-i), [(ii)](/cfr/26/1.148-9.md?p=d-2-ii), and [(iii)](/cfr/26/1.148-9.md?p=d-2-iii).
  - (3) **Certain parity reserve funds.** The limitation contained in [paragraph (f)(1)](#f-1) of this section does not apply to an issue if the master legal document authorizing the issuance of the bonds (e.g., a master indenture) was adopted before August 16, 1986, and that document—
    - (i) Requires a reserve or replacement fund in excess of 10 percent of the sale proceeds, but not more than maximum annual principal and interest requirements;
    - (ii) Is not amended after August 31, 1986 (other than to permit the issuance of additional bonds as contemplated in the master legal document); and
    - (iii) Provides that bonds having a parity of security may not be issued by or on behalf of the issuer for the purposes provided under the document without satisfying the reserve fund requirements of the indenture.
- (g) **Minor portion.** Under [section 148(e)](/cfr/26/148.md?p=e), a bond of an issue is not an arbitrage bond solely because of the investment in higher yielding investments of gross proceeds of the issue in an amount not exceeding the lesser of—
  - (1) 5 percent of the sale proceeds of the issue; or
  - (2) $100,000.
- (h) **Certain waivers permitted.** On or before the issue date, an issuer may elect to waive the right to invest in higher yielding investments during any temporary period under [paragraph (e)](#e) of this section or as part of a reasonably required reserve or replacement fund under [paragraph (f)](#f) of this section. At any time, an issuer may waive the right to invest in higher yielding investments as part of a minor portion under [paragraph (g)](#g) of this section.

# §1.148-3. General arbitrage rebate rules.

- (a) **In general.** [Section 148(f)](/cfr/26/148.md?p=f) requires that certain earnings on nonpurpose investments allocable to the gross proceeds of an issue be paid to the United States to prevent the bonds in the issue from being arbitrage bonds. The arbitrage that must be rebated is based on the difference between the amount actually earned on nonpurpose investments and the amount that would have been earned if those investments had a yield equal to the yield on the issue.
- (b) **Definition of rebate amount.** As of any date, the rebate amount for an issue is the excess of the future value, as of that date, of all receipts on nonpurpose investments over the future value, as of that date, of all payments on nonpurpose investments.
- (c) **Computation of future value of a payment or receipt.** The future value of a payment or receipt at the end of any period is determined using the economic accrual method and equals the value of that payment or receipt when it is paid or received (or treated as paid or received), plus interest assumed to be earned and compounded over the period at a rate equal to the yield on the issue, using the same compounding interval and financial conventions used to compute that yield.
- (d) **Payments and receipts—**
  - (1) **Definition of payments.** For purposes of this section, payments are—
    - (i) Amounts actually or constructively paid to acquire a nonpurpose investment (or treated as paid to a commingled fund);
    - (ii) For a nonpurpose investment that is first allocated to an issue on a date after it is actually acquired (e.g., an investment that becomes allocable to transferred proceeds or to replacement proceeds) or that becomes subject to the rebate requirement on a date after it is actually acquired (e.g., an investment allocated to a reasonably required reserve or replacement fund for a construction issue at the end of the 2-year spending period), the value of that investment on that date;
    - (iii) For a nonpurpose investment that was allocated to an issue at the end of the preceding computation period, the value of that investment at the beginning of the computation period;
    - (iv) On the last day of each bond year during which there are amounts allocated to gross proceeds of an issue that are subject to the rebate requirement, and on the final maturity date, a computation credit of $1,400 for any bond year ending in 2007 and, for bond years ending after 2007, a computation credit in the amount determined under [paragraph (d)(4)](#d-4) of this section; and
    - (v) Yield reduction payments on nonpurpose investments made pursuant to [§ 1.148-5(c)](/cfr/26/1.148-5.md?p=c).
  - (2) **Definition of receipts.** For purposes of this section, receipts are—
    - (i) Amounts actually or constructively received from a nonpurpose investment (including amounts treated as received from a commingled fund), such as earnings and return of principal;
    - (ii) For a nonpurpose investment that ceases to be allocated to an issue before its disposition or redemption date (e.g., an investment that becomes allocable to transferred proceeds of another issue or that ceases to be allocable to the issue pursuant to the universal cap under [§ 1.148-6](/cfr/26/1.148-6.md)) or that ceases to be subject to the rebate requirement on a date earlier than its disposition or redemption date (e.g., an investment allocated to a fund initially subject to the rebate requirement but that subsequently qualifies as a bona fide debt service fund), the value of that nonpurpose investment on that date; and
    - (iii) For a nonpurpose investment that is held at the end of a computation period, the value of that investment at the end of that period.
  - (3) **Special rules for commingled funds.** [Section 1.148-6(e)](/cfr/26/1.148-6.md?p=e) provides special rules to limit certain of the required determinations of payments and receipts for investments of a commingled fund.
  - (4) **Cost-of-living adjustment.** For any calendar year after 2007, the $1,400 computation credit set forth in [paragraph (d)(1)(iv)](#d-1-iv) of this section shall be increased by an amount equal to such dollar amount multiplied by the cost-of-living adjustment determined under [section 1(f)(3)](/cfr/26/1.md?p=f-3) for such year, as modified by this [paragraph (d)(4)](#d-4). In applying [section 1(f)(3)](/cfr/26/1.md?p=f-3) to determine this cost-of-living adjustment, the reference to “calendar year 1992” in [section 1(f)(3)(B)](/cfr/26/1.md?p=f-3-B) shall be changed to “calendar year 2006.” If any such increase determined under this [paragraph (d)(4)](#d-4) is not a multiple of $10, such increase shall be rounded to the nearest multiple thereof.
- (e) **Computation dates—**
  - (1) **In general.** For a fixed yield issue, an issuer may treat any date as a computation date. For a variable yield issue, an issuer:
    - (i) May treat the last day of any bond year ending on or before the latest date on which the first rebate amount is required to be paid under [paragraph (f)](#f) of this section (the first required payment date) as a computation date but may not change that treatment after the first payment date; and
    - (ii) After the first required payment date, must consistently treat either the end of each bond year or the end of each fifth bond year as computation dates and may not change these computation dates after the first required payment date.
  - (2) **Final computation date.** The date that an issue is discharged is the final computation date. For an issue retired within 3 years of the issue date, however, the final computation date need not occur before the end of 8 months after the issue date or during the period in which the issuer reasonably expects that any of the spending exceptions under [§ 1.148-7](/cfr/26/1.148-7.md) will apply to the issue.
- (f) **Amount of required rebate installment payment—**
  - (1) **Amount of interim rebate payments.** The first rebate installment payment must be made for a computation date that is not later than 5 years after the issue date. Subsequent rebate installment payments must be made for a computation date that is not later than 5 years after the previous computation date for which an installment payment was made. A rebate installment payment must be in an amount that, when added to the future value, as of the computation date, of previous rebate payments made for the issue, equals at least 90 percent of the rebate amount as of that date.
  - (2) **Amount of final rebate payment.** For the final computation date, a final rebate payment must be paid in an amount that, when added to the future value of previous rebate payments made for the issue, equals 100 percent of the rebate amount as of that date.
  - (3) **Future value of rebate payments.** The future value of a rebate payment is determined under [paragraph (c)](#c) of this section. This value is computed by taking into account recoveries of overpayments.
- (g) **Time and manner of payment.** Each rebate payment must be paid no later than 60 days after the computation date to which the payment relates. Any rebate payment paid within this 60-day period may be treated as paid on the computation date to which it relates. A rebate payment is paid when it is filed with the Internal Revenue Service at the place or places designated by the Commissioner. A payment must be accompanied by the form provided by the Commissioner for this purpose.
- (h) **Penalty in lieu of loss of tax exemption—**
  - (1) **In general.** The failure to pay the correct rebate amount when required will cause the bonds of the issue to be arbitrage bonds, unless the Commissioner determines that the failure was not caused by willful neglect and the issuer promptly pays a penalty to the United States. If no bond of the issue is a private activity bond (other than a qualified 501(c)(3) bond), the penalty equals 50 percent of the rebate amount not paid when required to be paid, plus interest on that amount. Otherwise, the penalty equals 100 percent of the rebate amount not paid when required to be paid, plus interest on that amount.
  - (2) **Interest on underpayments.** Interest accrues at the underpayment rate under [section 6621](/cfr/26/6621.md), beginning on the date the correct rebate amount is due and ending on the date 10 days before it is paid.
  - (3) **Waivers of the penalty.** The penalty is automatically waived if the rebate amount that the issuer failed to pay plus interest is paid within 180 days after discovery of the failure, unless, the Commissioner determines that the failure was due to willful neglect, or the issue is under examination by the Commissioner at any time during the period beginning on the date the failure first occurred and ending on the date 90 days after the receipt of the rebate amount. Generally, extensions of this 180-day period and waivers of the penalty in other cases will be granted by the Commissioner only in unusual circumstances. For purposes of this [paragraph (h)(3)](#h-3), willful neglect does not include a failure that is attributable solely to the permissible retroactive selection of a short first bond year if the rebate amount that the issuer failed to pay is paid within 60 days of the selection of that bond year.
  - (4) **Application to alternative penalty under § 1.148-7.** [Paragraphs (h)](#h) (1), (2), and (3) of this section apply to failures to pay penalty payments under [§ 1.148-7](/cfr/26/1.148-7.md) (alternative penalty amounts) by substituting alternative penalty amounts for rebate amount and the last day of each spending period for computation date.
    - (i) **Recovery of overpayment of rebate—**
  - (1) **In general.** An issuer may recover an overpayment for an issue of tax-exempt bonds by establishing to the satisfaction of the Commissioner that the overpayment occurred. An overpayment is the excess of the amount paid to the United States for an issue under [section 148](/cfr/26/148.md) over the sum of the rebate amount for the issue as of the most recent computation date and all amounts that are otherwise required to be paid under [section 148](/cfr/26/148.md) as of the date the recovery is requested.
  - (2) **Limitations on recovery.**
    - (i) An overpayment may be recovered only to the extent that a recovery on the date that it is first requested would not result in an additional rebate amount if that date were treated as a computation date.
    - (ii) Except for overpayments of penalty in lieu of rebate under [section 148(f)(4)(C)(vii)](/cfr/26/148.md?p=f-4-C-vii) and [§ 1.148-7(k)](/cfr/26/1.148-7.md?p=k), an overpayment of less than $5,000 may not be recovered before the final computation date.
  - (3) **Time and manner for requesting refund.**
    - (i) An issuer must request a refund of an overpayment (claim) no later than the date that is two years after the final computation date for the issue to which the overpayment relates (the filing deadline). The claim must be made using the form provided by the Commissioner for this purpose.
    - (ii) The Commissioner may request additional information to support a claim. The issuer must file the additional information by the date specified in the Commissioner's request, which date may be extended by the Commissioner if unusual circumstances warrant. An issuer will be given at least 21 calendar days to respond to a request for additional information.
    - (iii) A claim described in either paragraph (i)(3)(iii)(A) or (B) of this section that has been denied by the Commissioner may be appealed to the Office of Appeals under this paragraph (i)(3)(iii). Upon a determination in favor of the issuer, the Office of Appeals must return the undeveloped case to the Commissioner for further consideration of the substance of the claim.
      - (A) A claim is described in this paragraph (i)(3)(iii)(A) if the Commissioner asserts that the claim was filed after the filing deadline.
      - (B) A claim is described in this paragraph (i)(3)(iii)(B) if the Commissioner asserts that additional information to support the claim was not submitted within the time specified in the request for information or in any extension of such specified time period.
- (j) **Examples.** The provisions of this section may be illustrated by the following examples.
- (k) **Bona fide debt service fund exception.** Under [section 148(f)(4)(A)](/cfr/26/148.md?p=f-4-A), the rebate requirement does not apply to amounts in certain bona fide debt service funds. An issue with an average annual debt service that is not in excess of $2,500,000 may be treated as satisfying the $100,000 limitation in [section 148(f)(4)(A)(ii)](/cfr/26/148.md?p=f-4-A-ii).

# §1.148-4. Yield on an issue of bonds.

- (a) **In general.** The yield on an issue of bonds is used to apply investment yield restrictions under [section 148(a)](/cfr/26/148.md?p=a) and to compute rebate liability under [section 148(f)](/cfr/26/148.md?p=f). Yield is computed under the economic accrual method using any consistently applied compounding interval of not more than one year. A short first compounding interval and a short last compounding interval may be used. Yield is expressed as an annual percentage rate that is calculated to at least four decimal places (for example, 5.2525 percent). Other reasonable, standard financial conventions, such as the 30 days per month/360 days per year convention, may be used in computing yield but must be consistently applied. The yield on an issue that would be a purpose investment (absent [section 148(b)(3)(A)](/cfr/26/148.md?p=b-3-A)) is equal to the yield on the conduit financing issue that financed that purpose investment.
- (b) **Computing yield on a fixed yield issue—**
  - (1) **In general—**
    - (i) **Yield on an issue.** The yield on a fixed yield issue is the discount rate that, when used in computing the present value as of the issue date of all unconditionally payable payments of principal, interest, and fees for qualified guarantees on the issue and amounts reasonably expected to be paid as fees for qualified guarantees on the issue, produces an amount equal to the present value, using the same discount rate, of the aggregate issue price of bonds of the issue as of the issue date. Further, payments include certain amounts properly allocable to a qualified hedge. Yield on a fixed yield issue is computed as of the issue date and is not affected by subsequent unexpected events, except to the extent provided in paragraphs [(b)(4)](#b-4) and [(h)(3)](#h-3) of this section.
    - (ii) **Yield on a bond.** Yield on a fixed yield bond is computed in the same manner as yield on a fixed yield issue.
  - (2) **Yield on certain fixed yield bonds subject to mandatory or contingent early redemption—**
    - (i) **In general.** The yield on a fixed yield issue that includes a bond subject to mandatory early redemption or expected contingent redemption is computed by treating that bond as redeemed on its reasonably expected early redemption date for an amount equal to its value on that date. Reasonable expectations are determined on the issue date. A bond is subject to mandatory early redemption if it is unconditionally payable in full before its final maturity date. A bond is subject to a contingent redemption if it must be, or is reasonably expected to be, redeemed prior to final maturity upon the occurrence of a contingency. A contingent redemption is taken into account only if the contingency is reasonably expected to occur, in which case the date of occurrence of the contingency must be reasonably estimated. For example, if bonds are reasonably expected to be redeemed early using excess revenues from general or special property taxes or benefit assessments or similar amounts, the reasonably expected redemption schedule is used to determine yield. For purposes of this [paragraph (b)(2)(i)](#b-2-i), excess proceeds calls for issues for which the requirements of [§ 1.148-2(e)](/cfr/26/1.148-2.md?p=e) (2) or (3) are satisfied, calamity calls, and refundings do not cause a bond to be subject to early redemption. The value of a bond is determined under [paragraph (e)](#e) of this section.
    - (ii) **Substantially identical bonds subject to mandatory early redemption.** If substantially identical bonds of an issue are subject to specified mandatory redemptions prior to final maturity (e.g., a mandatory sinking fund redemption requirement), yield on that issue is computed by treating those bonds as redeemed in accordance with the redemption schedule for an amount equal to their value. Generally, bonds are substantially identical if the stated interest rate, maturity, and payment dates are the same. In computing the yield on an issue containing bonds described in this [paragraph (b)(2)(ii)](#b-2-ii), each of those bonds must be treated as redeemed at its present value, unless the stated redemption price at maturity of the bond does not exceed the issue price of the bond by more than one-fourth of one percent multiplied by the product of the stated redemption price at maturity and the number of years to the weighted average maturity date of the substantially identical bonds, in which case each of those bonds must be treated as redeemed at its outstanding stated principal amount, plus accrued, unpaid interest. Weighted average maturity is determined by taking into account the mandatory redemption schedule.
  - (3) **Yield on certain fixed yield bonds subject to optional early redemption—**
    - (i) **In general.** If a fixed yield bond is subject to optional early redemption and is described in [paragraph (b)(3)(ii)](#b-3-ii) of this section, the yield on the issue containing the bond is computed by treating the bond as redeemed at its stated redemption price on the optional redemption date that would produce the lowest yield on that bond.
    - (ii) **Fixed yield bonds subject to special yield calculation rule.** A fixed yield bond is described in this [paragraph (b)(3)(ii)](#b-3-ii) only if it—
      - (A) Is subject to optional redemption within five years of the issue date, but only if the yield on the issue computed by assuming all bonds in the issue subject to redemption within 5 years of the issue date are redeemed at maturity is more than one-eighth of one percentage point higher than the yield on that issue computed by assuming all bonds subject to optional redemption within 5 years of the issue date are redeemed at the earliest date for their redemption;
      - (B) Is issued at an issue price that exceeds the stated redemption price at maturity by more than one-fourth of one percent multiplied by the product of the stated redemption price at maturity and the number of complete years to the first optional redemption date for the bond; or
      - (C) Bears interest at increasing interest rates (i.e., a stepped coupon bond).
  - (4) **Yield recomputed upon transfer of certain rights associated with the bond.** For purposes of [§ 1.148-3](/cfr/26/1.148-3.md), as of the date of any transfer, waiver, modification, or similar transaction (collectively, a transfer) of any right that is part of the terms of a bond or is otherwise associated with a bond (e.g., a redemption right), in a transaction that is separate and apart from the original sale of the bond, the issue is treated as if it were retired and a new issue issued on the date of the transfer (reissued). The redemption price of the retired issue and the issue price of the new issue equal the aggregate values of all the bonds of the issue on the date of the transfer. In computing yield on the new issue, any amounts received by the issuer as consideration for the transfer are taken into account.
  - (5) **Special aggregation rule treating certain bonds as a single fixed yield bond.** Two variable yield bonds of an issue are treated in the aggregate as a single fixed yield bond if—
    - (i) Aggregate treatment would result in the single bond being a fixed yield bond; and
    - (ii) The terms of the bonds do not contain any features that could distort the aggregate fixed yield from what the yield would be if a single fixed yield bond were issued. For example, if an issue contains a bond bearing interest at a floating rate and a related bond bearing interest at a rate equal to a fixed rate minus that floating rate, those two bonds are treated as a single fixed yield bond only if neither bond may be redeemed unless the other bond is also redeemed at the same time.
  - (6) **Examples.** The provisions of this [paragraph (b)](#b) may be illustrated by the following examples.
- (c) **Computing yield on a variable yield issue—**
  - (1) **In general.** The yield on a variable yield issue is computed separately for each computation period. The yield for each computation period is the discount rate that, when used in computing the present value as of the first day of the computation period of all the payments of principal and interest and fees for qualified guarantees that are attributable to the computation period, produces an amount equal to the present value, using the same discount rate, of the aggregate issue price (or deemed issue price, as determined in [paragraph (c)(2)(iv)](#c-2-iv) of this section) of the bonds of the issue as of the first day of the computation period. The yield on a variable yield bond is computed in the same manner as the yield on a variable yield issue. Except as provided in [paragraph (c)(2)](#c-2) of this section, yield on any fixed yield bond in a variable yield issue is computed in the same manner as the yield on a fixed yield issue as provided in [paragraph (b)](#b) of this section.
  - (2) **Payments on bonds included in yield for a computation period—**
    - (i) **Payments in general.** The payments on a bond that are attributable to a computation period include any amounts actually paid during the period for principal on the bond. Payments also include any amounts paid during the current period both for interest accruing on the bond during the current period and for interest accruing during the prior period that was included in the deemed issue price of the bond as accrued unpaid interest at the start of the current period under this [paragraph (c)(2)](#c-2). Further, payments include any amounts properly allocable to fees for a qualified guarantee of the bond for the period and to any amounts properly allocable to a qualified hedge for the period.
    - (ii) **Payments at actual redemption.** If a bond is actually redeemed during a computation period, an amount equal to the greater of its value on the redemption date or the actual redemption price is a payment on the actual redemption date.
    - (iii) **Payments for bonds outstanding at end of computation period.** If a bond is outstanding at the end of a computation period, a payment equal to the bond's value is taken into account on the last day of that period.
    - (iv) **Issue price for bonds outstanding at beginning of next computation period.** A bond outstanding at the end of a computation period is treated as if it were immediately reissued on the next day for a deemed issue price equal to the value from the day before as determined under [paragraph (c)(2)(iii)](#c-2-iii) of this section.
  - (3) **Example.** The provisions of this [paragraph (c)](#c) may be illustrated by the following example.
- (d) **Conversion from variable yield issue to fixed yield issue.** For purposes of determining yield under this section, as of the first day on which a variable yield issue would qualify as a fixed yield issue if it were newly issued on that date (a conversion date), that issue is treated as if it were reissued as a fixed yield issue on the conversion date. The redemption price of the variable yield issue and the issue price of the fixed yield issue equal the aggregate values of all the bonds on the conversion date. Thus, for example, for plain par bonds (e.g., tender bonds), the deemed issue price would be the outstanding principal amount, plus accrued unpaid interest. If the conversion date occurs on a date other than a computation date, the issuer may continue to treat the issue as a variable yield issue until the next computation date, at which time it must be treated as converted to a fixed yield issue.
- (e) **Value of bonds—**
  - (1) **Plain par bonds.** Except as otherwise provided, the value of a plain par bond is its outstanding stated principal amount, plus accrued unpaid interest. The value of a plain par bond that is actually redeemed or treated as redeemed is its stated redemption price on the redemption date, plus accrued, unpaid interest.
  - (2) **Other bonds.** The value of a bond other than a plain par bond on a date is its present value on that date. The present value of a bond is computed under the economic accrual method taking into account all the unconditionally payable payments of principal, interest, and fees for a qualified guarantee to be paid on or after that date and using the yield on the bond as the discount rate, except that for purposes of [§ 1.148-6(b)(2)](/cfr/26/1.148-6.md?p=b-2) (relating to the universal cap), these values may be determined by consistently using the yield on the issue of which the bonds are a part. To determine yield on fixed yield bonds, see [paragraph (b)(1)](#b-1) of this section. The rules contained in paragraphs [(b)(2)](#b-2) and [(b)(3)](#b-3) of this section apply for this purpose. In the case of bonds described in [paragraph (b)(2)(ii)](#b-2-ii) of this section, the present value of those bonds on any date is computed using the yield to the final maturity date of those bonds as the discount rate. In determining the present value of a variable yield bond under this [paragraph (e)(2)](#e-2), the initial interest rate on the bond established by the interest index or other interest rate setting mechanism is used to determine the interest payments on that bond.
- (f) **Qualified guarantees—**
  - (1) **In general.** Fees properly allocable to payments for a qualified guarantee for an issue (as determined under [paragraph (f)(6)](#f-6) of this section) are treated as additional interest on that issue under [section 148](/cfr/26/148.md). A guarantee is a qualified guarantee if it satisfies each of the requirements of [paragraphs (f)(2) through (f)(4)](#f-2..f-4) of this section.
  - (2) **Interest savings.** As of the date the guarantee is obtained, the issuer must reasonably expect that the present value of the fees for the guarantee will be less than the present value of the expected interest savings on the issue as a result of the guarantee. For this purpose, present value is computed using the yield on the issue, determined with regard to guarantee payments, as the discount rate.
  - (3) **Guarantee in substance.** The arrangement must create a guarantee in substance. The arrangement must impose a secondary liability that unconditionally shifts substantially all of the credit risk for all or part of the payments, such as payments for principal and interest, redemption prices, or tender prices, on the guaranteed bonds. Reasonable procedural or administrative requirements of the guarantee do not cause the guarantee to be conditional. In the case of a guarantee against failure to remarket a qualified tender bond, commercially reasonable limitations based on credit risk, such as limitations on payment in the event of default by the primary obligor or the bankruptcy of a long-term credit guarantor, do not cause the guarantee to be conditional. The guarantee may be in any form. The guarantor may not be a co-obligor. Thus, the guarantor must not expect to make any payments other than under a direct-pay letter of credit or similar arrangement for which the guarantor will be reimbursed immediately. The guarantor and any related parties together must not use more than 10 percent of the proceeds of the portion of the issue allocable to the guaranteed bonds.
  - (4) **Reasonable charge—**
    - (i) **In general.** Fees for a guarantee must not exceed a reasonable, arm's-length charge for the transfer of credit risk. In complying with this requirement, the issuer may not rely on the representations of the guarantor.
    - (ii) **Fees for services other than transfer of credit risk must be separately stated.** A fee for a guarantee must not include any payment for any direct or indirect services other than the transfer of credit risk, unless the compensation for those other services is separately stated, reasonable, and excluded from the guarantee fee. Fees for the transfer of credit risk include fees for the guarantor's overhead and other costs relating to the transfer of credit risk. For example, a fee includes payment for services other than transfer of credit risk if—
      - (A) It includes payment for the cost of underwriting or remarketing bonds or for the cost of insurance for casualty to bond-financed property;
      - (B) It is refundable upon redemption of the guaranteed bond before the final maturity date and the amount of the refund would exceed the portion of the fee that had not been earned; or
      - (C) The requirements of [§ 1.148-2(e)(2)](/cfr/26/1.148-2.md?p=e-2) (relating to temporary periods for capital projects) are not satisfied, and the guarantor is not reasonably assured that the bonds will be repaid if the project to be financed is not completed.
  - (5) **Guarantee of purpose investments.** Except for guarantees of qualified mortgage loans and qualified student loans, a guarantee of payments on a purpose investment is a qualified guarantee of the issue if all payments on the purpose investment reasonably coincide with payments on the related bonds and the payments on the purpose investment are unconditionally payable no more than 6 months before the corresponding interest payment and 12 months before the corresponding principal payments on the bonds. This [paragraph (f)(5)](#f-5) only applies if, in addition to satisfying the other requirements of this [paragraph (f)](#f), the guarantee is, in substance, a guarantee of the bonds allocable to that purpose investment and to no other bonds except for bonds that are equally and ratably secured by purpose investments of the same conduit borrower.
  - (6) **Allocation of qualified guarantee payments—**
    - (i) **In general.** Payments for a qualified guarantee must be allocated to bonds and to computation periods in a manner that properly reflects the proportionate credit risk for which the guarantor is compensated. Proportionate credit risk for bonds that are not substantially identical may be determined using any reasonable, consistently applied method. For example, this risk may be based on the ratio of the total principal and interest paid and to be paid on a guaranteed bond to the total principal and interest paid and to be paid on all bonds of the guaranteed issue. An allocation method generally is not reasonable, for example, if a substantial portion of the fee is allocated to the construction portion of the issue and a correspondingly insubstantial portion is allocated to the later years covered by the guarantee. Reasonable letter of credit set up fees may be allocated ratably during the initial term of the letter of credit. Upon an early redemption of a variable yield bond, fees otherwise allocable to the period after the redemption are allocated to remaining outstanding bonds of the issue or, if none remain outstanding, to the period before the redemption.
    - (ii) **Safe harbor for allocation of qualified guarantee fees for variable yield issues.** An allocation of non-level payments for a qualified guarantee for variable yield bonds is treated as meeting the requirements of [paragraph (f)(6)(i)](#f-6-i) of this section if, for each bond year for which the guarantee is in effect, an equal amount (or for any short bond year, a proportionate amount of the equal amount) is treated as paid as of the beginning of that bond year. The present value of the annual amounts must equal the fee for the guarantee allocated to that bond, with present value computed as of the first day the guarantee is in effect by using as the discount rate the yield on the variable yield bonds covered by the guarantee, determined without regard to any fee allocated under this [paragraph (f)(6)(ii)](#f-6-ii).
  - (7) **Refund or reduction of guarantee payments.** If as a result of an investment of proceeds of a refunding issue in a refunding escrow, there will be a reduction in, or refund of, payments for a guarantee (savings), the savings must be treated as a reduction in the payments on the refunding issue.
- (g) **Yield on certain mortgage revenue and student loan bonds.** For purposes of [section 148](/cfr/26/148.md) and this section, [section 143(g)(2)(C)(ii)](/cfr/26/143.md?p=g-2-C-ii) applies to the computation of yield on an issue of qualified mortgage bonds or qualified veterans' mortgage bonds. For purposes of applying [section 148](/cfr/26/148.md) and [section 143(g)](/cfr/26/143.md?p=g) with respect to purpose investments allocable to a variable yield issue of qualified mortgage bonds, qualified veterans' mortgage bonds, or qualified student loan bonds that is reasonably expected as of the issue date to convert to a fixed yield issue, the yield may be computed over the term of the issue, and, if the yield is so computed, [paragraph (d)](#d) of this section does not apply to the issue. As of any date, the yield over the term of the issue is based on—
  - (1) With respect to any bond of the issue that has not converted to a fixed and determinable yield on or before that date, the actual amounts paid or received to that date and the amounts that are reasonably expected (as of that date) to be paid or received with respect to that bond over the remaining term of the issue (taking into account prepayment assumptions under [section 143(g)(2)(B)(iv)](/cfr/26/143.md?p=g-2-B-iv), if applicable); and
  - (2) With respect to any bond of the issue that has converted to a fixed and determinable yield on or before that date, the actual amounts paid or received before that bond converted, if any, and the amount that was reasonably expected (on the date that bond converted) to be paid or received with respect to that bond over the remaining term of the issue (taking into account prepayment assumptions under [section 143(g)(2)(B)(iv)](/cfr/26/143.md?p=g-2-B-iv), if applicable).
- (h) **Qualified hedging transactions—**
  - (1) **In general.** Payments made or received by an issuer under a qualified hedge (as defined in [paragraph (h)(2)](#h-2) of this section) relating to bonds of an issue are taken into account (as provided in [paragraph (h)(3)](#h-3) of this section) to determine the yield on the issue. Except as provided in paragraphs [(h)(4)](#h-4) and [(h)(5)(ii)(E)](#h-5-ii-E) of this section, the bonds to which a qualified hedge relates are treated as variable yield bonds from the issue date of the bonds. This [paragraph (h)](#h) applies solely for purposes of sections [143(g)](/cfr/26/143.md?p=g), [148](/cfr/26/148.md), and [149(d)](/cfr/26/149.md?p=d).
  - (2) **Qualified hedge defined.** Except as provided in [paragraph (h)(5)](#h-5) of this section, the term qualified hedge means a contract that satisfies each of the following requirements:
    - (i) **Hedge—**
      - (A) **In general.** The contract is entered into primarily to modify the issuer's risk of interest rate changes with respect to a bond (a hedge). For example, the contract may be an interest rate swap, an interest rate cap, a futures contract, a forward contract, or an option.
      - (B) **Special rule for fixed rate issues.** If the contract modifies the issuer's risk of interest rate changes with respect to a bond that is part of an issue that, absent the contract, would be a fixed rate issue, the contract must be entered into—

