Tax-Exempt Bonds: Managing Private Use in University Facilities

In today’s competitive higher education industry, institutions are constantly seeking innovative ways to grow revenue streams, especially through athletic facilities like stadiums. But when these facilities are financed with tax-exempt bonds, critical considerations surrounding private use must be understood to avoid potential tax complications.

Understanding Tax-Exempt Bonds and Private Use

Tax-exempt bonds allow universities and colleges to finance capital projects at a lower cost due to their federal tax-exempt status. This advantage makes them a popular choice for funding large infrastructure projects like dormitories, academic buildings and athletic facilities.

However, a key limitation of tax-exempt bonds is the restriction on the amount of private business use (PBU) that can occur in the facility financed by these bonds. Private business use is defined as the use of a tax-exempt bond-financed facility by a private entity for trade or business purposes.

For higher education institutions, this becomes relevant when leasing or granting access to athletic facilities to third parties, such as private businesses, sports teams or other non-governmental entities.

Private Use Considerations and IRS Guidance

Private letter rulings (PLRs) are written decisions by the IRS that offer specific interpretations of tax laws in response to a taxpayer’s request for clarification. While they’re binding only to the requesting party, they provide useful guidance on how the IRS applies tax regulations.

In one such ruling, the IRS found that private business use can occur even without a private entity taking physical possession of a facility. In that case, a tax-exempt bond-financed sports facility sold naming rights to a private business. The IRS concluded that granting these rights, including associated marketing rights (such as logos and exclusive sponsorship), resulted in private use of the facility.

This ruling highlights the need for universities to be cautious when entering into naming rights agreements. The IRS views such rights as a form of private use, potentially jeopardizing the tax-exempt status of the bonds.

Institutions should also evaluate other potential private use arrangements, such as exclusive sponsorships, pouring rights and merchandise rights. These types of agreements can also contribute to the private use percentage and may risk crossing the 10% threshold allowed by the IRS, which could lead to significant tax consequences.

Implications for Athletic Facility Revenue Generation

Institutions often generate additional revenue from their athletic facilities through partnerships — naming rights, sponsorship deals and leasing for non-university events like concerts. While these strategies can provide a significant revenue boost, they also increase the risk of surpassing the private use limits on tax-exempt bonds.

If a university enters into a naming rights agreement that grants exclusive rights to certain areas or access during events, this could be considered private use. Renting out the stadium for non-university events can add to the private use percentage.

When Taxable Bonds May Be the Solution

When the institution anticipates significant private use of a facility, it might make sense to issue taxable bonds instead of tax-exempt bonds. Although taxable bonds typically come with higher interest rates, they offer more flexibility, allowing institutions to maximize revenue opportunities without regulatory limitations. This approach may be particularly useful for universities planning to leverage athletic facilities for revenue through substantial private partnerships or events.

Key Takeaways for Higher Education Institutions

As universities explore revenue growth from athletic facilities, understanding the private use restrictions of tax-exempt bonds is essential. For institutions looking to maximize private partnerships or events at these venues, careful planning is necessary to avoid breaching the IRS’s private use limits.

When significant private use is anticipated, considering taxable bonds from the outset may provide institutions with the financial flexibility to pursue their revenue goals without risking the tax-exempt status of bonds.

If you have questions or aren’t sure which is right for you, discuss with a qualified higher education CPA. They’ll have the knowledge to help you make this important choice.

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