        (1) No later than 15 days after the issue date (or the deemed issue date under [paragraph (d)](#d) of this section) of the issue; or

        (2) No later than the expiration of a qualified hedge with respect to bonds of that issue that satisfies paragraph (h)(2)(i)(B)(1) of this section; or

        (3) No later than the expiration of a qualified hedge with respect to bonds of that issue that satisfies either paragraph (h)(2)(i)(B)(2) of this section or this paragraph (h)(2)(i)(B)(3).

      - (C) **Contracts with certain acquisition payments.** If a hedge provider makes a single payment to the issuer (e.g., a payment for an off-market swap) in connection with the acquisition of a contract, the issuer may treat a portion of that contract as a hedge provided—

        (1) The hedge provider's payment to the issuer and the issuer's payments under the contract in excess of those that it would make if the contract bore rates equal to the on-market rates for the contract (determined as of the date the parties enter into the contract) are separately identified in a certification of the hedge provider; and

        (2) The payments described in paragraph (h)(2)(i)(C)(1) of this section are not treated as payments on the hedge.

    - (ii) **No significant investment element—**
      - (A) **In general.** The contract does not contain a significant investment element. Except as provided in [paragraph (h)(2)(ii)(B)](#h-2-ii-B) of this section, a contract contains a significant investment element if a significant portion of any payment by one party relates to a conditional or unconditional obligation by the other party to make a payment on a different date. Examples of contracts that contain a significant investment element are a debt instrument held by the issuer; an interest rate swap requiring any payments other than periodic payments, within the meaning of [§ 1.446-3](/cfr/26/1.446-3.md) (periodic payments) (e.g., a payment for an off-market swap or prepayment of part or all of one leg of a swap); and an interest rate cap requiring the issuer's premium for the cap to be paid in a single, up-front payment. Solely for purposes of determining if a hedge is a qualified hedge under this section, payments that an issuer receives pursuant to the terms of a hedge that are equal to the issuer's cost of funds are treated as periodic payments under [§ 1.446-3](/cfr/26/1.446-3.md) without regard to whether the payments are calculated by reference to a “specified index” described in [§ 1.446-3(c)(2)](/cfr/26/1.446-3.md?p=c-2). Accordingly, a hedge does not have a significant investment element under this [paragraph (h)(2)(ii)(A)](#h-2-ii-A) solely because an issuer receives payments pursuant to the terms of a hedge that are computed to be equal to the issuer's cost of funds, such as the issuer's actual market-based tax-exempt variable interest rate on its bonds.
      - (B) **Special level payment rule for interest rate caps.** An interest rate cap does not contain a significant investment element if—

        (1) All payments to the issuer by the hedge provider are periodic payments;

        (2) The issuer makes payments for the cap at the same time as periodic payments by the hedge provider must be made if the specified index (within the meaning of [§ 1.446-3](/cfr/26/1.446-3.md)) of the cap is above the strike price of the cap; and

        (3) Each payment by the issuer bears the same ratio to the notional principal amount (within the meaning of [§ 1.446-3](/cfr/26/1.446-3.md)) that is used to compute the hedge provider's payment, if any, on that date.

    - (iii) **Parties.** The contract is entered into between the issuer or the political subdivision on behalf of which the issuer issues the bonds (collectively referred to in this [paragraph (h)](#h) as the issuer) and a provider that is not a related party (the hedge provider).
    - (iv) **Hedged bonds.** The contract covers, in whole or in part, all of one or more groups of substantially identical bonds in the issue (i.e., all of the bonds having the same interest rate, maturity, and terms). Thus, for example, a qualified hedge may include a hedge of all or a pro rata portion of each interest payment on the variable rate bonds in an issue for the first 5 years following their issuance. For purposes of this [paragraph (h)](#h), unless the context clearly requires otherwise, hedged bonds means the specific bonds or portions thereof covered by a hedge.
    - (v) **Interest-based contract and size and scope of hedge.** The contract is primarily interest-based (for example, a hedge based on a debt index, including a tax-exempt debt index or a taxable debt index, rather than an equity index). In addition, the size and scope of the hedge under the contract is limited to that which is reasonably necessary to hedge the issuer's risk with respect to interest rate changes on the hedged bonds. For example, a contract is limited to hedging an issuer's risk with respect to interest rate changes on the hedged bonds if the hedge is based on the principal amount and the reasonably expected interest payments of the hedged bonds. For anticipatory hedges under [paragraph (h)(5)](#h-5) of this section, the size and scope limitation applies based on the reasonably expected terms of the hedged bonds to be issued. A contract is not primarily interest based unless—
      - (A) The hedged bond, without regard to the contract, is either a fixed rate bond, a variable rate debt instrument within the meaning of [§ 1.1275-5](/cfr/26/1.1275-5.md) provided the rate is not based on an objective rate other than a qualified inverse floating rate or a qualified inflation rate, a tax-exempt obligation described in [§ 1.1275-4(d)(2)](/cfr/26/1.1275-4.md?p=d-2), or an inflation-indexed debt instrument within the meaning of [§ 1.1275-7](/cfr/26/1.1275-7.md); and
      - (B) As a result of treating all payments on (and receipts from) the contract as additional payments on (and receipts from) the hedged bond, the resulting bond would be substantially similar to either a fixed rate bond, a variable rate debt instrument within the meaning of [§ 1.1275-5](/cfr/26/1.1275-5.md) provided the rate is not based on an objective rate other than a qualified inverse floating rate or a qualified inflation rate, a tax-exempt obligation described in [§ 1.1275-4(d)(2)](/cfr/26/1.1275-4.md?p=d-2), or an inflation-indexed debt instrument within the meaning of [§ 1.1275-7](/cfr/26/1.1275-7.md). For this purpose, differences that would not prevent the resulting bond from being substantially similar to another type of bond include: a difference between the interest rate used to compute payments on the hedged bond and the interest rate used to compute payments on the hedge where one interest rate is substantially similar to the other; the difference resulting from the payment of a fixed premium for a cap (for example, payments for a cap that are made in other than level installments); and the difference resulting from the allocation of a termination payment where the termination was not expected as of the date the contract was entered into.
    - (vi) **Payments closely correspond.** The payments received by the issuer from the hedge provider under the contract correspond closely in time to either the specific payments being hedged on the hedged bonds or specific payments required to be made pursuant to the bond documents, regardless of the hedge, to a sinking fund, debt service fund, or similar fund maintained for the issue of which the hedged bond is a part. For this purpose, such payments will be treated as corresponding closely in time under this [paragraph (h)(2)(vi)](#h-2-vi) if they are made within 90 calendar days of each other.
    - (vii) **Source of payments.** Payments to the hedge provider are reasonably expected to be made from the same source of funds that, absent the hedge, would be reasonably expected to be used to pay principal and interest on the hedged bonds.
    - (viii) **Identification—**
      - (A) **In general.** The actual issuer must identify the contract on its books and records maintained for the hedged bonds not later than 15 calendar days after the date on which there is a binding agreement to enter into a hedge contract (for example, the date of a hedge pricing confirmation, as distinguished from the closing date for the hedge or start date for payments on the hedge, if different). The identification must specify the name of the hedge provider, the terms of the contract, the hedged bonds, and include a hedge provider's certification as described in [paragraph (h)(2)(viii)(B)](#h-2-viii-B) of this section. The identification must contain sufficient detail to establish that the requirements of this [paragraph (h)(2)](#h-2) and, if applicable, [paragraph (h)(4)](#h-4) of this section are satisfied. In addition, the existence of the hedge must be noted on the first form relating to the issue of which the hedged bonds are a part that is filed with the Internal Revenue Service on or after the date on which the contract is identified pursuant to this [paragraph (h)(2)(viii)](#h-2-viii).
      - (B) **Hedge provider's certification.** The hedge provider's certification must—

        (1) Provide that the terms of the hedge were agreed to between a willing buyer and willing seller in a bona fide, arm's-length transaction;

        (2) Provide that the hedge provider has not made, and does not expect to make, any payment to any third party for the benefit of the issuer in connection with the hedge, except for any such third-party payment that the hedge provider expressly identifies in the documents for the hedge;

        (3) Provide that the amounts payable to the hedge provider pursuant to the hedge do not include any payments for underwriting or other services unrelated to the hedge provider's obligations under the hedge, except for any such payment that the hedge provider expressly identifies in the documents for the hedge; and

        (4) Contain any other statements that the Commissioner may provide in guidance published in the Internal Revenue Bulletin. See [§ 601.601(d)(2)(ii)](/cfr/26/601.601.md?p=d-2-ii) of this chapter.

  - (3) **Accounting for qualified hedges—**
    - (i) **In general.** Except as otherwise provided in [paragraph (h)(4)](#h-4) of this section, payments made or received by the issuer under a qualified hedge are treated as payments made or received, as appropriate, on the hedged bonds that are taken into account in determining the yield on those bonds. These payments are reasonably allocated to the hedged bonds in the period to which the payments relate, as determined under [paragraph (h)(3)(iii)](#h-3-iii) of this section. Payments made or received by the issuer include payments deemed made or received when a contract is terminated or deemed terminated under this [paragraph (h)(3)](#h-3). Payments reasonably allocable to the modification of risk of interest rate changes and to the hedge provider's overhead under this [paragraph (h)](#h) are included as payments made or received under a qualified hedge.
    - (ii) **Exclusions from hedge.** If any payment for services or other items under the contract is not expressly treated by [paragraph (h)(3)(i)](#h-3-i) of this section as a payment under the qualified hedge, the payment is not a payment with respect to a qualified hedge.
    - (iii) **Timing and allocation of payments.** Except as provided in paragraphs [(h)(3)(iv)](#h-3-iv) and (h)(5) of this section, payments made or received by the issuer under a qualified hedge are taken into account in the same period in which those amounts would be treated as income or deductions under [§ 1.446-4](/cfr/26/1.446-4.md) (without regard to [§ 1.446-4(a)(2)(iv)](/cfr/26/1.446-4.md?p=a-2-iv)) and are adjusted as necessary to reflect the end of a computation period and the start of a new computation period.
    - (iv) **Accounting for modifications and terminations—**
      - (A) **Modification defined.** A modification of a qualified hedge includes, without limitation, a change in the terms of the hedge or an issuer's acquisition of another hedge with terms that have the effect of modifying an issuer's risk of interest rate changes or other terms of an existing qualified hedge. For example, if the issuer enters into a qualified hedge that is an interest rate swap under which it receives payments based on the Securities Industry and Financial Market Association (SIFMA) Municipal Swap Index and subsequently enters a second hedge (with the same or different provider) that limits the issuer's exposure under the existing qualified hedge to variations in the SIFMA Municipal Swap Index, the new hedge modifies the qualified hedge.
      - (B) **Termination defined.** A termination means either an actual termination or a deemed termination of a qualified hedge. Except as otherwise provided, an actual termination of a qualified hedge occurs to the extent that the issuer sells, disposes of, or otherwise actually terminates all or a portion of the hedge. A deemed termination of a qualified hedge occurs if the hedge ceases to meet the requirements for a qualified hedge; the issuer makes a modification (as defined in [paragraph (h)(3)(iv)(A)](#h-3-iv-A) of this section) that is material either in kind or in extent and, therefore, results in a deemed exchange of the hedge and a realization event to the issuer under [section 1001](/cfr/26/1001.md); or the issuer redeems all or a portion of the hedged bonds.
      - (C) **Special rules for certain modifications when the hedge remains qualified.** A modification of a qualified hedge that otherwise would result in a deemed termination under [paragraph (h)(3)(iv)(B)](#h-3-iv-B) of this section does not result in such a termination if the modified hedge is re-tested for qualification as a qualified hedge as of the date of the modification, the modified hedge meets the requirements for a qualified hedge as of such date, and the modified hedge is treated as a qualified hedge prospectively in determining the yield on the hedged bonds. For purposes of this [paragraph (h)(3)(iv)(C)](#h-3-iv-C), when determining whether the modified hedge is qualified, the fact that the existing qualified hedge is off-market as of the date of the modification is disregarded and the identification requirement in [paragraph (h)(2)(viii)](#h-2-viii) of this section applies by measuring the time period for identification from the date of the modification and without regard to the requirement for a hedge provider's certification.
      - (D) **Continuations of certain qualified hedges in refundings.** If hedged bonds are redeemed using proceeds of a refunding issue, the qualified hedge for the refunded bonds is not actually terminated, and the hedge meets the requirements for a qualified hedge for the refunding bonds as of the issue date of the refunding bonds, then no termination of the hedge occurs and the hedge instead is treated as a qualified hedge for the refunding bonds. For purposes of this [paragraph (h)(3)(iv)(D)](#h-3-iv-D), when determining whether the hedge is a qualified hedge for the refunding bonds, the fact that the hedge is off-market with respect to the refunding bonds as of the issue date of the refunding bonds is disregarded and the identification requirement in [paragraph (h)(2)(viii)](#h-2-viii) of this section applies by measuring the time period for identification from the issue date of the refunding bonds and without regard to the requirement for a hedge provider's certification.
      - (E) **General allocation rules for hedge termination payments.** Except as otherwise provided in paragraphs [(h)(3)(iv)(F)](#h-3-iv-F), [(G)](#h-3-iv-G), and [(H)](#h-3-iv-H) of this section, a payment made or received by an issuer to terminate a qualified hedge, or a payment deemed made or received for a deemed termination, is treated as a payment made or received, as appropriate, on the hedged bonds. Upon an actual termination or a deemed termination of a qualified hedge, the amount that an issuer may treat as a termination payment made or received on the hedged bonds is the fair market value of the qualified hedge on its termination date, based on all of the facts and circumstances. Except as otherwise provided, a termination payment is reasonably allocated to the remaining periods originally covered by the terminated hedge in a manner that reflects the economic substance of the hedge.
      - (F) **Special rule for terminations when bonds are redeemed.** Except as otherwise provided in this [paragraph (h)(3)(iv)(F)](#h-3-iv-F) and in [paragraph (h)(3)(iv)(G)](#h-3-iv-G) of this section, when a qualified hedge is deemed terminated because the hedged bonds are redeemed, the termination payment as determined under [paragraph (h)(3)(iv)(E)](#h-3-iv-E) of this section is treated as made or received on that date. When hedged bonds are redeemed, any payment received by the issuer on termination of a hedge, including a termination payment or a deemed termination payment, reduces, but not below zero, the interest payments made by the issuer on the hedged bonds in the computation period ending on the termination date. The remainder of the payment, if any, is reasonably allocated over the bond years in the immediately preceding computation period or periods to the extent necessary to eliminate the excess.
      - (G) **Special rules for refundings.** When there is a termination of a qualified hedge because there is a refunding of the hedged bonds, to the extent that the hedged bonds are redeemed using the proceeds of a refunding issue, the termination payment is accounted for under [paragraph (h)(3)(iv)(E)](#h-3-iv-E) of this section by treating it as a payment on the refunding issue, rather than the hedged bonds. In addition, to the extent that the refunding issue is redeemed during the period to which the termination payment has been allocated to that issue, [paragraph (h)(3)(iv)(F)](#h-3-iv-F) of this section applies to the termination payment by treating it as a payment on the redeemed refunding issue.
      - (H) **Safe harbor for allocation of certain termination payments.** A payment to terminate a qualified hedge does not result in that hedge failing to satisfy the applicable provisions of [paragraph (h)(3)(iv)(E)](#h-3-iv-E) of this section if that payment is allocated in accordance with this [paragraph (h)(3)(iv)(H)](#h-3-iv-H). For an issue that is a variable yield issue after termination of a qualified hedge, an amount must be allocated to each date on which the hedge provider's payment, if any, would have been made had the hedge not been terminated. The amounts allocated to each date must bear the same ratio to the notional principal amount (within the meaning of [§ 1.446-3](/cfr/26/1.446-3.md)) that would have been used to compute the hedge provider's payment, if any, on that date, and the sum of the present values of those amounts must equal the present value of the termination payment. Present value is computed as of the day the qualified hedge is terminated, using the yield on the hedged bonds, determined without regard to the termination payment. The yield used for this purpose is computed for the period beginning on the first date the qualified hedge is in effect and ending on the date the qualified hedge is terminated. On the other hand, for an issue that is a fixed yield issue after termination of a qualified hedge, the termination payment is taken into account as a single payment on the date it is paid.
  - (4) **Certain variable yield bonds treated as fixed yield bonds—**
    - (i) **In general.** Except as otherwise provided in this [paragraph (h)(4)](#h-4), if the issuer of variable yield bonds enters into a qualified hedge, the hedged bonds are treated as fixed yield bonds paying a fixed interest rate if:
      - (A) **Maturity.** The term of the hedge is equal to the entire period during which the hedged bonds bear interest at variable interest rates, and the issuer does not reasonably expect that the hedge will be terminated before the end of that period.
      - (B) **Payments closely correspond.** Payments to be received under the hedge correspond closely in time to the hedged portion of payments on the hedged bonds. Hedge payments received within 15 days of the related payments on the hedged bonds generally so correspond.
      - (C) **Aggregate payments fixed.** Taking into account all payments made and received under the hedge and all payments on the hedged bonds (i.e., after netting all payments), the issuer's aggregate payments are fixed and determinable as of a date not later than 15 days after the issue date of the hedged bonds. Payments on bonds are treated as fixed for purposes of this [paragraph (h)(4)(i)(C)](#h-4-i-C) if payments on the bonds are based, in whole or in part, on one interest rate, payments on the hedge are based, in whole or in part, on a second interest rate that is substantially the same as, but not identical to, the first interest rate and payments on the bonds would be fixed if the two rates were identical. Rates are treated as substantially the same if they are reasonably expected to be substantially the same throughout the term of the hedge. For example, an objective 30-day tax-exempt variable rate index or other objective index may be substantially the same as an issuer's individual 30-day interest rate. A hedge based on a taxable interest rate or taxable interest index cannot meet the requirements of this [paragraph (h)(4)(i)(C)](#h-4-i-C) unless either—

        (1) The hedge is an anticipatory hedge that is terminated or otherwise closed substantially contemporaneously with the issuance of the hedged bond in accordance with paragraph [(h)(5)(ii)](#h-5-ii) or [(iii)](#h-5-iii) of this section; or

        (2) The issuer's payments on the hedged bonds and the hedge provider's payments on the hedge are based on identical interest rates.

    - (ii) **Accounting.** Except as otherwise provided in this [paragraph (h)(4)(ii)](#h-4-ii), in determining yield on the hedged bonds, all the issuer's payments on the hedged bonds and all payments made and received on a hedge described in [paragraph (h)(4)(i)](#h-4-i) of this section are taken into account. If payments on the bonds and payments on the hedge are based, in whole or in part, on variable interest rates that are substantially the same within the meaning of [paragraph (h)(4)(i)(C)](#h-4-i-C) of this section (but not identical), yield on the issue is determined by treating the variable interest rates as identical. For example, if variable rate bonds bearing interest at a weekly rate equal to the rate necessary to remarket the bonds at par are hedged with an interest rate swap under which the issuer receives payments based on a short-term floating rate index that is substantially the same as, but not identical to, the weekly rate on the bonds, the interest payments on the bonds are treated as equal to the payments received by the issuer under the swap for purposes of computing the yield on the bonds.
    - (iii) **Effect of termination—**
      - (A) **In general.** Except as otherwise provided in this [paragraph (h)(4)(iii)](#h-4-iii) and [paragraph (h)(5)](#h-5) of this section, the issue of which the hedged bonds are a part is treated as if it were reissued as of the termination date of the qualified hedge covered by [paragraph (h)(4)(i)](#h-4-i) of this section in determining yield on the hedged bonds for purposes of [§ 1.148-3](/cfr/26/1.148-3.md). The redemption price of the retired issue and the issue price of the new issue equal the aggregate values of all the bonds of the issue on the termination date. In computing the yield on the new issue for this purpose, any termination payment is accounted for under [paragraph (h)(3)(iv)](#h-3-iv) of this section, applied by treating the termination payment as made or received on the new issue under this [paragraph (h)(4)(iii)](#h-4-iii).
      - (B) **Effect of early termination.** Except as otherwise provided in this [paragraph (h)(4)(iii)](#h-4-iii), the general rules of [paragraph (h)(4)(i)](#h-4-i) of this section do not apply in determining the yield on the hedged bonds for purposes of [§ 1.148-3](/cfr/26/1.148-3.md) if the hedge is terminated or deemed terminated within 5 years after the issue date of the issue of which the hedged bonds are a part. Thus, the hedged bonds are treated as variable yield bonds for purposes of [§ 1.148-3](/cfr/26/1.148-3.md) from the issue date.
      - (C) **Certain terminations disregarded.** This [paragraph (h)(4)(iii)](#h-4-iii) does not apply to a termination if, based on the facts and circumstances (e.g., taking into account both the termination and any qualified hedge that immediately replaces the terminated hedge), there is no change in the yield.
    - (iv) **Consequences of certain modifications.** The special rules under [paragraph (h)(4)(iii)](#h-4-iii) of this section regarding the effects of termination of a qualified hedge of fixed yield hedged bonds apply to a modification described in [paragraph (h)(3)(iv)(C)](#h-3-iv-C) of this section. Thus, such a modification is treated as a termination for purposes of [paragraph (h)(4)(iii)](#h-4-iii) of this section unless the rule in [paragraph (h)(4)(iii)(C)](#h-4-iii-C) applies.
  - (5) **Contracts entered into before issue date of hedged bond—**
    - (i) **In general.** A contract does not fail to be a hedge under [paragraph (h)(2)(i)](#h-2-i) of this section solely because it is entered into before the issue date of the hedged bond. However, that contract must be one to which either paragraph [(h)(5)(ii)](#h-5-ii) or [(h)(5)(iii)](#h-5-iii) of this section applies.
    - (ii) **Contracts expected to be closed substantially contemporaneously with the issue date of hedged bond—**
      - (A) **Application.** This [paragraph (h)(5)(ii)](#h-5-ii) applies to a contract if, on the date the contract is identified, the issuer reasonably expects to terminate or otherwise close (terminate) the contract substantially contemporaneously with the issue date of the hedged bond.
      - (B) **Contract terminated.** If a contract to which this [paragraph (h)(5)(ii)](#h-5-ii) applies is terminated substantially contemporaneously with the issue date of the hedged bond, the amount paid or received, or deemed to be paid or received, by the issuer in connection with the issuance of the hedged bond to terminate the contract is treated as an adjustment to the issue price of the hedged bond and as an adjustment to the sale proceeds of the hedged bond for purposes of [section 148](/cfr/26/148.md). Amounts paid or received, or deemed to be paid or received, before the issue date of the hedged bond are treated as paid or received on the issue date in an amount equal to the future value of the payment or receipt on that date. For this purpose, future value is computed using yield on the hedged bond without taking into account amounts paid or received (or deemed paid or received) on the contract.
      - (C) **Contract not terminated.** If a contract to which this [paragraph (h)(5)(ii)](#h-5-ii) applies is not terminated substantially contemporaneously with the issue date of the hedged bond, the contract is deemed terminated for its fair market value as of the issue date of the hedged bond. Once a contract has been deemed terminated pursuant to this [paragraph (h)(5)(ii)(C)](#h-5-ii-C), payments on and receipts from the contract are no longer taken into account under this [paragraph (h)](#h) for purposes of determining yield on the hedged bond.
      - (D) **Relation to other requirements of a qualified hedge.** Payments made in connection with the issuance of a bond to terminate a contract to which this [paragraph (h)(5)(ii)](#h-5-ii) applies do not prevent the contract from satisfying the requirements of [paragraph (h)(2)(vi)](#h-2-vi) of this section.
      - (E) **Fixed yield treatment.** A bond that is hedged with a contract to which this [paragraph (h)(5)(ii)](#h-5-ii) applies does not fail to be a fixed yield bond if, taking into account payments on the contract and the payments to be made on the bond, the bond satisfies the definition of fixed yield bond. See also [paragraph (h)(4)](#h-4) of this section.
    - (iii) **Contracts expected not to be closed substantially contemporaneously with the issue date of hedged bond—**
      - (A) **Application.** This [paragraph (h)(5)(iii)](#h-5-iii) applies to a contract if, on the date the contract is identified, the issuer does not reasonably expect to terminate the contract substantially contemporaneously with the issue date of the hedge bond.
      - (B) **Contract terminated.** If a contract to which this [paragraph (h)(5)(iii)](#h-5-iii) applies is terminated in connection with the issuance of the hedged bond, the amount paid or received, or deemed to be paid or received, by the issuer to terminate the contract is treated as an adjustment to the issue price of the hedged bond and as an adjustment to the sale proceeds of the hedged bond for purposes of [section 148](/cfr/26/148.md).
      - (C) **Contract not terminated.** If a contract to which this [paragraph (h)(5)(iii)](#h-5-iii) applies is not terminated substantially contemporaneously with the issue date of the hedged bond, no payments with respect to the hedge made by the issuer before the issue date of the hedged bond are taken into account under this section.
    - (iv) **Identification.** The identification required under [paragraph (h)(2)(viii)](#h-2-viii) of this section must specify the reasonably expected governmental purpose, issue price, maturity, and issue date of the hedged bond, the manner in which interest is reasonably expected to be computed, and whether paragraph [(h)(5)(ii)](#h-5-ii) or [(h)(5)(iii)](#h-5-iii) of this section applies to the contract. If an issuer identifies a contract under this [paragraph (h)(5)(iv)](#h-5-iv) that would be a qualified hedge with respect to the anticipated bond, but does not issue the anticipated bond on the identified issue date, the contract is taken into account as a qualified hedge of any bond of the issuer that is issued for the identified governmental purpose within a reasonable interval around the identified issue date of the anticipated bond.
  - (6) **Authority of the Commissioner.** The Commissioner, by publication of a revenue ruling or revenue procedure (see [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter), may specify contracts that, although they do not meet the requirements of [paragraph (h)(2)](#h-2) of this section, are qualified hedges or, although they do not meet the requirements of [paragraph (h)(4)](#h-4) of this section, cause the hedged bonds to be treated as fixed yield bonds.

# §1.148-5. Yield and valuation of investments.

- (a) **In general.** This section provides rules for computing the yield and value of investments allocated to an issue for various purposes under [section 148](/cfr/26/148.md).
- (b) **Yield on an investment—**
  - (1) **In general.** Except as otherwise provided, the yield on an investment allocated to an issue is computed under the economic accrual method, using the same compounding interval and financial conventions used to compute the yield on the issue. The yield on an investment allocated to an issue is the discount rate that, when used in computing the present value as of the date the investment is first allocated to the issue of all unconditionally payable receipts from the investment, produces an amount equal to the present value of all unconditionally payable payments for the investment. For this purpose, payments means amounts to be actually or constructively paid to acquire the investment, and receipts means amounts to be actually or constructively received from the investment, such as earnings and return of principal. The yield on a variable rate investment is determined in a manner comparable to the determination of the yield on a variable rate issue. For an issue of qualified mortgage bonds, qualified veterans' mortgage bonds, or qualified student loan bonds on which interest is paid semiannually, all regular monthly loan payments to be received during a semiannual debt service period may be treated as received at the end of that period. In addition, for any conduit financing issue, payments made by the conduit borrower are not treated as paid until the conduit borrower ceases to receive the benefit of earnings on those amounts.
  - (2) **Yield on a separate class of investments—**
    - (i) **In general.** For purposes of the yield restriction rules of [section 148(a)](/cfr/26/148.md?p=a) and [§ 1.148-2](/cfr/26/1.148-2.md), yield is computed separately for each class of investments. For this purpose, in determining the yield on a separate class of investments, the yield on each individual investment within the class is blended with the yield on other individual investments within the class, whether or not held concurrently, by treating those investments as a single investment. The yields on investments that are not within the same class are not blended.
    - (ii) **Separate classes of investments.** Each of the following is a separate class of investments—
      - (A) Each category of yield restricted purpose investment and program investment that is subject to a different definition of materially higher under [§ 1.148-2(d)(2)](/cfr/26/1.148-2.md?p=d-2);
      - (B) Yield-restricted nonpurpose investments; and
      - (C) All other nonpurpose investments;
    - (iii) **Permissive application of single investment rules to certain yield restricted investments for all purposes of section 148.** For all purposes of [section 148](/cfr/26/148.md), if an issuer reasonably expects as of the issue date to establish and maintain a sinking fund solely to reduce the yield on the investments in a refunding escrow, then the issuer may treat all of the yield restricted nonpurpose investments in the refunding escrow and that sinking fund as a single investment having a single yield, determined under this [paragraph (b)(2)](#b-2). Thus, an issuer may not treat the nonpurpose investments in a reasonably required reserve fund and a refunding escrow as a single investment having a single yield under this [paragraph (b)(2)(iii)](#b-2-iii).
    - (iv) **Mandatory application of single investment rules for refunding escrows for all purposes of section 148.** For all purposes of [section 148](/cfr/26/148.md), in computing the yield on yield restricted investments allocable to proceeds (i.e., sale proceeds, investment proceeds, and transferred proceeds) of a refunding issue that are held in one or more refunding escrows, the individual investments are treated as a single investment having a single yield, whether or not held concurrently. For example, this single investment includes both the individual investments allocable to sale and investment proceeds of a refunding issue that are held in one refunding escrow for a prior issue and the investments allocable to transferred proceeds of that refunding issue that are held in another refunding escrow.
  - (3) **Investments to be held beyond issue's maturity or beyond temporary period.** In computing the yield on investments allocable to an issue that are to be held beyond the reasonably expected redemption date of the issue, those investments are treated as sold for an amount equal to their value on that date. In computing the yield on investments that are held beyond an applicable temporary period under [§ 1.148-2](/cfr/26/1.148-2.md), for purposes of [§ 1.148-2](/cfr/26/1.148-2.md) those investments may be treated as purchased for an amount equal to their fair market value as of the end of the temporary period.
  - (4) **Consistent redemption assumptions on purpose investments.** The yield on purpose investments allocable to an issue is computed using the same redemption assumptions used to compute the yield on the issue. Yield on purpose investments allocable to an issue of qualified mortgage bonds and qualified veterans' mortgage bonds must be determined in a manner that is consistent with, and using the assumptions required by, [section 143(g)(2)(B)](/cfr/26/143.md?p=g-2-B).
  - (5) **Student loan special allowance payments included in yield.** Except as provided in [§ 1.148-11(e)](/cfr/26/1.148-11.md?p=e), the yield on qualified student loans is computed by including as receipts any special allowance payments made by the Secretary of Education pursuant to section 438 of the Higher Education Act of 1965.
- (c) **Yield reduction payments to the United States—**
  - (1) **In general.** In determining the yield on an investment to which this [paragraph (c)](#c) applies, any amount paid to the United States in accordance with this [paragraph (c)](#c), including a rebate amount, is treated as a payment for that investment that reduces the yield on that investment.
  - (2) **Manner of payment—**
    - (i) **In general.** Except as otherwise provided in [paragraph (c)(2)(ii)](#c-2-ii) of this section, an amount is paid under this [paragraph (c)](#c) if it is paid to the United States at the same time and in the same manner as rebate amounts are required to be paid or at such other time or in such manner as the Commissioner may prescribe. For example, yield reduction payments must be made on or before the date of required rebate installment payments as described in §§ [1.148-3(f)](/cfr/26/1.148-3.md?p=f), [(g)](/cfr/26/1.148-3.md?p=g), and [(h)](/cfr/26/1.148-3.md?p=h). The provisions of [§ 1.148-3(i)](/cfr/26/1.148-3.md?p=i) apply to payments made under this [paragraph (c)](#c).
    - (ii) **Special rule for purpose investments.** For purpose investments allocable to an issue—
      - (A) No amounts are required to be paid to satisfy this [paragraph (c)](#c) until the earlier of the end of the tenth bond year after the issue date of the issue or 60 days after the date on which the issue is no longer outstanding; and
      - (B) For payments made prior to the date on which the issue is retired, the issuer need not pay more than 75 percent of the amount otherwise required to be paid as of the date to which the payment relates.
  - (3) **Applicability of special yield reduction rule.** [Paragraph (c)](#c) applies only to investments that are described in at least one of [paragraphs (c)(3)(i) through (ix)](#c-3-i..c-3-ix) of this section and, except as otherwise expressly provided in [paragraphs (c)(3)(i) through (ix)](#c-3-i..c-3-ix) of this section, that are allocated to proceeds of an issue other than gross proceeds of an advance refunding issue.
    - (i) **Nonpurpose investments allocated to proceeds of an issue that qualified for certain temporary periods.** Nonpurpose investments allocable to proceeds of an issue that qualified for one of the temporary periods available for capital projects, working capital expenditures, pooled financings, or investment proceeds under § [1.148-2(e)(2)](/cfr/26/1.148-2.md?p=e-2), [(3)](/cfr/26/1.148-2.md?p=e-3), [(4)](/cfr/26/1.148-2.md?p=e-4), or [(6)](/cfr/26/1.148-2.md?p=e-6), respectively.
    - (ii) **Investments allocable to certain variable yield issues.** Investments allocable to a variable yield issue during any computation period in which at least 5 percent of the value of the issue is represented by variable yield bonds, unless the issue is an issue of hedge bonds (as defined in [section 149(g)(3)(A)](/cfr/26/149.md?p=g-3-A)).
    - (iii) **Nonpurpose investments allocable to certain transferred proceeds.** Nonpurpose investments allocable to transferred proceeds of—
      - (A) A current refunding issue to the extent necessary to reduce the yield on those investments to satisfy yield restrictions under [section 148(a)](/cfr/26/148.md?p=a); or
      - (B) An advance refunding issue to the extent that investment of the refunding escrows allocable to the proceeds, other than transferred proceeds, of the refunding issue in zero-yielding nonpurpose investments is insufficient to satisfy yield restrictions under [section 148(a)](/cfr/26/148.md?p=a).
    - (iv) **Purpose investments allocable to qualified student loans and qualified mortgage loans.** Purpose investments allocable to qualified student loans and qualified mortgage loans.
    - (v) **Nonpurpose investments allocable to gross proceeds in certain reserve funds.** Nonpurpose investments allocable to gross proceeds of an issue in a reasonably required reserve or replacement fund or a fund that, except for its failure to satisfy the size limitation in [§ 1.148-2(f)(2)(ii)](/cfr/26/1.148-2.md?p=f-2-ii), would qualify as a reasonably required reserve or replacement fund, but only to the extent the requirements in paragraphs [(c)(3)(v)(A)](#c-3-v-A) or [(B)](#c-3-v-B) of this section are met. This [paragraph (c)(3)(v)](#c-3-v) includes nonpurpose investments described in this paragraph that are allocable to transferred proceeds of an advance refunding issue, but only to the extent necessary to satisfy yield restriction under [section 148(a)](/cfr/26/148.md?p=a) on those proceeds treating all investments allocable to those proceeds as a separate class.
      - (A) The value of the nonpurpose investments in the fund is not greater than 15 percent of the stated principal amount of the issue, as computed under [§ 1.148-2(f)(2)(ii)](/cfr/26/1.148-2.md?p=f-2-ii).
      - (B) The amounts in the fund (other than investment earnings) are not reasonably expected to be used to pay debt service on the issue other than in connection with reductions in the amount required to be in that fund (for example, a reserve fund for a revolving fund loan program).
    - (vi) **Nonpurpose investments allocable to certain replacement proceeds of refunded issues.** Nonpurpose investments allocated to replacement proceeds of a refunded issue, including a refunded issue that is an advance refunding issue, as a result of the application of the universal cap to amounts in a refunding escrow.
    - (vii) **Investments allocable to replacement proceeds under a certain transition rule.** Investments described in [§ 1.148-11(f)](/cfr/26/1.148-11.md?p=f).
    - (viii) **Nonpurpose investments allocable to proceeds when State and Local Government Series Securities are unavailable.** Nonpurpose investments allocable to proceeds of an issue, including an advance refunding issue, that an issuer purchases if, on the date the issuer enters into the agreement to purchase such investments, the issuer is unable to subscribe for State and Local Government Series Securities because the U.S. Department of the Treasury, Bureau of the Fiscal Service, has suspended sales of those securities.
    - (ix) **Nonpurpose investments allocable to proceeds of certain variable yield advance refunding issues.** Nonpurpose investments allocable to proceeds of the portion of a variable yield issue used for advance refunding purposes that are deposited in a yield restricted defeasance escrow if—
      - (A) The issuer has entered into a qualified hedge under [§ 1.148-4(h)(2)](/cfr/26/1.148-4.md?p=h-2) with respect to all of the variable yield bonds of the issue allocable to the yield restricted defeasance escrow and that hedge is in the form of a variable-to-fixed interest rate swap under which the issuer pays the hedge provider a fixed interest rate and receives from the hedge provider a floating interest rate;
      - (B) Such qualified hedge covers a period beginning on the issue date of the hedged bonds and ending on or after the date on which the final payment is to be made from the yield restricted defeasance escrow; and
      - (C) The issuer restricts the yield on the yield restricted defeasance escrow to a yield that is not greater than the yield on the issue, determined by taking into account the issuer's fixed payments to be made under the hedge and by assuming that the issuer's variable yield payments to be paid on the hedged bonds are equal to the floating payments to be received by the issuer under the qualified hedge and are paid on the same dates (that is, such yield reduction payments can only be made to address basis risk differences between the variable yield payments on the hedged bonds and the floating payments received on the hedge).
- (d) **Value of investments—**
  - (1) **In general.** Except as otherwise provided, the value of an investment (including a payment or receipt on the investment) on a date must be determined using one of the following valuation methods consistently for all purposes of [section 148](/cfr/26/148.md) to that investment on that date:
    - (i) **Plain par investment—outstanding principal amount.** A plain par investment may be valued at its outstanding stated principal amount, plus any accrued unpaid interest on that date.
    - (ii) **Fixed rate investment—present value.** A fixed rate investment may be valued at its present value on that date.
    - (iii) **Any investment—fair market value.** An investment may be valued at its fair market value on that date.
  - (2) **Mandatory valuation of certain yield restricted investments at present value.** A purpose investment must be valued at present value, and except as otherwise provided in paragraphs [(b)(3)](#b-3) and [(d)(3)](#d-3) of this section, a yield restricted nonpurpose investment must be valued at present value.
  - (3) **Mandatory valuation of certain investments at fair market value—**
    - (i) **In general.** Except as otherwise provided in paragraphs [(d)(3)(ii)](#d-3-ii) and (d)(4) of this section, a nonpurpose investment must be valued at fair market value on the date that it is first allocated to an issue or first ceases to be allocated to an issue as a consequence of a deemed acquisition or deemed disposition. For example, if an issuer deposits existing nonpurpose investments into a sinking fund for an issue, those investments must be valued at fair market value as of the date first deposited into the fund.
    - (ii) **Exception to fair market value requirement for transferred proceeds allocations, certain universal cap allocations, and commingled funds.** [Paragraph (d)(3)(i)](#d-3-i) of this section does not apply if the investment is allocated from one issue to another as a result of the transferred proceeds allocation rule under [§ 1.148-9(b)](/cfr/26/1.148-9.md?p=b) or is deallocated from one issue as a result of the universal cap rule under [§ 1.148-6(b)(2)](/cfr/26/1.148-6.md?p=b-2) and reallocated to another issue as a result of a preexisting pledge of the investment to secure that other issue, provided that, in either circumstance (that is, transferred proceeds allocations or universal cap deallocations), the issue from which the investment is allocated (that is, the first issue in an allocation from one issue to another issue) consists of tax-exempt bonds. In addition, [paragraph (d)(3)(i)](#d-3-i) of this section does not apply to investments in a commingled fund (other than a bona fide debt service fund) unless it is an investment being initially deposited in or withdrawn from a commingled fund described in [§ 1.148-6(e)(5)(iii)](/cfr/26/1.148-6.md?p=e-5-iii).
  - (4) **Special transition rule for transferred proceeds.** The value of a nonpurpose investment that is allocated to transferred proceeds of a refunding issue on a transfer date may not exceed the value of that investment on the transfer date used for purposes of applying the arbitrage restrictions to the refunded issue.
  - (5) **Definition of present value of an investment.** Except as otherwise provided, present value of an investment is computed under the economic accrual method, using the same compounding interval and financial conventions used to compute the yield on the issue. The present value of an investment on a date is equal to the present value of all unconditionally payable receipts to be received from and payments to be paid for the investment after that date, using the yield on the investment as the discount rate.
  - (6) **Definition of fair market value—**
    - (i) **In general.** The fair market value of an investment is the price at which a willing buyer would purchase the investment from a willing seller in a bona fide, arm's-length transaction. Fair market value generally is determined on the date on which a contract to purchase or sell the nonpurpose investment becomes binding (i.e., the trade date rather than the settlement date). Except as otherwise provided in this [paragraph (d)(6)](#d-6), an investment that is not of a type traded on an established securities market, within the meaning of [section 1273](/cfr/26/1273.md), is rebuttably presumed to be acquired or disposed of for a price that is not equal to its fair market value. On the purchase date, the fair market value of a United States Treasury obligation that is purchased directly from the United States Treasury, including a State and Local Government Series Security, is its purchase price. The fair market value of a State and Local Government Series Security on any date other than the purchase date is the redemption price for redemption on that date.
    - (ii) **Safe harbor for establishing fair market value for certificates of deposit.** This [paragraph (d)(6)(ii)](#d-6-ii) applies to a certificate of deposit that has a fixed interest rate, a fixed payment schedule, and a substantial penalty for early withdrawal. The purchase price of such a certificate of deposit is treated as its fair market value on the purchase date if the yield on the certificate of deposit is not less than—
      - (A) The yield on reasonably comparable direct obligations of the United States; and
      - (B) The highest yield that is published or posted by the provider to be currently available from the provider on reasonably comparable certificates of deposit offered to the public.
    - (iii) **Safe harbor for establishing fair market value for guaranteed investment contracts and investments purchased for a yield restricted defeasance escrow.** The purchase price of a guaranteed investment contract and the purchase price of an investment purchased for a yield restricted defeasance escrow will be treated as the fair market value of the investment on the purchase date if all of the following requirements are satisfied:
      - (A) **The issuer makes a bona fide solicitation for the purchase of the investment.** A bona fide solicitation is a solicitation that satisfies all of the following requirements:

        (1) The bid specifications are in writing and are timely disseminated to potential providers. For purposes of this paragraph (d)(6)(iii)(A)(1), a writing may be in electronic form and may be disseminated by fax, email, an internet-based Web site, or other electronic medium that is similar to an internet-based Web site and regularly used to post bid specifications.

        (2) The bid specifications include all material terms of the bid. A term is material if it may directly or indirectly affect the yield or the cost of the investment.

        (3) The bid specifications include a statement notifying potential providers that submission of a bid is a representation that the potential provider did not consult with any other potential provider about its bid, that the bid was determined without regard to any other formal or informal agreement that the potential provider has with the issuer or any other person (whether or not in connection with the bond issue), and that the bid is not being submitted solely as a courtesy to the issuer or any other person for purposes of satisfying the requirements of paragraph (d)(6)(iii)(B)(1) or (2) of this section.

        (4) The terms of the bid specifications are commercially reasonable. A term is commercially reasonable if there is a legitimate business purpose for the term other than to increase the purchase price or reduce the yield of the investment. For example, for solicitations of investments for a yield restricted defeasance escrow, the hold firm period must be no longer than the issuer reasonably requires.

        (5) For purchases of guaranteed investment contracts only, the terms of the solicitation take into account the issuer's reasonably expected deposit and drawdown schedule for the amounts to be invested.

        (6) All potential providers have an equal opportunity to bid. If the bidding process affords any opportunity for a potential provider to review other bids before providing a bid, then providers have an equal opportunity to bid only if all potential providers have an equal opportunity to review other bids. Thus, no potential provider may be given an opportunity to review other bids that is not equally given to all potential providers (that is, no exclusive “last look”).

        (7) At least three reasonably competitive providers are solicited for bids. A reasonably competitive provider is a provider that has an established industry reputation as a competitive provider of the type of investments being purchased.

      - (B) **The bids received by the issuer meet all of the following requirements—** (1) The issuer receives at least three bids from providers that the issuer solicited under a bona fide solicitation meeting the requirements of [paragraph (d)(6)(iii)(A)](#d-6-iii-A) of this section and that do not have a material financial interest in the issue. A lead underwriter in a negotiated underwriting transaction is deemed to have a material financial interest in the issue until 15 days after the issue date of the issue. In addition, any entity acting as a financial advisor with respect to the purchase of the investment at the time the bid specifications are forwarded to potential providers has a material financial interest in the issue. A provider that is a related party to a provider that has a material financial interest in the issue is deemed to have a material financial interest in the issue.

        (2) At least one of the three bids described in paragraph (d)(6)(iii)(B)(1) of this section is from a reasonably competitive provider, within the meaning of paragraph (d)(6)(iii)(A)(7) of this section.

        (3) If the issuer uses an agent to conduct the bidding process, the agent did not bid to provide the investment.

      - (C) **The winning bid meets the following requirements—** (1) Guaranteed investment contracts. If the investment is a guaranteed investment contract, the winning bid is the highest yielding bona fide bid (determined net of any broker's fees).

        (2) Other investments. If the investment is not a guaranteed investment contract, the following requirements are met:

        (i) The winning bid is the lowest cost bona fide bid (including any broker's fees). The lowest cost bid is either the lowest cost bid for the portfolio or, if the issuer compares the bids on an investment-by-investment basis, the aggregate cost of a portfolio comprised of the lowest cost bid for each investment. Any payment received by the issuer from a provider at the time a guaranteed investment contract is purchased (e.g., an escrow float contract) for a yield restricted defeasance escrow under a bidding procedure meeting the requirements of this [paragraph (d)(6)(iii)](#d-6-iii) is taken into account in determining the lowest cost bid.

        (ii) The lowest cost bona fide bid (including any broker's fees) is not greater than the cost of the most efficient portfolio comprised exclusively of State and Local Government Series Securities from the United States Department of the Treasury, Bureau of Public Debt. The cost of the most efficient portfolio of State and Local Government Series Securities is to be determined at the time that bids are required to be submitted pursuant to the terms of the bid specifications.

        (iii) If State and Local Government Series Securities from the United States Department of the Treasury, Bureau of Public Debt are not available for purchase on the day that bids are required to be submitted pursuant to terms of the bid specifications because sales of those securities have been suspended, the cost comparison of [paragraph (d)(6)(iii)](#d-6-iii) (C)(2)(ii) of this section is not required.

      - (D) The provider of the investments or the obligor on the guaranteed investment contract certifies the administrative costs that it pays (or expects to pay, if any) to third parties in connection with supplying the investment.
      - (E) The issuer retains the following records with the bond documents until three years after the last outstanding bond is redeemed:

        (1) For purchases of guaranteed investment contracts, a copy of the contract, and for purchases of investments other than guaranteed investment contracts, the purchase agreement or confirmation.

        (2) The receipt or other record of the amount actually paid by the issuer for the investments, including a record of any administrative costs paid by the issuer, and the certification under [paragraph (d)(6)(iii)(D)](#d-6-iii-D) of this section.

        (3) For each bid that is submitted, the name of the person and entity submitting the bid, the time and date of the bid, and the bid results.

        (4) The bid solicitation form and, if the terms of the purchase agreement or the guaranteed investment contract deviated from the bid solicitation form or a submitted bid is modified, a brief statement explaining the deviation and stating the purpose for the deviation. For example, if the issuer purchases a portfolio of investments for a yield restricted defeasance escrow and, in order to satisfy the yield restriction requirements of [section 148](/cfr/26/148.md), an investment in the winning bid is replaced with an investment with a lower yield, the issuer must retain a record of the substitution and how the price of the substitute investment was determined. If the issuer replaces an investment in the winning bid portfolio with another investment, the purchase price of the new investment is not covered by the safe harbor unless the investment is bid under a bidding procedure meeting the requirements of this [paragraph (d)(6)(iii)](#d-6-iii).

        (5) For purchases of investments other than guaranteed investment contracts, the cost of the most efficient portfolio of State and Local Government Series Securities, determined at the time that the bids were required to be submitted pursuant to the terms of the bid specifications.

- (e) **Administrative costs of investments—**
  - (1) **In general.** Except as otherwise provided in this [paragraph (e)](#e), an allocation of gross proceeds of an issue to a payment or a receipt on an investment is not adjusted to take into account any costs or expenses paid, directly or indirectly, to purchase, carry, sell, or retire the investment (administrative costs). Thus, these administrative costs generally do not increase the payments for, or reduce the receipts from, investments.
  - (2) **Qualified administrative costs on nonpurpose investments—**
    - (i) **In general.** In determining payments and receipts on nonpurpose investments, qualified administrative costs are taken into account. Thus, qualified administrative costs increase the payments for, or decrease the receipts from, the investments. Qualified administrative costs are reasonable, direct administrative costs, other than carrying costs, such as separately stated brokerage or selling commissions, but not legal and accounting fees, recordkeeping, custody, and similar costs. General overhead costs and similar indirect costs of the issuer such as employee salaries and office expenses and costs associated with computing the rebate amount under [section 148(f)](/cfr/26/148.md?p=f) are not qualified administrative costs. In general, administrative costs are not reasonable unless they are comparable to administrative costs that would be charged for the same investment or a reasonably comparable investment if acquired with a source of funds other than gross proceeds of tax-exempt bonds.
    - (ii) **Special rule for administrative costs of nonpurpose investments in certain regulated investment companies and commingled funds.** Qualified administrative costs include all reasonable administrative costs, without regard to the limitation on indirect costs under [paragraph (e)(2)(i)](#e-2-i) of this section, incurred by:
      - (A) **Regulated investment companies.** A publicly offered regulated investment company (as defined in [section 67(c)(2)(B)](/cfr/26/67.md?p=c-2-B)); and
      - (B) **External commingled funds.** A widely held commingled fund in which no investor in the fund owns more than 10 percent of the beneficial interest in the fund. For purposes of this [paragraph (e)(2)(ii)(B)](#e-2-ii-B), a fund is treated as widely held only if, during the immediately preceding fixed, semiannual period chosen by the fund (for example, semiannual periods ending June 30 and December 31), the fund had a daily average of more than 15 investors that were not related parties, and at least 16 of the unrelated investors each maintained a daily average amount invested in the fund that was not less than the lesser of $500,000 and one percent (1%) of the daily average of the total amount invested in the fund (with it being understood that additional smaller investors will not disqualify the fund). For purposes of this [paragraph (e)(2)(ii)(B)](#e-2-ii-B), an investor will be treated as owning not more than 10 percent of the beneficial interest in the fund if, on the date of each deposit by the investor into the fund, the total amount the investor and any related parties have on deposit in the fund is not more than 10 percent of the total amount that all investors have on deposit in the fund. For purposes of the preceding sentence, the total amount that all investors have on deposit in the fund is equal to the sum of all deposits made by the investor and any related parties on the date of those deposits and the closing balance in the fund on the day before those deposits. If any investor in the fund owns more than 10 percent of the beneficial interest in the fund, the fund does not qualify under this [paragraph (e)(2)(ii)(B)](#e-2-ii-B) until that investor makes sufficient withdrawals from the fund to reduce its beneficial interest in the fund to 10 percent or less.
    - (iii) **Special rule for guaranteed investment contracts and investments purchased for a yield restricted defeasance escrow—**
      - (A) **In general.** An amount paid for a broker's commission or similar fee with respect to a guaranteed investment contract or investments purchased for a yield restricted defeasance escrow is a qualified administrative cost if the fee is reasonable within the meaning of [paragraph (e)(2)(i)](#e-2-i) of this section.
      - (B) **Safe harbor—** (1) In general. A broker's commission or similar fee with respect to the acquisition of a guaranteed investment contract or investments purchased for a yield restricted defeasance escrow is reasonable within the meaning of [paragraph (e)(2)(i)](#e-2-i) of this section to the extent that—

        (i) The amount of the fee that the issuer treats as a qualified administrative cost does not exceed the lesser of:

        (A) $30,000 and

        (B) 0.2% of the computational base or, if more, $3,000; and

        (ii) For any issue, the issuer does not treat as qualified administrative costs more than $85,000 in brokers' commissions or similar fees with respect to all guaranteed investment contracts and investments for yield restricted defeasance escrows purchased with gross proceeds of the issue.

        (2) Computational base. For purposes of paragraph (e)(2)(iii)(B)(1) of this section, computational base shall mean—

        (i) For a guaranteed investment contract, the amount of gross proceeds the issuer reasonably expects, as of the date the contract is acquired, to be deposited in the guaranteed investment contract over the term of the contract, and

        (ii) For investments (other than guaranteed investment contracts) to be deposited in a yield restricted defeasance escrow, the amount of gross proceeds initially invested in those investments.

        (3) Cost-of-living adjustment. In the case of a calendar year after 2004, each of the dollar amounts in paragraph (e)(2)(iii)(B)(1) of this section shall be increased by an amount equal to—

        (i) Such dollar amount; multiplied by

        (ii) The cost-of-living adjustment determined under [section 1(f)(3)](/cfr/26/1.md?p=f-3) for such calendar year by using the language “calendar year 2003” instead of “calendar year 1992” in [section 1(f)(3)(B)](/cfr/26/1.md?p=f-3-B).

        (4) Rounding. If any increase determined under paragraph (e)(2)(iii)(B)(3) of this section is not a multiple of $1,000, such increase shall be rounded to the nearest multiple thereof.

        (5) Applicable year for cost-of-living adjustment. The cost-of-living adjustments under paragraph (e)(2)(iii)(B)(3) of this section shall apply to the safe harbor amounts under paragraph (e)(2)(iii)(B)(1) of this section based on the year the guaranteed investment contract or the investments for the yield restricted defeasance escrow, as applicable, are acquired.

        (6) Cost-of-living adjustment to determine remaining amount of per-issue safe harbor—(i) In general. This paragraph (e)(2)(iii)(B)(6) applies to determine the portion of the safe harbor amount under paragraph (e)(2)(iii)(B)(1)(ii) of this section, as modified by paragraph (e)(2)(iii)(B)(3) of this section (the per-issue safe harbor), that is available (the remaining amount) for any year (the determination year) if the per-issue safe harbor was partially used in one or more prior years.

        (ii) Remaining amount of per-issue safe harbor. The remaining amount of the per-issue safe harbor for any determination year is equal to the per-issue safe harbor for that year, reduced by the portion of the per-issue safe harbor used in one or more prior years.

        (iii) Portion of per-issue safe harbor used in prior years. The portion of the per-issue safe harbor used in any prior year (the prior year) is equal to the total amount of broker's commissions or similar fees paid in connection with guaranteed investment contracts or investments for a yield restricted defeasance escrow acquired in the prior year that the issuer treated as qualified administrative costs for the issue, multiplied by a fraction the numerator of which is the per-issue safe harbor for the determination year and the denominator of which is the per-issue safe harbor for the prior year. See [paragraph (e)(2)(iii)(C)](#e-2-iii-C) Example 2 of this section.

      - (C) **Examples.** The following examples illustrate the application of the safe harbor in [paragraph (e)(2)(iii)(B)](#e-2-iii-B) of this section:
  - (3) **Qualified administrative costs on purpose investments—**
    - (i) **In general.** In determining payments and receipts on purpose investments, qualified administrative costs described in this [paragraph (e)(3)](#e-3) paid by the conduit borrower are taken into account. Thus, these costs increase the payments for, or decrease the receipts from, the purpose investments. This rule applies even if those payments merely reimburse the issuer. Although the actual payments by the conduit borrower may be made at any time, for this purpose, a pro rata portion of each payment made by a conduit borrower is treated as a reimbursement of reasonable administrative costs, if the present value of those payments does not exceed the present value of the reasonable administrative costs paid by the issuer, using the yield on the issue as the discount rate.
    - (ii) **Definition of qualified administrative costs of purpose investments—**
      - (A) **In general.** Except as otherwise provided in this [paragraph (e)(3)(ii)](#e-3-ii), qualified administrative costs of a purpose investment means—

        (1) Costs or expenses paid, directly or indirectly, to purchase, carry, sell, or retire the investment; and

        (2) Costs of issuing, carrying, or repaying the issue, and any underwriters' discount.

      - (B) **Limitation on program investments.** For a program investment, qualified administrative costs include only those costs described in paragraph (e)(3)(ii)(A)(2) of this section.

# §1.148-6. General allocation and accounting rules.

- (a) **In general—**
  - (1) **Reasonable accounting methods required.** An issuer may use any reasonable, consistently applied accounting method to account for gross proceeds, investments, and expenditures of an issue.
  - (2) **Bona fide deviations from accounting method.** An accounting method does not fail to be reasonable and consistently applied solely because a different accounting method is used for a bona fide governmental purpose to consistently account for a particular item. Bona fide governmental purposes may include special State law restrictions imposed on specific funds or actions to avoid grant forfeitures.
  - (3) **Absence of allocation and accounting methods.** If an issuer fails to maintain books and records sufficient to establish the accounting method for an issue and the allocation of the proceeds of that issue, the rules of this section are applied using the specific tracing method. This [paragraph (a)(3)](#a-3) applies to bonds issued on or after May 16, 1997.
- (b) **Allocation of gross proceeds to an issue—**
  - (1) **One-issue rule and general ordering rules.** Except as otherwise provided, amounts are allocable to only one issue at a time as gross proceeds, and if amounts simultaneously are proceeds of one issue and replacement proceeds of another issue, those amounts are allocable to the issue of which they are proceeds. Amounts cease to be allocated to an issue as proceeds only when those amounts are allocated to an expenditure for a governmental purpose, are allocated to transferred proceeds of another issue, or cease to be allocated to that issue at retirement of the issue or under the universal cap of [paragraph (b)(2)](#b-2) of this section. Amounts cease to be allocated to an issue as replacement proceeds only when those amounts are allocated to an expenditure for a governmental purpose, are no longer used in a manner that causes those amounts to be replacement proceeds of that issue, or cease to be allocated to that issue because of the retirement of the issue or the application of the universal cap under [paragraph (b)(2)](#b-2) of this section. Amounts that cease to be allocated to an issue as gross proceeds are eligible for allocation to another issue. Under [§ 1.148-10(a)](/cfr/26/1.148-10.md?p=a), however, the rules in this [paragraph (b)(1)](#b-1) do not apply in certain cases involving abusive arbitrage devices.
  - (2) **Universal cap on value of nonpurpose investments allocated to an issue—**
    - (i) **Application.** The rules in this [paragraph (b)(2)](#b-2) provide an overall limitation on the amount of gross proceeds allocable to an issue. Although the universal cap generally may be applied at any time in the manner described in this [paragraph (b)(2)](#b-2), it need not be applied on any otherwise required date of application if its application on that date would not result in a reduction or reallocation of gross proceeds of an issue. For this purpose, if an issuer reasonably expects as of the issue date that the universal cap will not reduce the amount of gross proceeds allocable to the issue during the term of the issue, the universal cap need not be applied on any date on which an issue actually has all of the following characteristics—
      - (A) No replacement proceeds are allocable to the issue, other than replacement proceeds in a bona fide debt service fund or a reasonably required reserve or replacement fund;
      - (B) **The net sale proceeds of the issue—** (1) Qualified for one of the temporary periods available for capital projects, restricted working capital expenditures, or pooled financings under § [1.148-2 (e)(2)](/cfr/26/1.148-2.md?p=e-2), [(e)(3)](/cfr/26/1.148-2.md?p=e-3), or [(e)(4)](/cfr/26/1.148-2.md?p=e-4), and those net sales proceeds were in fact allocated to expenditures prior to the expiration of the longest applicable temporary period; or

        (2) were deposited in a refunding escrow and expended as originally expected;

      - (C) The issue does not refund a prior issue that, on any transfer date, has unspent proceeds allocable to it;
      - (D) None of the bonds are retired prior to the date on which those bonds are treated as retired in computing the yield on the issue; and
      - (E) **No proceeds of the issue are invested in qualified student loans or qualified mortgage loans.**
    - (ii) **General rule.** Except as otherwise provided below, amounts that would otherwise be gross proceeds allocable to an issue are allocated (and remain allocated) to the issue only to the extent that the value of the nonpurpose investments allocable to those gross proceeds does not exceed the value of all outstanding bonds of the issue. For this purpose, gross proceeds allocable to cash, tax-exempt bonds that would be nonpurpose investments (absent [section 148(b)(3)(A)](/cfr/26/148.md?p=b-3-A)), qualified student loans, and qualified mortgage loans are treated as nonpurpose investments. The values of bonds and investments are determined under [§ 1.148-4(e)](/cfr/26/1.148-4.md?p=e) and [§ 1.148-5(d)](/cfr/26/1.148-5.md?p=d), respectively. The value of all outstanding bonds of the issue is referred to as the universal cap. Thus, for example, the universal cap for an issue of plain par bonds is equal to the outstanding stated principal amount of those bonds plus accrued interest.
    - (iii) **Determination and application of the universal cap.** Except as otherwise provided, beginning with the first bond year that commences after the second anniversary of the issue date, the amount of the universal cap and the value of the nonpurpose investments must be determined as of the first day of each bond year. For refunding and refunded issues, the cap and values must be determined as of each date that, but for this [paragraph (b)(2)](#b-2), proceeds of the refunded issue would become transferred proceeds of the refunding issue, and need not otherwise be determined in the bond year in which that date occurs. All values are determined as of the close of business on each determination date, after giving effect to all payments on bonds and payments for and receipts on investments on that date.
    - (iv) **General ordering rule for allocations of amounts in excess of the universal cap—**
      - (A) **In general.** If the value of all nonpurpose investments allocated to the gross proceeds of an issue exceeds the universal cap for that issue on a date as of which the cap is determined under [paragraph (b)(2)(iii)](#b-2-iii) of this section, nonpurpose investments allocable to gross proceeds necessary to eliminate that excess cease to be allocated to the issue, in the following order of priority—

        (1) First, nonpurpose investments allocable to replacement proceeds;

        (2) Second, nonpurpose investments allocable to transferred proceeds; and

        (3) Third, nonpurpose investments allocable to sale proceeds and investment proceeds.

      - (B) **Re-allocation of certain amounts.** Except as provided in [§ 1.148-9(b)(3)](/cfr/26/1.148-9.md?p=b-3), amounts that cease to be allocated to an issue as a result of the application of the universal cap may only be allocated to another issue as replacement proceeds.
      - (C) **Allocations of portions of investments.** Portions of investments to which this [paragraph (b)(2)(iv)](#b-2-iv) applies are allocated under either the ratable method or the representative method in the same manner as allocations of portions of investments to transferred proceeds under [§ 1.148-9(c)](/cfr/26/1.148-9.md?p=c).
    - (v) **Nonpurpose investments in a bona fide debt service fund not counted.** For purposes of this [paragraph (b)(2)](#b-2), nonpurpose investments allocated to gross proceeds in a bona fide debt service fund for an issue are not taken into account in determining the value of the nonpurpose investments, and those nonpurpose investments remain allocated to the issue.
- (c) **Fair market value limit on allocations to nonpurpose investments.** Upon a purchase or sale of a nonpurpose investment, gross proceeds of an issue are not allocated to a payment for that nonpurpose investment in an amount greater than, or to a receipt from that nonpurpose investment in an amount less than, the fair market value of the nonpurpose investment as of the purchase or sale date. For purposes of this [paragraph (c)](#c) only, the fair market value of a nonpurpose investment is adjusted to take into account qualified administrative costs allocable to the investment.
- (d) **Allocation of gross proceeds to expenditures—**
  - (1) **Expenditures in general—**
    - (i) **General rule.** Reasonable accounting methods for allocating funds from different sources to expenditures for the same governmental purpose include any of the following methods if consistently applied: a specific tracing method; a gross proceeds spent first method; a first-in, first-out method; or a ratable allocation method.
    - (ii) **General limitation.** An allocation of gross proceeds of an issue to an expenditure must involve a current outlay of cash for a governmental purpose of the issue. A current outlay of cash means an outlay reasonably expected to occur not later than 5 banking days after the date as of which the allocation of gross proceeds to the expenditure is made.
    - (iii) **Timing.** An issuer must account for the allocation of proceeds to expenditures not later than 18 months after the later of the date the expenditure is paid or the date the project, if any, that is financed by the issue is placed in service. This allocation must be made in any event by the date 60 days after the fifth anniversary of the issue date or the date 60 days after the retirement of the issue, if earlier. This [paragraph (d)(1)(iii)](#d-1-iii) applies to bonds issued on or after May 16, 1997.
  - (2) **Treatment of gross proceeds invested in purpose investments—**
    - (i) **In general.** Gross proceeds of an issue invested in a purpose investment are allocated to an expenditure on the date on which the conduit borrower under the purpose investment allocates the gross proceeds to an expenditure in accordance with this [paragraph (d)](#d).
    - (ii) **Exception for qualified mortgage loans and qualified student loans.** If gross proceeds of an issue are allocated to a purpose investment that is a qualified mortgage loan or a qualified student loan, those gross proceeds are allocated to an expenditure for the governmental purpose of the issue on the date on which the issuer allocates gross proceeds to that purpose investment.
    - (iii) **Continuing allocation of gross proceeds to purpose investments.** Regardless of whether gross proceeds of a conduit financing issue invested in a purpose investment have been allocated to an expenditure under [paragraph (d)(2)](#d-2) (i) or (ii) of this section, with respect to the actual issuer those gross proceeds continue to be allocated to the purpose investment until the sale, discharge, or other disposition of the purpose investment.
  - (3) **Expenditures for working capital purposes—**
    - (i) **In general.** Except as otherwise provided in this [paragraph (d)(3)](#d-3) or [paragraph (d)(4)](#d-4) of this section, proceeds of an issue may only be allocated to working capital expenditures as of any date to the extent that those working capital expenditures exceed available amounts (as defined in [paragraph (d)(3)(iii)](#d-3-iii) of this section) as of that date (i.e., a “proceeds-spent-last” method). For this purpose, proceeds include replacement proceeds described in [§ 1.148-1(c)(4)](/cfr/26/1.148-1.md?p=c-4).
    - (ii) **Exceptions—**
      - (A) **General de minimis exception.** [Paragraph (d)(3)(i)](#d-3-i) of this section does not apply to expenditures to pay—

        (1) Any issuance costs of the issue or any qualified administrative costs within the meaning of [§§ 1.148-5(e)(2)](/cfr/26/1.148-5.md?p=e-2) (i) or (ii), or [§ 1.148-5(e)(3)(ii)(A)](/cfr/26/1.148-5.md?p=e-3-ii-A);

        (2) Fees for qualified guarantees of the issue or payments for a qualified hedge for the issue;

        (3) Interest on the issue for a period commencing on the issue date and ending on the date that is the later of three years from the issue date or one year after the date on which the project is placed in service;

        (4) Amounts paid to the United States under §§ [1.148-3](/cfr/26/1.148-3.md), [1.148-5(c)](/cfr/26/1.148-5.md?p=c), or [1.148-7](/cfr/26/1.148-7.md) for the issue;

        (5) Costs, other than those described in [paragraphs (d)(3)(ii)(A)](#d-3-ii-A) (1) through (4) of this section, that do not exceed 5 percent of the sale proceeds of an issue and that are directly related to capital expenditures financed by the issue (e.g., initial operating expenses for a new capital project);

        (6) Principal or interest on an issue paid from unexpected excess sale or investment proceeds; and

        (7) Principal or interest on an issue paid from investment earnings on a reserve or replacement fund that are deposited in a bona fide debt service fund.

      - (B) **Exception for extraordinary items.** [Paragraph (d)(3)(i)](#d-3-i) of this section does not apply to expenditures for extraordinary, nonrecurring items that are not customarily payable from current revenues, such as casualty losses or extraordinary legal judgments in amounts in excess of reasonable insurance coverage. If, however, an issuer or a related party maintains a reserve for such items (e.g., a self-insurance fund) or has set aside other available amounts for such expenses, gross proceeds within that reserve must be allocated to expenditures only after all other available amounts in that reserve are expended.
      - (C) **Exception for payment of principal and interest on prior issues.** [Paragraph (d)(3)(i)](#d-3-i) of this section does not apply to expenditures for payment of principal, interest, or redemption prices on a prior issue and, for a crossover refunding issue, interest on that issue.
      - (D) **No exceptions if replacement proceeds created.** The exceptions provided in this [paragraph (d)(3)(ii)](#d-3-ii) do not apply if the allocation merely substitutes gross proceeds for other amounts that would have been used to make those expenditures in a manner that gives rise to replacement proceeds. For example, if a purported reimbursement allocation of proceeds of a reimbursement bond does not result in an expenditure under [§ 1.150-2](/cfr/26/1.150-2.md), those proceeds may not be allocated to pay interest on an issue that, absent this allocation, would have been paid from the issuer's current revenues.
    - (iii) **Definition of available amount—**
      - (A) **In general.** For purposes of this [paragraph (d)(3)](#d-3), available amount means any amount that is available to an issuer for working capital expenditure purposes of the type financed by an issue. Except as otherwise provided, available amount excludes proceeds of any issue but includes cash, investments, and other amounts held in accounts or otherwise by the issuer or a related party if those amounts may be used by the issuer for working capital expenditures of the type being financed by an issue without legislative or judicial action and without a legislative, judicial, or contractual requirement that those amounts be reimbursed.
      - (B) **Reasonable working capital reserve treated as unavailable.** A reasonable working capital reserve is treated as unavailable. Any working capital reserve is reasonable if it does not exceed 5 percent of the actual working capital expenditures of the issuer in the fiscal year before the year in which the determination of available amounts is made. For this purpose only, in determining the working capital expenditures of an issuer for a prior fiscal year, any expenditures (whether capital or working capital expenditures) that are paid out of current revenues may be treated as working capital expenditures.
      - (C) **Qualified endowment funds treated as unavailable.** For a 501(c)(3) organization, a qualified endowment fund is treated as unavailable. A fund is a qualified endowment fund if—

        (1) The fund is derived from gifts or bequests, or the income thereon, that were neither made nor reasonably expected to be used to pay working capital expenditures;

        (2) Pursuant to reasonable, established practices of the organization, the governing body of the 501(c)(3) organization designates and consistently operates the fund as a permanent endowment fund or quasi-endowment fund restricted as to use; and

        (3) There is an independent verification that the fund is reasonably necessary as part of the organization's permanent capital.

      - (D) **Application to statutory safe harbor for tax and revenue anticipation bonds.** For purposes of [section 148(f)(4)(B)(iii)(II)](/cfr/26/148.md?p=f-4-B-iii-II), available amount has the same meaning as in [paragraph (d)(3)(iii)](#d-3-iii) of this section, except that the otherwise-permitted reasonable working capital reserve is treated as part of the available amount.
  - (4) **Expenditures for grants—**
    - (i) **In general.** Gross proceeds of an issue that are used to make a grant are allocated to an expenditure on the date on which the grant is made.
    - (ii) **Characterization of repayments of grants.** If any amount of a grant financed by gross proceeds of an issue is repaid to the grantor, the repaid amount is treated as unspent proceeds of the issue as of the repayment date unless expended within 60 days of repayment.
  - (5) **Expenditures for reimbursement purposes.** In allocating gross proceeds of issues of reimbursement bonds (as defined in [§ 1.150-2](/cfr/26/1.150-2.md))) to certain expenditures, [§ 1.150-2](/cfr/26/1.150-2.md) applies. In allocating gross proceeds to an expenditure to reimburse a previously paid working capital expenditure, [paragraph (d)(3)](#d-3) of this section applies. Thus, if the expenditure is described in [paragraph (d)(3)(ii)](#d-3-ii) of this section or there are no available amounts on the date a working capital expenditure is made and there are no other available amounts on the date of the reimbursement of that expenditure, gross proceeds are allocated to the working capital expenditure as of the date of the reimbursement.
  - (6) **Expenditures of certain commingled investment proceeds of governmental issues.** This [paragraph (d)(6)](#d-6) applies to any issue of governmental bonds, any issue of private activity bonds issued to finance a facility that is required by [section 142](/cfr/26/142.md) to be owned by a governmental unit, and any portion of an issue that is not treated as consisting of private activity bonds under [section 141(b)(9)](/cfr/26/141.md?p=b-9). Investment proceeds of the issue (other than investment proceeds held in a refunding escrow) are treated as allocated to expenditures for a governmental purpose when the amounts are deposited in a commingled fund with substantial tax or other revenues from governmental operations of the issuer and the amounts are reasonably expected to be spent for governmental purposes within 6 months from the date of the commingling. In establishing these reasonable expectations, an issuer may use any reasonable accounting assumption and is not bound by the proceeds-spent-last assumption generally required for working capital expenditures under [paragraph (d)(3)](#d-3) of this section.
  - (7) **Payments to related parties.** Any payment of gross proceeds of the issue to a related party of the payor is not an expenditure of those gross proceeds.
- (e) **Special rules for commingled funds—**
  - (1) **In general.** An accounting method for gross proceeds of an issue in a commingled fund, other than a bona fide debt service fund, is reasonable only if it satisfies the requirements of [paragraphs (e)(2) through (6)](#e-2..e-6) of this section in addition to the other requirements of this section.
  - (2) **Investments held by a commingled fund—**
    - (i) **Required ratable allocations.** Not less frequently than as of the close of each fiscal period, all payments and receipts (including deemed payments and receipts) on investments held by a commingled fund must be allocated (but not necessarily distributed) among the different investors in the fund. This allocation must be based on a consistently applied, reasonable ratable allocation method.
    - (ii) **Safe harbors for ratable allocation methods.** Reasonable ratable allocation methods include, without limitation, methods that allocate these items in proportion to either—
      - (A) The average daily balances of the amounts in the commingled fund from different investors during a fiscal period (as described in [paragraph (e)(4)](#e-4) of this section); or
      - (B) The average of the beginning and ending balances of the amounts in the commingled fund from different investors for a fiscal period that does not exceed one month.
    - (iii) **Definition of investor.** For purposes of this [paragraph (e)](#e), the term investor means each different source of funds invested in a commingled fund. For example, if a city invests gross proceeds of an issue and tax revenues in a commingled fund, it is treated as two different investors.
  - (3) **Certain expenditures involving a commingled fund.** If a ratable allocation method is used under [paragraph (d)](#d) of this section to allocate expenditures from the commingled fund, the same ratable allocation method must be used to allocate payments and receipts on investments in the commingled fund under [paragraph (e)(2)](#e-2) of this section.
  - (4) **Fiscal periods.** The fiscal year of a commingled fund is the calendar year unless the fund adopts another fiscal year. A commingled fund may use any consistent fiscal period that does not exceed three months (e.g., a daily, weekly, monthly, or quarterly fiscal period).
  - (5) **Unrealized gains and losses on investments of a commingled fund—**
    - (i) **Mark-to-market requirement for internal commingled funds with longer-term investment portfolios.** Except as otherwise provided in this [paragraph (e)](#e), in the case of a commingled fund in which the issuer and any related party own more than 25 percent of the beneficial interests in the fund (an internal commingled fund), the fund must treat all its investments as if sold at fair market value either on the last day of the fiscal year or the last day of each fiscal period. The net gains or losses from these deemed sales of investments must be allocated to all investors of the commingled fund during the period since the last allocation.
    - (ii) **Exception for internal commingled funds with shorter-term investment portfolios.** If the remaining weighted average maturity of all investments held by a commingled fund during a particular fiscal year does not exceed 18 months, and the investments held by the commingled fund during that fiscal year consist exclusively of obligations, the mark-to-market requirement of [paragraph (e)(5)(i)](#e-5-i) of this section does not apply.
    - (iii) **Exception for commingled reserve funds and sinking funds.** The mark-to-market requirement of [paragraph (e)(5)(i)](#e-5-i) of this section does not apply to a commingled fund that operates exclusively as a reserve fund, sinking fund, or replacement fund for two or more issues of the same issuer.
  - (6) **Allocations of commingled funds serving as common reserve funds or sinking funds—**
    - (i) **Permitted ratable allocation methods.** If a commingled fund serves as a common reserve fund, replacement fund, or sinking fund for two or more issues (a commingled reserve), after making reasonable adjustments to account for proceeds allocated under paragraph [(b)(1)](#b-1) or [(b)(2)](#b-2) of this section, investments held by that commingled fund must be allocated ratably among the issues served by the commingled fund in accordance with one of the following methods—
      - (A) The relative values of the bonds of those issues under [§ 1.148-4(e)](/cfr/26/1.148-4.md?p=e);
      - (B) The relative amounts of the remaining maximum annual debt service requirements on the outstanding principal amounts of those issues; or
      - (C) **The relative original stated principal amounts of the outstanding issues.**
    - (ii) **Frequency of allocations.** An issuer must make any allocations required by this [paragraph (e)(6)](#e-6) as of a date at least every 3 years and as of each date that an issue first becomes secured by the commingled reserve. If relative original principal amounts are used to allocate, allocations must also be made on the retirement of any issue secured by the commingled reserve.

# §1.148-7. Spending exceptions to the rebate requirement.

- (a) **Scope of section—**
  - (1) **In general.** This section provides guidance on the spending exceptions to the arbitrage rebate requirement of [section 148(f)(2)](/cfr/26/148.md?p=f-2). These exceptions are the 6-month exception in [section 148(f)(4)(B)](/cfr/26/148.md?p=f-4-B) (the 6-month exception), the 18-month exception under [paragraph (d)](#d) of this section (the 18-month exception), and the 2-year construction exception under [section 148(f)(4)(C)](/cfr/26/148.md?p=f-4-C) (the 2-year exception) (collectively, the spending exceptions).
  - (2) **Relationship of spending exceptions.** Each of the spending exceptions is an independent exception to arbitrage rebate. For example, a construction issue may qualify for the 6-month exception or the 18-month exception even though the issuer makes one or more elections under the 2-year exception with respect to the issue.
  - (3) **Spending exceptions not mandatory.** Use of the spending exceptions is not mandatory. An issuer may apply the arbitrage rebate requirement to an issue that otherwise satisfies a spending exception. If an issuer elects to pay penalty in lieu of rebate under the 2-year exception, however, the issuer must apply those penalty provisions.
- (b) **Rules applicable for all spending exceptions.** The provisions of this [paragraph (b)](#b) apply for purposes of applying each of the spending exceptions.
  - (1) **Special transferred proceeds rules—**
    - (i) **Application to prior issues.** For purposes of applying the spending exceptions to a prior issue only, proceeds of the prior issue that become transferred proceeds of the refunding issue continue to be treated as unspent proceeds of the prior issue. If the prior issue satisfies one of the spending exceptions, the proceeds of the prior issue that are excepted from rebate under that spending exception are not subject to rebate either as proceeds of the prior issue or as transferred proceeds of the refunding issue.
    - (ii) **Application to refunding issues—**
      - (A) **In general.** The only spending exception applicable to refunding issues is the 6-month exception. For purposes of applying the 6-month exception to a refunding issue only, proceeds of the prior issue that become transferred proceeds of the refunding issue generally are not treated as proceeds of the refunding issue and need not be spent for the refunding issue to satisfy that spending exception. Even if the refunding issue qualifies for that spending exception, those transferred proceeds are subject to rebate as proceeds of the refunding issue unless an exception to rebate applied to those proceeds as proceeds of the prior issue.
      - (B) **Exception.** For purposes of applying the 6-month exception to refunding issues, those transferred proceeds of the refunding issue excluded from the gross proceeds of the prior issue under the special definition of gross proceeds in [paragraph (c)(3)](#c-3) of this section, and those that transferred from a prior taxable issue, are generally treated as gross proceeds of the refunding issue. Thus, for the refunding issue to qualify for the 6-month exception, those proceeds must be spent within 6 months of the issue date of the refunding issue, unless those amounts continue to be used in a manner that does not cause those amounts to be gross proceeds under [paragraph (c)(3)](#c-3) of this section.
  - (2) **Application of multipurpose issue rules.** Except as otherwise provided, if any portion of an issue is treated as a separate issue allocable to refunding purposes under [§ 1.148-9(h)](/cfr/26/1.148-9.md?p=h) (relating to multipurpose issues), for purposes of this section, that portion is treated as a separate issue.
  - (3) **Expenditures for governmental purposes of the issue.** For purposes of this section, expenditures for the governmental purpose of an issue include payments for interest, but not principal, on the issue, and for principal or interest on another issue of obligations. The preceding sentence does not apply for purposes of the 18-month and 2-year exceptions if those payments cause the issue to be a refunding issue.
  - (4) **De minimis rule.** Any failure to satisfy the final spending requirement of the 18-month exception or the 2-year exception is disregarded if the issuer exercises due diligence to complete the project financed and the amount of the failure does not exceed the lesser of 3 percent of the issue price of the issue or $250,000.
  - (5) **Special definition of reasonably required reserve or replacement fund.** For purposes of this section only, a reasonably required reserve or replacement fund also includes any fund to the extent described in § [1.148-5(c)(3)(i)(E)](/cfr/26/1.148-5.md?p=c-3-i-E) or [(G)](/cfr/26/1.148-5.md?p=c-3-i-G).
  - (6) **Pooled financing issue—**
    - (i) **In general.** Except as otherwise provided in this [paragraph (b)(6)](#b-6), the spending exceptions apply to a pooled financing issue as a whole, rather than to each loan separately.
    - (ii) **Election to apply spending exceptions separately to each loan—**
      - (A) **In general.** At the election (made on or before the issue date) of the issuer of a pooled financing issue, the spending exceptions are applied separately to each conduit loan, and the applicable spending requirements for a loan begin on the earlier of the date the loan is made, or the first day following the 1-year period beginning on the issue date of the pooled financing issue. If this election is made, the rebate requirement applies to, and none of the spending exceptions are available for, gross proceeds of the pooled financing bonds before the date on which the spending requirements for those proceeds begin.
      - (B) **Application of spending exceptions.** If the issuer makes the election under this [paragraph (b)(6)(ii)](#b-6-ii), the rebate requirement is satisfied for proceeds used to finance a particular conduit loan to the extent that the loan satisfies a spending exception or the small issuer exception under [§ 1.148-8](/cfr/26/1.148-8.md), regardless of whether any other conduit loans allocable to the issue satisfy such an exception. A pooled financing issue is an issue of arbitrage bonds, however, unless the entire issue satisfies the requirements of [section 148](/cfr/26/148.md). An issuer may pay rebate for some conduit loans and 1 1/2 percent penalty for other conduit loans from the same pooled financing issue. The 1 1/2 percent penalty is computed separately for each conduit loan.
      - (C) **Elections under 2-year exception.** If the issuer makes the election under this [paragraph (b)(6)(ii)](#b-6-ii), the issuer may make all elections under the 2-year exception separately for each loan. Elections regarding a loan that otherwise must be made by the issuer on or before the issue date instead may be made on or before the date the loan is made (but not later than 1 year after the issue date).
      - (D) **Example.** The operation of this [paragraph (b)(6)](#b-6) is illustrated by the following example:
- (c) **6-month exception—**
  - (1) **General rule.** An issue is treated as meeting the rebate requirement if—
    - (i) The gross proceeds (as modified by [paragraph (c)(3)](#c-3) of this section) of the issue are allocated to expenditures for the governmental purposes of the issue within the 6-month period beginning on the issue date (the 6-month spending period); and
    - (ii) The rebate requirement is met for amounts not required to be spent within the 6-month spending period (excluding earnings on a bona fide debt service fund).
  - (2) **Additional period for certain bonds.** The 6-month spending period is extended for an additional 6 months in certain circumstances specified under [section 148(f)(4)(B)(ii)](/cfr/26/148.md?p=f-4-B-ii).
  - (3) **Amounts not included in gross proceeds.** For purposes of [paragraph (c)(1)(i)](#c-1-i) of this section only, gross proceeds has the meaning used in [§ 1.148-1](/cfr/26/1.148-1.md), except it does not include amounts—
    - (i) In a bona fide debt service fund;
    - (ii) In a reasonably required reserve or replacement fund (see [§ 1.148-7(b)(5)](#b-5));
    - (iii) That, as of the issue date, are not reasonably expected to be gross proceeds but that become gross proceeds after the end of the 6-month spending period;
    - (iv) Representing sale or investment proceeds derived from payments under any purpose investment of the issue; and
    - (v) Representing repayments of grants (as defined in [§ 1.150-1(f)](/cfr/26/1.150-1.md?p=f)) financed by the issue.
  - (4) **Series of refundings.** If a principal purpose of a series of refunding issues is to exploit the difference between taxable and tax-exempt interest rates by investing proceeds during the temporary periods provided in [§ 1.148-9(d)](/cfr/26/1.148-9.md?p=d), the 6-month spending period for all issues in the series begins on the issue date of the first issue in the series.
- (d) **18-month exception—**
  - (1) **General rule.** An issue is treated as meeting the rebate requirement if all of the following requirements are satisfied—
    - (i) **18-month expenditure schedule met.** The gross proceeds (as defined in [paragraph (d)(3)](#d-3) of this section) are allocated to expenditures for a governmental purpose of the issue in accordance with the following schedule (the 18-month expenditure schedule) measured from the issue date—
      - (A) At least 15 percent within 6 months (the first spending period);
      - (B) At least 60 percent within 12 months (the second spending period); and
      - (C) 100 percent within 18 months (the third spending period).
    - (ii) **Rebate requirement met for amounts not required to be spent.** The rebate requirement is met for all amounts not required to be spent in accordance with the 18-month expenditure schedule (other than earnings on a bona fide debt service fund).
    - (iii) **Issue qualifies for initial temporary period.** All of the gross proceeds (as defined in [paragraph (d)(3)(i)](#d-3-i) of this section) of the issue qualify for the initial temporary period under [§ 1.148-2(e)(2)](/cfr/26/1.148-2.md?p=e-2).
  - (2) **Extension for reasonable retainage.** An issue does not fail to satisfy the spending requirement for the third spending period as a result of a reasonable retainage if the reasonable retainage is allocated to expenditures within 30 months of the issue date. Reasonable retainage has the meaning under [paragraph (h)](#h) of this section, as modified to refer to net sale proceeds on the date 18 months after the issue date.
  - (3) **Gross proceeds—**
    - (i) **Definition of gross proceeds.** For purposes of [paragraph (d)(1)](#d-1) of this section only, gross proceeds means gross proceeds as defined in [paragraph (c)(3)](#c-3) of this section, as modified to refer to “18 months” in [paragraph (c)(3)(iii)](#c-3-iii) of this section in lieu of “6 months.”
    - (ii) **Estimated earnings.** For purposes of determining compliance with the first two spending periods under [paragraph (d)(1)(i)](#d-1-i) of this section, the amount of investment proceeds included in gross proceeds of the issue is determined based on the issuer's reasonable expectations on the issue date.
  - (4) **Application to multipurpose issues.** This [paragraph (d)](#d) does not apply to an issue any portion of which is treated as meeting the rebate requirement under [paragraph (e)](#e) of this section (relating to the 2-year exception).
- (e) **2-year exception—**
  - (1) **General rule.** A construction issue is treated as meeting the rebate requirement for available construction proceeds if those proceeds are allocated to expenditures for governmental purposes of the issue in accordance with the following schedule (the 2-year expenditure schedule), measured from the issue date—
    - (i) At least 10 percent within 6 months (the first spending period);
    - (ii) At least 45 percent within 1 year (the second spending period);
    - (iii) At least 75 percent within 18 months (the third spending period); and
    - (iv) 100 percent within 2 years (the fourth spending period).
  - (2) **Extension for reasonable retainage.** An issue does not fail to satisfy the spending requirement for the fourth spending period as a result of unspent amounts for reasonable retainage (as defined in [paragraph (h)](#h) of this section) if those amounts are allocated to expenditures within 3 years of the issue date.
  - (3) **Definitions.** For purposes of the 2-year exception, the following definitions apply:
    - (i) Real property means land and improvements to land, such as buildings or other inherently permanent structures, including interests in real property. For example, real property includes wiring in a building, plumbing systems, central heating or air-conditioning systems, pipes or ducts, elevators, escalators installed in a building, paved parking areas, roads, wharves and docks, bridges, and sewage lines.
    - (ii) Tangible personal property means any tangible property other than real property, including interests in tangible personal property. For example, tangible personal property includes machinery that is not a structural component of a building, subway cars, fire trucks, automobiles, office equipment, testing equipment, and furnishings.
    - (iii) **Substantially completed.** Construction may be treated as substantially completed when the issuer abandons construction or when at least 90 percent of the total costs of the construction reasonably expected, as of that date, to be financed with the available construction proceeds have been allocated to expenditures.
- (f) **Construction issue—**
  - (1) Definition. Construction issue means any issue that is not a refunding issue if—
    - (i) The issuer reasonably expects, as of the issue date, that at least 75 percent of the available construction proceeds of the issue will be allocated to construction expenditures (as defined in [paragraph (g)](#g) of this section) for property owned by a governmental unit or a 501(c)(3) organization; and
    - (ii) Any private activity bonds that are part of the issue are qualified 501(c)(3) bonds or private activity bonds issued to finance property to be owned by a governmental unit or a 501(c)(3) organization.
  - (2) **Use of actual facts.** For the provisions of [paragraphs (e) through (m)](#e..m) of this section that apply based on the issuer's reasonable expectations, an issuer may elect on or before the issue date to apply all of those provisions based on actual facts, except that this election does not apply for purposes of determining whether an issue is a construction issue under [paragraph (f)(1)](#f-1) of this section if the 1 1/2 percent penalty election is made under [paragraph (k)](#k) of this section.
  - (3) **Ownership requirement—**
    - (i) **In general.** A governmental unit or 501(c)(3) organization is treated as the owner of property if it would be treated as the owner for Federal income tax purposes. For obligations issued on behalf of a State or local governmental unit, the entity that actually issues the bonds is treated as a governmental unit.
    - (ii) **Safe harbor for leases and management contracts.** Property leased by a governmental unit or a 501(c)(3) organization is treated as owned by the governmental unit or 501(c)(3) organization if the lessee complies with the requirements of [section 142(b)(1)(B)](/cfr/26/142.md?p=b-1-B). For a bond described in [section 142(a)(6)](/cfr/26/142.md?p=a-6), the requirements of [section 142(b)(1)(B)](/cfr/26/142.md?p=b-1-B) apply as modified by [section 146(h)(2)](/cfr/26/146.md?p=h-2).
- (g) **Construction expenditures—**
  - (1) **Definition.** Except as otherwise provided, construction expenditures means capital expenditures (as defined in [§ 1.150-1](/cfr/26/1.150-1.md)) that are allocable to the cost of real property or constructed personal property (as defined in [paragraph (g)(3)](#g-3) of this section). Except as provided in [paragraph (g)(2)](#g-2) of this section, construction expenditures do not include expenditures for acquisitions of interests in land or other existing real property.
  - (2) **Certain acquisitions under turnkey contracts treated as construction expenditures.** Expenditures are not for the acquisition of an interest in existing real property other than land if the contract between the seller and the issuer requires the seller to build or install the property (e.g., a turnkey contract), but only to the extent that the property has not been built or installed at the time the parties enter into the contract.
  - (3) Constructed personal property. Constructed personal property means tangible personal property (or, if acquired pursuant to a single acquisition contract, properties) or specially developed computer software if—
    - (i) A substantial portion of the property or properties is completed more than 6 months after the earlier of the date construction or rehabilitation commenced and the date the issuer entered into an acquisition contract;
    - (ii) Based on the reasonable expectations of the issuer, if any, or representations of the person constructing the property, with the exercise of due diligence, completion of construction or rehabilitation (and delivery to the issuer) could not have occurred within that 6-month period; and
    - (iii) If the issuer itself builds or rehabilitates the property, not more than 75 percent of the capitalizable cost is attributable to property acquired by the issuer (e.g., components, raw materials, and other supplies).
  - (4) Specially developed computer software. Specially developed computer software means any programs or routines used to cause a computer to perform a desired task or set of tasks, and the documentation required to describe and maintain those programs, provided that the software is specially developed and is functionally related and subordinate to real property or other constructed personal property.
  - (5) **Examples.** The operation of this [paragraph (g)](#g) is illustrated by the following examples:
- (h) Reasonable retainage definition. Reasonable retainage means an amount, not to exceed 5 percent of available construction proceeds as of the end of the fourth spending period, that is retained for reasonable business purposes relating to the property financed with the proceeds of the issue. For example, a reasonable retainage may include a retention to ensure or promote compliance with a construction contract in circumstances in which the retained amount is not yet payable, or in which the issuer reasonably determines that a dispute exists regarding completion or payment.
- (i) **Available construction proceeds—**
  - (1) **Definition in general. Available construction proceeds—** has the meaning used in [section 148(f)(4)(C)(vi)](/cfr/26/148.md?p=f-4-C-vi). For purposes of this definition, earnings include earnings on any tax-exempt bond. Pre-issuance accrued interest and earnings thereon may be disregarded. Amounts that are not gross proceeds as a result of the application of the universal cap under [§ 1.148-6(b)(2)](/cfr/26/1.148-6.md?p=b-2) are not available construction proceeds.
  - (2) **Earnings on a reasonably required reserve or replacement fund.** Earnings on any reasonably required reserve or replacement fund are available construction proceeds only to the extent that those earnings accrue before the earlier of the date construction is substantially completed or the date that is 2 years after the issue date. An issuer may elect on or before the issue date to exclude from available construction proceeds the earnings on such a fund. If the election is made, the rebate requirement applies to the excluded amounts from the issue date.
  - (3) **Reasonable expectations test for future earnings.** For purposes of determining compliance with the spending requirements as of the end of each of the first three spending periods, available construction proceeds include the amount of future earnings that the issuer reasonably expected as of the issue date.
  - (4) **Issuance costs.** Available construction proceeds do not include gross proceeds used to pay issuance costs financed by an issue, but do include earnings on such proceeds. Thus, an expenditure of gross proceeds of an issue for issuance costs does not count toward meeting the spending requirements. The expenditure of earnings on gross proceeds used to pay issuance costs does count toward meeting those requirements. If the spending requirements are met and the proceeds used to pay issuance costs are expended by the end of the fourth spending period, those proceeds and the earnings thereon are treated as having satisfied the rebate requirement.
  - (5) **One and one-half percent penalty in lieu of arbitrage rebate.** For purposes of the spending requirements of [paragraph (e)](#e) of this section, available construction proceeds as of the end of any spending period are reduced by the amount of penalty in lieu of arbitrage rebate (under [paragraph (k)](#k) of this section) that the issuer has paid from available construction proceeds before the last day of the spending period.
  - (6) **Payments on purpose investments and repayments of grants.** Available construction proceeds do not include—
    - (i) Sale or investment proceeds derived from payments under any purpose investment of the issue; or
    - (ii) Repayments of grants (as defined in [§ 1.150-1(f)](/cfr/26/1.150-1.md?p=f)) financed by the issue.
  - (7) **Examples.** The operation of this [paragraph (i)](#i) is illustrated by the following examples:
- (j) **Election to treat portion of issue used for construction as separate issue—**
  - (1) **In general.** For purposes of [paragraph (e)](#e) of this section, if any proceeds of an issue are to be used for construction expenditures, the issuer may elect on or before the issue date to treat the portion of the issue that is not a refunding issue as two, and only two, separate issues, if—
    - (i) One of the separate issues is a construction issue as defined in [paragraph (f)](#f) of this section;
    - (ii) The issuer reasonably expects, as of the issue date, that this construction issue will finance all of the construction expenditures to be financed by the issue; and
    - (iii) The issuer makes an election to apportion the issue under this [paragraph (j)(1)](#j-1) in which it identifies the amount of the issue price of the issue allocable to the construction issue.
  - (2) **Example.** The operation of this [paragraph (j)](#j) is illustrated by the following example.
- (k) **One and one-half percent penalty in lieu of arbitrage rebate—**
  - (1) **In general.** Under [section 148(f)(4)(C)(vii)](/cfr/26/148.md?p=f-4-C-vii), an issuer of a construction issue may elect on or before the issue date to pay a penalty (the 1 1/2 percent penalty) to the United States in lieu of the obligation to pay the rebate amount on available construction proceeds upon failure to satisfy the spending requirements of [paragraph (e)](#e) of this section. The 1 1/2 percent penalty is calculated separately for each spending period, including each semiannual period after the end of the fourth spending period, and is equal to 1.5 percent times the underexpended proceeds as of the end of the spending period. For each spending period, underexpended proceeds equal the amount of available construction proceeds required to be spent by the end of the spending period, less the amount actually allocated to expenditures for the governmental purposes of the issue by that date. The 1 1/2 percent penalty must be paid to the United States no later than 90 days after the end of the spending period to which it relates. The 1 1/2 percent penalty continues to apply at the end of each spending period and each semiannual period thereafter until the earliest of the following—
    - (i) The termination of the penalty under [paragraph (l)](#l) of this section;
    - (ii) The expenditure of all of the available construction proceeds; or
    - (iii) The last stated final maturity date of bonds that are part of the issue and any bonds that refund those bonds.
  - (2) **Application to reasonable retainage.** If an issue meets the exception for reasonable retainage except that all retainage is not spent within 3 years of the issue date, the issuer must pay the 1 1/2 percent penalty to the United States for any reasonable retainage that was not so spent as of the close of the 3-year period and each later spending period.
  - (3) **Coordination with rebate requirement.** The rebate requirement is treated as met with respect to available construction proceeds for a period if the 1 1/2 percent penalty is paid in accordance with this section.
- (l) **Termination of 1 1/2 percent penalty—**
  - (1) **Termination after initial temporary period.** The issuer may terminate the 1 1/2 percent penalty after the initial temporary period (a [section 148(f)(4)(C)(viii)](/cfr/26/148.md?p=f-4-C-viii) penalty termination) if—
    - (i) Not later than 90 days after the earlier of the end of the initial temporary period or the date construction is substantially completed, the issuer elects to terminate the 1 1/2 percent penalty; provided that solely for this purpose, the initial temporary period may be extended by the issuer to a date ending 5 years after the issue date;
    - (ii) Within 90 days after the end of the initial temporary period, the issuer pays a penalty equal to 3 percent of the unexpended available construction proceeds determined as of the end of the initial temporary period, multiplied by the number of years (including fractions of years computed to 2 decimal places) in the initial temporary period;
    - (iii) For the period beginning as of the close of the initial temporary period, the unexpended available construction proceeds are not invested in higher yielding investments; and
    - (iv) On the earliest date on which the bonds may be called or otherwise redeemed, with or without a call premium, the unexpended available construction proceeds as of that date (not including any amount earned after the date on which notice of the redemption was required to be given) must be used to redeem the bonds. Amounts used to pay any call premium are treated as used to redeem bonds. This redemption requirement may be met by purchases of bonds by the issuer on the open market at prices not exceeding fair market value. A portion of the annual principal payment due on serial bonds of a construction issue may be paid from the unexpended amount, but only in an amount no greater than the amount that bears the same ratio to the annual principal due that the total unexpended amount bears to the issue price of the construction issue.
  - (2) **Termination before end of initial temporary period.** If the construction to be financed by the construction issue is substantially completed before the end of the initial temporary period, the issuer may elect to terminate the 1 1/2 percent penalty before the end of the initial temporary period (a [section 148(f)(4)(C)(ix)](/cfr/26/148.md?p=f-4-C-ix) penalty termination) if—
    - (i) Before the close of the initial temporary period and not later than 90 days after the date the construction is substantially completed, the issuer elects to terminate the 1 1/2 percent penalty;
    - (ii) The election identifies the amount of available construction proceeds that will not be spent for the governmental purposes of the issue; and
    - (iii) The issuer has met all of the conditions for a [section 148(f)(4)(C)(viii)](/cfr/26/148.md?p=f-4-C-viii) penalty termination, applied as if the initial temporary period ended as of the date the required election for a [section 148(f)(4)(C)(ix)](/cfr/26/148.md?p=f-4-C-ix) penalty termination is made. That penalty termination election satisfies the required election for a [section 148(f)(4)(C)(viii)](/cfr/26/148.md?p=f-4-C-viii) termination.
  - (3) **Application to reasonable retainage.** Solely for purposes of determining whether the conditions for terminating the 1 1/2 percent penalty are met, reasonable retainage may be treated as spent for a governmental purpose of the construction issue. Reasonable retainage that is so treated continues to be subject to the 1 1/2 percent penalty.
  - (4) **Example.** The operation of this [paragraph (l)](#l) is illustrated by the following example.
- (m) **Payment of penalties.** Each penalty payment under this section must be paid in the manner provided in [§ 1.148-3(g)](/cfr/26/1.148-3.md?p=g). See [§ 1.148-3(h)](/cfr/26/1.148-3.md?p=h) for rules on failures to pay penalties under this section.

# §1.148-8. Small issuer exception to rebate requirement.

- (a) **Scope.** Under [section 148(f)(4)(D)](/cfr/26/148.md?p=f-4-D), bonds issued to finance governmental activities of certain small issuers are treated as meeting the arbitrage rebate requirement of [section 148(f)(2)](/cfr/26/148.md?p=f-2) (the “small issuer exception”). This section provides guidance on the small issuer exception.
- (b) **General taxing powers.** The small issuer exception generally applies only to bonds issued by governmental units with general taxing powers. A governmental unit has general taxing powers if it has the power to impose taxes (or to cause another entity to impose taxes) of general applicability which, when collected, may be used for the general purposes of the issuer. The taxing power may be limited to a specific type of tax, provided that the applicability of the tax is not limited to a small number of persons. The governmental unit's exercise of its taxing power may be subject to procedural limitations, such as voter approval requirements, but may not be contingent on approval by another governmental unit. See, also, [section 148(f)(4)(D)(iv)](/cfr/26/148.md?p=f-4-D-iv).
- (c) **Size limitation—**
  - (1) **In general.** An issue (other than a refunding issue) qualifies for the small issuer exception only if the issuer reasonably expects, as of the issue date, that the aggregate face amount of all tax-exempt bonds (other than private activity bonds) issued by it during that calendar year will not exceed $5,000,000; or the aggregate face amount of all tax-exempt bonds of the issuer (other than private activity bonds) actually issued during that calendar year does not exceed $5,000,000. For this purpose, if an issue has more than a de minimis amount of original issue discount or premium, aggregate face amount means the aggregate issue price of that issue (determined without regard to pre-issuance accrued interest).
  - (2) **Aggregation rules.** The following aggregation rules apply for purposes of applying the $5,000,000 size limitation under [paragraph (c)(1)](#c-1) of this section.
    - (i) **On-behalf-of issuers.** An issuer and all entities (other than political subdivisions) that issue bonds on behalf of that issuer are treated as one issuer.
    - (ii) **Subordinate entities—**
      - (A) **In general.** Except as otherwise provided in [paragraph (d)](#d) of this section and [section 148(f)(4)(D)(iv)](/cfr/26/148.md?p=f-4-D-iv), all bonds issued by a subordinate entity are also treated as issued by each entity to which it is subordinate. An issuer is subordinate to another governmental entity if it is directly or indirectly controlled by the other entity within the meaning of [§ 1.150-1(e)](/cfr/26/1.150-1.md?p=e).
      - (B) **Exception for allocations of size limitation.** If an entity properly makes an allocation of a portion of its $5,000,000 size limitation to a subordinate entity (including an on behalf of issuer) under [section 148(f)(4)(D)(iv)](/cfr/26/148.md?p=f-4-D-iv), the portion of bonds issued by the subordinate entity under the allocation is treated as issued only by the allocating entity and not by any other entity to which the issuing entity is subordinate. These allocations are irrevocable and must bear a reasonable relationship to the benefits received by the allocating unit from issues issued by the subordinate entity. The benefits to be considered include the manner in which—

        (1) Proceeds are to be distributed;

        (2) The debt service is to be paid;

        (3) The facility financed is to be owned;

        (4) The use or output of the facility is to be shared; and

        (5) Costs of operation and maintenance are to be shared.

    - (iii) **Avoidance of size limitation.** An entity formed or availed of to avoid the purposes of the $5,000,000 size limitation and all entities that would benefit from the avoidance are treated as one issuer. Situations in which an entity is formed or availed of to avoid the purposes of the $5,000,000 size limitation include those in which the issuer—
      - (A) Issues bonds which, but for the $5,000,000 size limitation, would have been issued by another entity; and
      - (B) **Does not receive a substantial benefit from the project financed by the bonds.**
  - (3) **Certain refunding bonds not taken into account.** In applying the $5,000,000 size limitation, there is not taken into account the portion of an issue that is a current refunding issue to the extent that the stated principal amount of the refunding bond does not exceed the portion of the outstanding stated principal amount of the refunded bond paid with proceeds of the refunding bond. For this purpose, principal amount means, in reference to a plain par bond, its stated principal amount plus accrued unpaid interest, and in reference to any other bond, its present value.
- (d) **Pooled financings—treatment of conduit borrowers.** A loan to a conduit borrower in a pooled financing qualifies for the small issuer exception, regardless of the size of either the pooled financing or of any loan to other conduit borrowers, only if—
  - (1) The bonds of the pooled financing are not private activity bonds;
  - (2) None of the loans to conduit borrowers are private activity bonds; and
  - (3) **The loan to the conduit borrower meets all the requirements of the small issuer exception.**
- (e) **Refunding issues—**
  - (1) **In general.** [Sections 148(f)(4)(D)](/cfr/26/148.md?p=f-4-D) (v) and (vi) provide restrictions on application of the small issuer exception to refunding issues.
  - (2) **Multipurpose issues.** The multipurpose issue allocation rules of [§ 1.148-9(h)](/cfr/26/1.148-9.md?p=h) apply for purposes of determining whether refunding bonds meet the requirements of [section 148(f)(4)(D)(v)](/cfr/26/148.md?p=f-4-D-v).

# §1.148-9. Arbitrage rules for refunding issues.

- (a) **Scope of application.** This section contains special arbitrage rules for refunding issues. These rules apply for all purposes of [section 148](/cfr/26/148.md) and govern allocations of proceeds, bonds, and investments to determine transferred proceeds, temporary periods, reasonably required reserve or replacement funds, minor portions, and separate issue treatment of certain multipurpose issues.
- (b) **Transferred proceeds allocation rule—**
  - (1) **In general.** When proceeds of the refunding issue discharge any of the outstanding principal amount of the prior issue, proceeds of the prior issue become transferred proceeds of the refunding issue and cease to be proceeds of the prior issue. The amount of proceeds of the prior issue that becomes transferred proceeds of the refunding issue is an amount equal to the proceeds of the prior issue on the date of that discharge multiplied by a fraction—
    - (i) The numerator of which is the principal amount of the prior issue discharged with proceeds of the refunding issue on the date of that discharge; and
    - (ii) The denominator of which is the total outstanding principal amount of the prior issue on the date immediately before the date of that discharge.
  - (2) **Special definition of principal amount.** For purposes of this section, principal amount means, in reference to a plain par bond, its stated principal amount, and in reference to any other bond, its present value.
  - (3) **Relation of transferred proceeds rule to universal cap rule—**
    - (i) **In general.** Paragraphs [(b)(1)](#b-1) and (c) of this section apply to allocate transferred proceeds and corresponding investments to a refunding issue on any date required by those paragraphs before the application of the universal cap rule of [§ 1.148-6(b)(2)](/cfr/26/1.148-6.md?p=b-2) to reallocate any of those amounts. To the extent nonpurpose investments allocable to proceeds of a refunding issue exceed the universal cap for the issue on the date that amounts become transferred proceeds of the refunding issue, those transferred proceeds and corresponding investments are reallocated back to the issue from which they transferred on that same date to the extent of the unused universal cap on that prior issue.
    - (ii) **Example.** The following example illustrates the application of this paragraph of (b)(3):
  - (4) **Limitation on multi-generational transfers.** This [paragraph (b)(4)](#b-4) contains limitations on the manner in which proceeds of a first generation issue that is refunded by a refunding issue (a second generation issue) become transferred proceeds of a refunding issue (a third generation issue) that refunds the second generation issue. Proceeds of the first generation issue that become transferred proceeds of the third generation issue are treated as having a yield equal to the yield on the refunding escrow allocated to the second generation issue (i.e., as determined under [§ 1.148-5(b)(2)(iv)](/cfr/26/1.148-5.md?p=b-2-iv)). The determination of the transferred proceeds of the third generation issue does not affect compliance with the requirements of [section 148](/cfr/26/148.md), including the determination of the amount of arbitrage rebate with respect to or the yield on the refunding escrow, of the second generation issue.
- (c) **Special allocation rules for refunding issues—**
  - (1) **Allocations of investments—**
    - (i) **In general.** Except as otherwise provided in this [paragraph (c)](#c), investments purchased with sale proceeds or investment proceeds of a refunding issue must be allocated to those proceeds, and investments not purchased with those proceeds may not be allocated to those proceeds (i.e., a specific tracing method).
    - (ii) **Allocations to transferred proceeds.** When proceeds of a prior issue become transferred proceeds of a refunding issue, investments (and the related payments and receipts) of proceeds of the prior issue that are held in a refunding escrow for another issue are allocated to the transferred proceeds under the ratable allocation method described in [paragraph (c)(1)(iii)](#c-1-iii) of this section. Investments of proceeds of the prior issue that are not held in a refunding escrow for another issue are allocated to the transferred proceeds by application of the allocation methods described in [paragraph (c)(1)](#c-1) (iii) or (iv) of this section, consistently applied to all investments on a transfer date.
    - (iii) **Ratable allocation method.** Under the ratable allocation method, a ratable portion of each nonpurpose and purpose investment of proceeds of the prior issue is allocated to transferred proceeds of the refunding issue.
    - (iv) **Representative allocation method—**
      - (A) **In general.** Under the representative allocation method, representative portions of the portfolio of nonpurpose investments and the portfolio of purpose investments of proceeds of the prior issue are allocated to transferred proceeds of the refunding issue. Unlike the ratable allocation method, this representative allocation method permits an allocation of particular whole investments. Whether a portion is representative is based on all the facts and circumstances, including, without limitation, whether the current yields, maturities, and current unrealized gains or losses on the particular allocated investments are reasonably comparable to those of the unallocated investments in the aggregate. In addition, if a portion of nonpurpose investments is otherwise representative, it is within the issuer's discretion to allocate the portion from whichever source of funds it deems appropriate, such as a reserve fund or a construction fund for a prior issue.
      - (B) **Mark-to-market safe harbor for representative allocation method.** In addition to other representative allocations, a specific allocation of a particular nonpurpose investment to transferred proceeds (e.g., of lower yielding investments) is treated as satisfying the representative allocation method if that investment is valued at fair market value on the transfer date in determining the payments and receipts on that date, but only if the portion of the nonpurpose investments that transfers is based on the relative fair market value of all nonpurpose investments.
  - (2) **Allocations of mixed escrows to expenditures for principal, interest, and redemption prices on a prior issue—**
    - (i) **In general.** Except for amounts required or permitted to be accounted for under [paragraph (c)(2)(ii)](#c-2-ii) of this section, proceeds of a refunding issue and other amounts that are not proceeds of a refunding issue that are deposited in a refunding escrow (a mixed escrow) must be accounted for under this [paragraph (c)(2)(i)](#c-2-i). Those proceeds and other amounts must be allocated to expenditures for principal, interest, or stated redemption prices on the prior issue so that the expenditures of those proceeds do not occur faster than ratably with expenditures of the other amounts in the mixed escrow. During the period that the prior issue has unspent proceeds, however, these allocations must be ratable (with reasonable adjustments for rounding) both between sources for expenditures (i.e., proceeds and other amounts) and between uses (i.e., principal, interest, and stated redemption prices on the prior issue).
    - (ii) **Exceptions—**
      - (A) **Mandatory allocation of certain non-proceeds to earliest expenditures.** If amounts other than proceeds of the refunding issue are deposited in a mixed escrow, but before the issue date of the refunding issue those amounts had been held in a bona fide debt service fund or a fund to carry out the governmental purpose of the prior issue (e.g., a construction fund), those amounts must be allocated to the earliest maturing investments in the mixed escrow.
      - (B) **Permissive allocation of non-proceeds to earliest expenditures.** Excluding amounts covered by [paragraph (c)(2)(ii)(A)](#c-2-ii-A) of this section and subject to any required earlier expenditure of those amounts, any amounts in a mixed escrow that are not proceeds of a refunding issue may be allocated to the earliest maturing investments in the mixed escrow, provided that those investments mature and the proceeds thereof are expended before the date of any expenditure from the mixed escrow to pay any principal of the prior issue.
- (d) **Temporary periods in refundings—**
  - (1) **In general.** Proceeds of a refunding issue may be invested in higher yielding investments under [section 148(c)](/cfr/26/148.md?p=c) only during the temporary periods described in [paragraph (d)(2)](#d-2) of this section.
  - (2) **Types of temporary periods in refundings.** The available temporary periods for proceeds of a refunding issue are as follows:
    - (i) **General temporary period for refunding issues.** Except as otherwise provided in this [paragraph (d)(2)](#d-2), the temporary period for proceeds (other than transferred proceeds) of a refunding issue is the period ending 30 days after the issue date of the refunding issue.
    - (ii) **Temporary periods for current refunding issues—**
      - (A) **In general.** Except as otherwise provided in [paragraph (d)(2)(ii)(B)](#d-2-ii-B) of this section, the temporary period for proceeds (other than transferred proceeds) of a current refunding issue is 90 days.
      - (B) **Temporary period for short-term current refunding issues.** The temporary period for proceeds (other than transferred proceeds) of a current refunding issue that has an original term to maturity of 270 days or less may not exceed 30 days. The aggregate temporary periods for proceeds (other than transferred proceeds) of all current refunding issues described in the preceding sentence that are part of the same series of refundings is 90 days. An issue is part of a series of refundings if it finances or refinances the same expenditures for a particular governmental purpose as another issue.
    - (iii) **Temporary periods for transferred proceeds—**
      - (A) **In general.** Except as otherwise provided in [paragraph (d)(2)(iii)(B)](#d-2-iii-B) of this section, each available temporary period for transferred proceeds of a refunding issue begins on the date those amounts become transferred proceeds of the refunding issue and ends on the date that, without regard to the discharge of the prior issue, the available temporary period for those proceeds would have ended had those proceeds remained proceeds of the prior issue.
      - (B) **Termination of initial temporary period for prior issue in an advance refunding.** The initial temporary period under [§ 1.148-2(e)](/cfr/26/1.148-2.md?p=e) (2) and (3) for the proceeds of a prior issue that is refunded by an advance refunding issue (including transferred proceeds) terminates on the issue date of the advance refunding issue.
    - (iv) **Certain short-term gross proceeds.** Except for proceeds of a refunding issue held in a refunding escrow, proceeds otherwise reasonably expected to be used to pay principal or interest on the prior issue, replacement proceeds not held in a bona fide debt service fund, and transferred proceeds, the temporary period for gross proceeds of a refunding issue is the 13-month period beginning on the date of receipt.
- (e) **Reasonably required reserve or replacement funds in refundings.** In addition to the requirements of [§ 1.148-2(f)](/cfr/26/1.148-2.md?p=f), beginning on the issue date of a refunding issue, a reserve or replacement fund for a refunding issue or a prior issue is a reasonably required reserve or replacement fund under [section 148(d)](/cfr/26/148.md?p=d) that may be invested in higher yielding investments only if the aggregate amount invested in higher yielding investments under this [paragraph (e)](#e) for both the refunding issue and the prior issue does not exceed the size limitations under § [1.148-2 (f)(2)](/cfr/26/1.148-2.md?p=f-2) and [(f)(3)](/cfr/26/1.148-2.md?p=f-3), measured by reference to the refunding issue only (regardless of whether proceeds of the prior issue have become transferred proceeds of the refunding issue).
- (f) **Minor portions in refundings.** Beginning on the issue date of the refunding issue, gross proceeds not in excess of a minor portion of the refunding issue qualify for investment in higher yielding investments under [section 148(e)](/cfr/26/148.md?p=e), and gross proceeds not in excess of a minor portion of the prior issue qualify for investment in higher yielding investments under either [section 148(e)](/cfr/26/148.md?p=e) or [section 149(d)(3)(A)(v)](/cfr/26/149.md?p=d-3-A-v), whichever is applicable. Minor portion is defined in [§ 1.148-2(g)](/cfr/26/1.148-2.md?p=g).
- (g) **Certain waivers permitted.** On or before the issue date, an issuer may waive the right to invest in higher yielding investments during any temporary period or as part of a reasonably required reserve or replacement fund. At any time, an issuer may waive the right to invest in higher yielding investments as part of a minor portion.
- (h) **Multipurpose issue allocations—**
  - (1) **Application of multipurpose issue allocation rules.** The portion of the bonds of a multipurpose issue reasonably allocated to any separate purpose under this [paragraph (h)](#h) is treated as a separate issue for all purposes of [section 148](/cfr/26/148.md) except the following—
    - (i) **Arbitrage yield.** Except to the extent that the proceeds of an issue are allocable to two or more conduit loans that are tax-exempt bonds, determining the yield on a multipurpose issue and the yield on investments for purposes of the arbitrage yield restrictions of [section 148](/cfr/26/148.md) and the arbitrage rebate requirement of [section 148(f)](/cfr/26/148.md?p=f);
    - (ii) **Rebate amount.** Except as provided in [paragraph (h)(1)(i)](#h-1-i) of this section, determining the rebate amount for a multipurpose issue, including subsidiary matters with respect to that determination, such as the computation date credit under [§ 1.148-3(d)(1)](/cfr/26/1.148-3.md?p=d-1), the due date for payments, and the $100,000 bona fide debt service fund exception under [section 148(f)(4)(A)(ii)](/cfr/26/148.md?p=f-4-A-ii);
    - (iii) **Minor portion.** Determining the minor portion of an issue under [section 148(e)](/cfr/26/148.md?p=e);
    - (iv) **Reasonably required reserve or replacement fund.** Determining the portion of an issue eligible for investment in higher yielding investments as part of a reasonably required reserve or replacement fund under [section 148(d)](/cfr/26/148.md?p=d); and
    - (v) **Effective date.** Applying the provisions of [§ 1.148-11(b)](/cfr/26/1.148-11.md?p=b) (relating to elective retroactive application of [§§ 1.148-1 through 1.148-10](/cfr/26/1.148-1..1.148-10.md) to certain issues).
  - (2) **Rules on allocations of multipurpose issues—**
    - (i) **In general.** This [paragraph (h)](#h) applies to allocations of multipurpose issues, including allocations involving the refunding purposes of the issue. Except as otherwise provided in this [paragraph (h)](#h), proceeds, investments, and bonds of a multipurpose issue may be allocated among the various separate purposes of the issue using any reasonable, consistently applied allocation method. An allocation is not reasonable if it achieves more favorable results under section [148](/cfr/26/148.md) or [149(d)](/cfr/26/149.md?p=d) than could be achieved with actual separate issues. An allocation under this [paragraph (h)](#h) may be made at any time, but once made may not be changed.
    - (ii) **Allocations involving certain common costs.** A ratable allocation of common costs (as described in [paragraph (h)(3)(ii)](#h-3-ii) of this section) among the separate purposes of the multipurpose issue is generally reasonable. If another allocation method more accurately reflects the extent to which any separate purpose of a multipurpose issue enjoys the economic benefit or bears the economic burden of certain common costs, that allocation method may be used.
  - (3) **Separate purposes of a multipurpose issue—**
    - (i) **In general.** Separate purposes of a multipurpose issue include refunding a separate prior issue, financing a separate purpose investment, financing a construction issue (as defined in [§ 1.148-7(f)](/cfr/26/1.148-7.md?p=f)), and any clearly discrete governmental purpose reasonably expected to be financed by that issue. In general, all integrated or functionally related capital projects that qualify for the same initial temporary period under [§ 1.148-2(e)(2)](/cfr/26/1.148-2.md?p=e-2) are treated as having a single governmental purpose. The separate purposes of a refunding issue include the separate purposes of the prior issue, if any. Separate purposes may be treated as a single purpose if the proceeds used to finance those purposes are eligible for the same initial temporary period under [section 148(c)](/cfr/26/148.md?p=c). For example, the use of proceeds of a multipurpose issue to finance separate qualified mortgage loans may be treated as a single purpose.
    - (ii) **Financing common costs.** Common costs of a multipurpose issue are not separate purposes. Common costs include issuance costs, accrued interest, capitalized interest on the issue, a reserve or replacement fund, qualified guarantee fees, and similar costs properly allocable to the separate purposes of the issue.
    - (iii) **Example.** The following example illustrates the application of this [paragraph (h)(3)](#h-3).
  - (4) **Allocations of bonds of a multipurpose issue—**
    - (i) **Reasonable allocation of bonds to portions of issue.** After reasonable adjustment of the issue price of a multipurpose issue to account for common costs, the portion of the bonds of a multipurpose issue allocated to a separate purpose must have an issue price that bears the same ratio to the aggregate issue price of the multipurpose issue as the portion of the sale proceeds of the multipurpose issue used for that separate purpose bears to the aggregate sale proceeds of the multipurpose issue. For a refunding issue used to refund two or more prior issues, the portion of the sales proceeds allocated to the refunding of a separate prior issue is based on the present value of the refunded debt service on that prior issue, using the yield on investments in the refunding escrow allocable to the entire refunding issue as the discount rate.
    - (ii) **Safe harbor for pro rata allocation method for bonds.** The use of the relative amount of sales proceeds used for each separate purpose to ratably allocate each bond or a ratable number of substantially identical whole bonds is a reasonable method for allocating bonds of a multipurpose issue.
    - (iii) **Safe harbor for allocations of bonds used to finance separate purpose investments.** An allocation of a portion of the bonds of a multipurpose issue to a particular purpose investment is generally reasonable if that purpose investment has principal and interest payments that reasonably coincide in time and amount to principal and interest payments on the bonds allocated to that purpose investment.
    - (iv) **Rounding of bond allocations to next whole bond denomination permitted.** An allocation that rounds each resulting fractional bond up or down to the next integral multiple of a permitted denomination of bonds of that issue not in excess of $100,000 does not prevent the allocation from satisfying this [paragraph (h)(4)](#h-4).
    - (v) **Restrictions on allocations of bonds to refunding purposes.** For each portion of a multipurpose issue that is used to refund a separate prior issue, a method of allocating bonds of that issue is reasonable under this [paragraph (h)](#h) only if, in addition to the requirements of paragraphs [(h)(1)](#h-1) and [(h)(2)](#h-2) of this section, the portion of the bonds allocated to the refunding of that prior issue—
      - (A) Results from a pro rata allocation under [paragraph (h)(4)(ii)](#h-4-ii) of this section;
      - (B) Reflects aggregate principal and interest payable in each bond year that is less than, equal to, or proportionate to, the aggregate principal and interest payable on the prior issue in each bond year;
      - (C) Results from an allocation of all the bonds of the entire multipurpose issue in proportion to the remaining weighted average economic life of the capital projects financed or refinanced by the issue, determined in the same manner as under [section 147(b)](/cfr/26/147.md?p=b); or
      - (D) Results from another reasonable allocation method, but only to the extent that the application of the allocation methods provided in this [paragraph (h)(4)(v)](#h-4-v) is not permitted under state law restrictions applicable to the bonds, reasonable terms of bonds issued before, or subject to a master indenture that became effective prior to, July 1, 1993, or other similar restrictions or circumstances. This [paragraph (h)(4)(v)(D)](#h-4-v-D) shall be strictly construed and is available only if it does not result in a greater burden on the market for tax-exempt bonds than would occur using one of the other allocation methods provided in this [paragraph (h)(4)(v)](#h-4-v). (See also [§ 1.148-11(c)(2)](/cfr/26/1.148-11.md?p=c-2).)
    - (vi) **Exception for refundings of interim notes.** [Paragraph (h)(4)(v)](#h-4-v) of this section need not be applied to refunding bonds issued to provide permanent financing for one or more projects if the prior issue had a term of less than 3 years and was sold in anticipation of permanent financing, but only if the aggregate term of all prior issues sold in anticipation of permanent financing was less than 3 years.
  - (5) **Limitation on multi-generation allocations.** This [paragraph (h)](#h) does not apply to allocations of a multipurpose refunded issue unless that refunded issue is refunded directly by an issue to which this [paragraph (h)](#h) applies. For example, if a 1994 issue refunds a 1984 multipurpose issue, which in turn refunded a 1980 multipurpose issue, this [paragraph (h)](#h) applies to allocations of the 1984 issue for purposes of allocating the refunding purposes of the 1994 issue, but does not permit allocations of the 1980 issue.
    - (i) **Operating rules for separation of prior issue into refunded and unrefunded portions—**
  - (1) **In general.** For purposes of [paragraph (h)(3)(i)](#h-3-i) of this section, the separate purposes of a prior issue include the refunded and unrefunded portions of the prior issue. Thus, the refunded and unrefunded portions are treated as separate issues under [paragraph (h)(1)](#h-1) of this section. Those separate issues must satisfy the requirements of paragraphs [(h)](#h) and (i) of this section. The refunded portion of the bonds of a prior issue is based on a fraction the numerator of which is the principal amount of the prior issue to be paid with proceeds of the refunding issue and the denominator of which is the outstanding principal amount of the bonds of the prior issue, each determined as of the issue date of the refunding issue. (See also [paragraph (b)(2)](#b-2) of this section.)
  - (2) **Allocations of proceeds and investments in a partial refunding.** As of the issue date of a partial refunding issue under this paragraph (i), unspent proceeds of the prior issue are allocated ratably between the refunded and unrefunded portions of the prior issue and the investments allocable to those unspent proceeds are allocated in the manner required for the allocation of investments to transferred proceeds under [paragraph (c)(1)(ii)](#c-1-ii) of this section.
  - (3) **References to prior issue.** If the refunded and unrefunded portions of a prior issue are treated as separate issues under this paragraph (i), then, except to the extent that the context clearly requires otherwise (e.g., references to the aggregate prior issue in the mixed escrow rule in [paragraph (c)(2)](#c-2) of this section), all references in this section to a prior issue refer only to the refunded portion of that prior issue.

# §1.148-10. Anti-abuse rules and authority of Commissioner.

- (a) **Abusive arbitrage device—**
  - (1) **In general.** Bonds of an issue are arbitrage bonds under [section 148](/cfr/26/148.md) if an abusive arbitrage device under [paragraph (a)(2)](#a-2) of this section is used in connection with the issue. This [paragraph (a)](#a) is to be applied and interpreted broadly to carry out the purposes of [section 148](/cfr/26/148.md), as further described in [§ 1.148-0](/cfr/26/1.148-0.md). Except as otherwise provided in [paragraph (c)](#c) of this section, any action that is expressly permitted by [section 148](/cfr/26/148.md) or [§§ 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md) is not an abusive arbitrage device (e.g., investment in higher yielding investments during a permitted temporary period under [section 148(c)](/cfr/26/148.md?p=c)).
  - (2) **Abusive arbitrage device defined.** Any action is an abusive arbitrage device if the action has the effect of—
    - (i) Enabling the issuer to exploit the difference between tax-exempt and taxable interest rates to obtain a material financial advantage; and
    - (ii) **Overburdening the tax-exempt bond market.**
  - (3) **Exploitation of tax-exempt interest rates.** An action may exploit tax-exempt interest rates under [paragraph (a)(2)](#a-2) of this section as a result of an investment of any portion of the gross proceeds of an issue over any period of time, notwithstanding that, in the aggregate, the gross proceeds of the issue are not invested in higher yielding investments over the term of the issue.
  - (4) **Overburdening the tax-exempt market.** An action overburdens the tax-exempt bond market under [paragraph (a)(2)(ii)](#a-2-ii) of this section if it results in issuing more bonds, issuing bonds earlier, or allowing bonds to remain outstanding longer than is otherwise reasonably necessary to accomplish the governmental purposes of the bonds, based on all the facts and circumstances. Whether an action is reasonably necessary to accomplish the governmental purposes of the bonds depends on whether the primary purpose of the transaction is a bona fide governmental purpose (e.g., an issue of refunding bonds to achieve a debt service restructuring that would be issued independent of any arbitrage benefit). An important factor bearing on this determination is whether the action would reasonably be taken to accomplish the governmental purpose of the issue if the interest on the issue were not excludable from gross income under [section 103(a)](/cfr/26/103.md?p=a) (assuming that the hypothetical taxable interest rate would be the same as the actual tax-exempt interest rate). Factors evidencing an overissuance include the issuance of an issue the proceeds of which are reasonably expected to exceed by more than a minor portion the amount necessary to accomplish the governmental purposes of the issue, or an issue the proceeds of which are, in fact, substantially in excess of the amount of sale proceeds allocated to expenditures for the governmental purposes of the issue. One factor evidencing an early issuance is the issuance of bonds that do not qualify for a temporary period under § [1.148-2(e)(2)](/cfr/26/1.148-2.md?p=e-2), [(e)(3)](/cfr/26/1.148-2.md?p=e-3), or [(e)(4)](/cfr/26/1.148-2.md?p=e-4). One factor evidencing that bonds may remain outstanding longer than necessary is a term that exceeds the safe harbors against the creation of replacement proceeds under [§ 1.148-1(c)(4)(i)(B)](/cfr/26/1.148-1.md?p=c-4-i-B). These factors may be outweighed by other factors, such as bona fide cost underruns, an issuer's bona fide need to finance extraordinary working capital items, or an issuer's long-term financial distress.
- (b) **Consequences of overburdening the tax-exempt bond market—**
  - (1) **In general.** An issue that overburdens the tax-exempt bond market (within the meaning of [paragraph (a)(4)](#a-4) of this section) is subject to the following special limitations—
    - (i) **Special yield restriction.** Investments are subject to the definition of materially higher yield under [§ 1.148-2(d)](/cfr/26/1.148-2.md?p=d) that is equal to one-thousandth of 1 percent. In addition, each investment is treated as a separate class of investments under [§ 1.148-5(b)(2)(ii)](/cfr/26/1.148-5.md?p=b-2-ii), the yield on which may not be blended with that of other investments.
    - (ii) **Certain regulatory provisions inapplicable.** The provisions of [§ 1.148-5(c)](/cfr/26/1.148-5.md?p=c) (relating to yield reduction payments) and [§ 1.148-5(e)](/cfr/26/1.148-5.md?p=e) (2) and (3) (relating to recovery of qualified administrative costs) do not apply.
    - (iii) **Restrictive expenditure rule.** Proceeds are not allocated to expenditures unless the proceeds-spent-last rule under [§ 1.148-6(d)(3)(i)](/cfr/26/1.148-6.md?p=d-3-i) is satisfied, applied by treating those proceeds as proceeds to be used for restricted working capital expenditures. For this purpose, available amount includes a reasonable working capital reserve as defined in [§ 1.148-6(d)(3)(iii)(B)](/cfr/26/1.148-6.md?p=d-3-iii-B).
  - (2) **Application.** The provisions of this [paragraph (b)](#b) only apply to the portion of an issue that, as a result of actions taken (or actions not taken) after the issue date, overburdens the market for tax-exempt bonds, except that for an issue that is reasonably expected as of the issue date to overburden the market, those provisions apply to all of the gross proceeds of the issue.
- (c) **Anti-abuse rules on excess gross proceeds of advance refunding issues—**
  - (1) **In general.** Except as otherwise provided in this [paragraph (c)](#c), an abusive arbitrage device is used and bonds of an advance refunding issue are arbitrage bonds if the issue has excess gross proceeds.
  - (2) **Definition of excess gross proceeds.** Excess gross proceeds means all gross proceeds of an advance refunding issue that exceed an amount equal to 1 percent of sale proceeds of the issue, other than gross proceeds allocable to—
    - (i) Payment of principal, interest, or call premium on the prior issue;
    - (ii) Payment of pre-issuance accrued interest on the refunding issue, and interest on the refunding issue that accrues for a period up to the completion date of any capital project for which the prior issue was issued, plus one year;
    - (iii) A reasonably required reserve or replacement fund for the refunding issue or investment proceeds of such a fund;
    - (iv) Payment of costs of issuance of the refunding issue;
    - (v) Payment of administrative costs allocable to repaying the prior issue, carrying and repaying the refunding issue, or investments of the refunding issue;
    - (vi) Transferred proceeds that will be used or maintained for the governmental purpose of the prior issue;
    - (vii) Interest on purpose investments;
    - (viii) Replacement proceeds in a sinking fund for the refunding issue;
    - (ix) Qualified guarantee fees for the refunding issue or the prior issue; and
    - (x) **Fees for a qualified hedge for the refunding issue.**
  - (3) **Special treatment of transferred proceeds.** For purposes of this [paragraph (c)](#c), all unspent proceeds of the prior issue as of the issue date of the refunding issue are treated as transferred proceeds of the advance refunding issue.
  - (4) **Special rule for crossover refundings.** An advance refunding issue is not an issue of arbitrage bonds under this [paragraph (c)](#c) if all excess gross proceeds of the refunding issue are used to pay interest that accrues on the refunding issue before the prior issue is discharged, and no gross proceeds of any refunding issue are used to pay interest on the prior issue or to replace funds used directly or indirectly to pay such interest (other than transferred proceeds used to pay interest on the prior issue that accrues for a period up to the completion date of the project for which the prior issue was issued, plus one year, or proceeds used to pay principal that is attributable to accrued original issue discount).
  - (5) **Special rule for gross refundings.** This [paragraph (c)(5)](#c-5) applies if an advance refunding issue (the series B issue) is used together with one or more other advance refunding issues (the series A issues) in a gross refunding of a prior issue, but only if the use of a gross refunding method is required under bond documents that were effective prior to November 6, 1992. These advance refunding issues are not arbitrage bonds under this [paragraph (c)](#c) if—
    - (i) All excess gross proceeds of the series B issue and each series A issue are investment proceeds used to pay principal and interest on the series B issue;
    - (ii) At least 99 percent of all principal and interest on the series B issue is paid with proceeds of the series B and series A issues or with the earnings on other amounts in the refunding escrow for the prior issue;
    - (iii) The series B issue is discharged not later than the prior issue; and
    - (iv) As of any date, the amount of gross proceeds of the series B issue allocated to expenditures does not exceed the aggregate amount of expenditures before that date for principal and interest on the series B issue, and administrative costs of carrying and repaying the series B issue, or of investments of the series B issue.
- (d) **Examples.** The provisions of this section are illustrated by the following examples:
- (e) **Authority of the Commissioner to prevent transactions that are inconsistent with the purpose of the arbitrage investment restrictions.** If an issuer enters into a transaction for a principal purpose of obtaining a material financial advantage based on the difference between tax-exempt and taxable interest rates in a manner that is inconsistent with the purposes of [section 148](/cfr/26/148.md), the Commissioner may exercise the Commissioner's discretion to depart from the rules of [§ 1.148-1](/cfr/26/1.148-1.md) through [§ 1.148-11](/cfr/26/1.148-11.md) as necessary to reflect the economics of the transaction to prevent such financial advantage. For this purpose, the Commissioner may recompute yield on an issue or on investments, reallocate payments and receipts on investments, recompute the rebate amount on an issue, treat a hedge as either a qualified hedge or not a qualified hedge, or otherwise adjust any item whatsoever bearing upon the investments and expenditures of gross proceeds of an issue. For example, if the amount paid for a hedge is specifically based on the amount of arbitrage earned or expected to be earned on the hedged bonds, a principal purpose of entering into the contract is to obtain a material financial advantage based on the difference between tax-exempt and taxable interest rates in a manner that is inconsistent with the purposes of [section 148](/cfr/26/148.md).
- (f) **Authority of the Commissioner to require an earlier date for payment of rebate.** If the Commissioner determines that an issue is likely to fail to meet the requirements of [§ 1.148-3](/cfr/26/1.148-3.md) and that a failure to serve a notice of demand for payment on the issuer will jeopardize the assessment or collection of tax on interest paid or to be paid on the issue, the date that the Commissioner serves notice on the issuer is treated as a required computation date for payment of rebate for that issue.
- (g) **Authority of the Commissioner to waive regulatory limitations.** Notwithstanding any specific provision in [§§ 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md), the Commissioner may prescribe extensions of temporary periods, larger reasonably required reserve or replacement funds, or consequences of failures or remedial action under [section 148](/cfr/26/148.md) in lieu of or in addition to other consequences of those failures, or take other action, if the Commissioner finds that good faith or other similar circumstances so warrant, consistent with the purposes of [section 148](/cfr/26/148.md).

# §1.148-11. Effective/applicability dates.

- (a) **In general.** Except as otherwise provided in this section, [§§ 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md) apply to bonds sold on or after July 8, 1997.
- (b) **Elective retroactive application in whole—**
  - (1) **In general.** Except as otherwise provided in this section, and subject to the applicable effective dates for the corresponding statutory provisions, an issuer may apply the provisions of [§§ 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md) in whole, but not in part, to any issue that is outstanding on July 8, 1997, and is subject to [section 148(f)](/cfr/26/148.md?p=f) or to sections 103(c)(6) or 103A(i) of the Internal Revenue Code of 1954, in lieu of otherwise applicable regulations under those sections.
  - (2) **No elective retroactive application for 18-month spending exception.** The provisions of [§ 1.148-7(d)](/cfr/26/1.148-7.md?p=d) (relating to the 18-month spending exception) may not be applied to any issue issued on or before June 30, 1993.
  - (3) **No elective retroactive application for hedges of fixed rate issues.** The provisions of [§ 1.148-4(h)(2)(i)(B)](/cfr/26/1.148-4.md?p=h-2-i-B) (relating to hedges of fixed rate issues) may not be applied to any bond sold on or before July 8, 1997.
  - (4) **No elective retroactive application for safe harbor for establishing fair market value for guaranteed investment contracts and investments purchased for a yield restricted defeasance escrow.** The provisions of [§§ 1.148-5(d)(6)(iii)](/cfr/26/1.148-5.md?p=d-6-iii) (relating to the safe harbor for establishing fair market value of guaranteed investment contracts and yield restricted defeasance escrow investments) and 1.148-5(e)(2)(iv) (relating to a special rule for yield restricted defeasance escrow investments) may not be applied to any bond sold before December 30, 1998.
- (c) **Elective retroactive application of certain provisions and special rules—**
  - (1) **Retroactive application of overpayment recovery provisions.** An issuer may apply the provisions of [§ 1.148-3(i)](/cfr/26/1.148-3.md?p=i) to any issue that is subject to [section 148(f)](/cfr/26/148.md?p=f) or to sections 103(c)(6) or 103A(i) of the Internal Revenue Code of 1954.
  - (2) **Certain allocations of multipurpose issues.** An allocation of bonds to a refunding purpose under [§ 1.148-9(h)](/cfr/26/1.148-9.md?p=h) may be adjusted as necessary to reflect allocations made between May 18, 1992, and August 15, 1993, if the allocations satisfied the corresponding prior provision of [§ 1.148-11(j)(4)](#j-4) under applicable prior regulations.
  - (3) **Special limitation.** The provisions of [§ 1.148-9](/cfr/26/1.148-9.md) apply to issues issued before August 15, 1993, only if the issuer in good faith estimates the present value savings, if any, associated with the effect of the application of that section on refunding escrows, using any reasonable accounting method, and applies those savings, if any, to redeem outstanding tax-exempt bonds of the applicable issue at the earliest possible date on which those bonds may be redeemed or otherwise retired. These savings are not reduced to take into account any administrative costs associated with applying these provisions retroactively.
- (d) **Transition rule excepting certain state guarantee funds from the definition of replacement proceeds—**
  - (1) **Certain perpetual trust funds.**
    - (i) A guarantee by a fund created and controlled by a State and established pursuant to its constitution does not cause the amounts in the fund to be pledged funds treated as replacement proceeds if—
      - (A) Substantially all of the corpus of the fund consists of nonfinancial assets, revenues derived from these assets, gifts, and bequests;
      - (B) The corpus of the guarantee fund may be invaded only to support specifically designated essential governmental functions (designated functions) carried on by political subdivisions with general taxing powers or public elementary and public secondary schools;
      - (C) Substantially all of the available income of the fund is required to be applied annually to support designated functions;
      - (D) The issue guaranteed consists of obligations that are not private activity bonds (other than qualified 501(c)(3) bonds) substantially all of the proceeds of which are to be used for designated functions;
      - (E) The fund satisfied each of the requirements of [paragraphs (d)(1)(i) through (d)(1)(iii)](#d-1-i..d-1-iii) of this section on August 16, 1986; and
      - (F) As of the sale date of the bonds to be guaranteed, the amount of the bonds to be guaranteed by the fund plus the then-outstanding amount of bonds previously guaranteed by the fund does not exceed a total amount equal to 500 percent of the total costs of the assets held by the fund as of December 16, 2009.
    - (ii) The Commissioner may, by published guidance, set forth additional circumstances under which guarantees by certain perpetual trust funds will not cause amounts in the fund to be treated as replacement proceeds.
  - (2) **Permanent University Fund.** Replacement proceeds do not include amounts allocable to investments of the fund described in section 648 of Public Law 98-369.
- (e) **Transition rule regarding special allowance payments.** [Section 1.148-5(b)(5)](/cfr/26/1.148-5.md?p=b-5) applies to any bond issued after January 5, 1990, except a bond issued exclusively to refund a bond issued before January 6, 1990, if the amount of the refunding bond does not exceed 101 percent of the amount of the refunded bond, and the maturity date of the refunding bond is not later than the date that is 17 years after the date on which the refunded bond was issued (or, in the case of a series of refundings, the date on which the original bond was issued), but only if [§ 1.148-2(d)(2)(iv)](/cfr/26/1.148-2.md?p=d-2-iv) is applied by substituting 1 and one-half percentage points for 2 percentage points.
- (f) **Transition rule regarding applicability of yield reduction rule.** [Section 1.148-5(c)](/cfr/26/1.148-5.md?p=c) applies to nonpurpose investments allocable to replacement proceeds of an issue that are held in a reserve or replacement fund to the extent that—
  - (1) Amounts must be paid into the fund under a constitutional provision, statute, or ordinance adopted before May 3, 1978;
  - (2) Under that provision, amounts paid into the fund (and investment earnings thereon) can be used only to pay debt service on the issues; and
  - (3) The size of the payments made into the fund is independent of the size of the outstanding issues or the debt service thereon.
- (g) **Provisions applicable to certain bonds sold before effective date.** Except for bonds to which [paragraph (b)(1)](#b-1) of this section applies—
  - (1) [Section 1.148-11A](/cfr/26/1.148-11A.md) provides rules applicable to bonds sold after June 6, 1994, and before July 8, 1997; and
  - (2) [Sections 1.148-1 through 1.148-11](/cfr/26/1.148-1..1.148-11.md) as in effect on July 1, 1993 (see [26 CFR part 1](/cfr/26/part1.md) as revised April 1, 1994), and [§ 1.148-11A(i)](/cfr/26/1.148-11A.md?p=i) (relating to elective retroactive application of certain provisions) provide rules applicable to certain issues issued before June 7, 1994.
- (h) **Safe harbor for establishing fair market value for guaranteed investment contracts and investments purchased for a yield restricted defeasance escrow.** The provisions of [§ 1.148-5(d)(6)(iii)](/cfr/26/1.148-5.md?p=d-6-iii) are applicable to bonds sold on or after March 1, 1999. Issuers may apply these provisions to bonds sold on or after December 30, 1998, and before March 1, 1999.
- (i) **Special rule for certain broker's commissions and similar fees.** [Section 1.148-5(e)(2)(iii)](/cfr/26/1.148-5.md?p=e-2-iii) applies to bonds sold on or after February 9, 2004. In the case of bonds sold before February 9, 2004, that are subject to [§ 1.148-5](/cfr/26/1.148-5.md) (pre-effective date bonds), issuers may apply [§ 1.148-5(e)(2)(iii)](/cfr/26/1.148-5.md?p=e-2-iii), in whole but not in part, with respect to transactions entered into on or after December 11, 2003. If an issuer applies [§ 1.148-5(e)(2)(iii)](/cfr/26/1.148-5.md?p=e-2-iii) to pre-effective date bonds, the per-issue safe harbor in [§ 1.148-5(e)(2)(iii)(B)(1)(ii)](/cfr/26/1.148-5.md?p=e-2-iii-B-1-ii) is applied by taking into account all brokers' commissions or similar fees with respect to guaranteed investment contracts and investments for yield restricted defeasance escrows that the issuer treats as qualified administrative costs for the issue, including all such commissions or fees paid before February 9, 2004. For purposes of §§ [1.148-5(e)(2)(iii)(B)(3)](/cfr/26/1.148-5.md?p=e-2-iii-B-3) and [1.148-5(e)(2)(iii)(B)(6)](/cfr/26/1.148-5.md?p=e-2-iii-B-6) (relating to cost-of-living adjustments), transactions entered into before 2003 are treated as entered into in 2003.
- (j) **Certain prepayments.** Section [1.148-1(e)(1)](/cfr/26/1.148-1.md?p=e-1) and [(2)](/cfr/26/1.148-1.md?p=e-2) apply to bonds sold on or after October 3, 2003. Issuers may apply § [1.148-1(e)(1)](/cfr/26/1.148-1.md?p=e-1) and [(2)](/cfr/26/1.148-1.md?p=e-2), in whole but not in part, to bonds sold before October 3, 2003, that are subject to [§ 1.148-1](/cfr/26/1.148-1.md).
- (k) **Certain arbitrage guidance updates—**
  - (1) **In general.** [Sections 1.148-1(c)(4)(i)(B)(1)](/cfr/26/1.148-1.md?p=c-4-i-B-1); 1.148-1(c)(4)(i)(B)(4); 1.148-1(c)(4)(ii); 1.148-2(e)(3)(i); 1.148-3(d)(1)(iv); 1.148-3(d)(4); 1.148-4(a); 1.148-4(b)(3)(i); 1.148-4(h)(2)(ii)(A); 1.148-4(h)(2)(v); 1.148-4(h)(2)(vi); 1.148(h)(4)(i)(C); 1.148-5(c)(3); 1.148-5(d)(2); 1.148-5(d)(3); 1.148-5(d)(6)(i); 1.148-5(d)(6)(iii)(A); 1.148-5(e)(2)(ii)(B); 1.148-6(d)(3)(iii)(A); 1.148-6(d)(4); 1.148-7(c)(3)(v); 1.148-7(i)(6)(ii); 1.148-10(a)(4); 1.148-10(e); 1.148-11(d)(1)(i)(B); 1.148-11(d)(1)(i)(D); 1.148-11(d)(1)(i)(F); and 1.148-11(d)(1)(ii) apply to bonds sold on or after October 17, 2016.
  - (2) **Valuation of investments in refunding transactions.** [Section 1.148-5(d)(3)](/cfr/26/1.148-5.md?p=d-3) also applies to bonds refunded by bonds sold on or after October 17, 2016.
  - (3) **Rebate overpayment recovery.**
    - (i) [Section 1.148-3(i)(3)(i)](/cfr/26/1.148-3.md?p=i-3-i) applies to claims arising from an issue of bonds to which [§ 1.148-3(i)](/cfr/26/1.148-3.md?p=i) applies and for which the final computation date is after June 24, 2008. For purposes of this [paragraph (k)(3)(i)](#k-3-i), issues for which the actual final computation date is on or before June 24, 2008, are deemed to have a final computation date of July 1, 2008, for purposes of applying [§ 1.148-3(i)(3)(i)](/cfr/26/1.148-3.md?p=i-3-i).
    - (ii) Section [1.148-3(i)(3)(ii)](/cfr/26/1.148-3.md?p=i-3-ii) and [(iii)](/cfr/26/1.148-3.md?p=i-3-iii) apply to claims arising from an issue of bonds to which [§ 1.148-3(i)](/cfr/26/1.148-3.md?p=i) applies and for which the final computation date is after September 16, 2013.
    - (iii) [Section 1.148-3(j)](/cfr/26/1.148-3.md?p=j) applies to bonds subject to [§ 1.148-3(i)](/cfr/26/1.148-3.md?p=i).
  - (4) **Hedge identification.** [Section 1.148-4(h)(2)(viii)](/cfr/26/1.148-4.md?p=h-2-viii) applies to hedges that are entered into on or after October 17, 2016.
  - (5) **Hedge modifications and termination.** Section [1.148-4(h)(3)(iv)(A) through (H)](/cfr/26/1.148-4.md?p=h-3-iv-A..h-3-iv-H) and [(h)(4)(iv)](/cfr/26/1.148-4.md?p=h-h-4-iv) apply to—
    - (i) Hedges that are entered into on or after October 17, 2016;
    - (ii) Qualified hedges that are modified on or after October 17, 2016 with respect to modifications on or after such date; and
    - (iii) Qualified hedges on bonds that are refunded on or after October 17, 2016 with respect to the refunding on or after such date.
  - (6) **Small issuer exception to rebate requirement for conduit borrowers of pooled financings.** [Section 1.148-8(d)](/cfr/26/1.148-8.md?p=d) applies to bonds issued after May 17, 2006.
- (l) **Permissive application of certain arbitrage updates—**
  - (1) **In general.** Except as otherwise provided in this [paragraph (l)](#l), issuers may apply the provisions described in paragraph [(k)(1)](#k-1), [(2)](#k-2), and [(5)](#k-5) in whole, but not in part, to bonds sold before October 17, 2016.
  - (2) **Computation credit.** Issuers may apply § [1.148-3(d)(1)(iv)](/cfr/26/1.148-3.md?p=d-1-iv) and [(d)(4)](/cfr/26/1.148-3.md?p=d-d-4) for bond years ending on or after July 18, 2016.
  - (3) **Yield reduction payments.** Issuers may apply [§ 1.148-5(c)(3)](/cfr/26/1.148-5.md?p=c-3) for investments purchased on or after July 18, 2016.
  - (4) **External commingled funds.** Issuers may apply [§ 1.148-5(e)(2)(ii)(B)](/cfr/26/1.148-5.md?p=e-2-ii-B) with respect to costs incurred on or after July 18, 2016.
- (m) **Definition of issue price.** The definition of issue price in § [1.148-1(b)](/cfr/26/1.148-1.md?p=b) and [(f)](/cfr/26/1.148-1.md?p=f) applies to bonds that are sold on or after June 7, 2017.
- (n) **Investment-type property.** Section [1.148-1(e)(1)](/cfr/26/1.148-1.md?p=e-1) and [(4)](/cfr/26/1.148-1.md?p=e-4) apply to bonds sold on or after July 8, 2019. An issuer may apply the provisions of § [1.148-1(e)(1)](/cfr/26/1.148-1.md?p=e-1) and [(4)](/cfr/26/1.148-1.md?p=e-4) to bonds sold before July 8, 2019.