An unnecessary (but hopefully interesting) introduction:

Earlier this year, the great economist and mathematician, John Nash, passed away in a car accident outside his home in New Jersey.  In 1994, John Nash won the Nobel Prize (formally referred to as the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel) for economics for his contributions to the field of game theory.[1]  Nash developed the Nash Equilibrium (be sure to watch the link), which analyzes how people and markets operate in a non-cooperative environment and which was depicted in the 2001 film A Beautiful Mind.[2]   The Nash Equilibrium did not agree with the then well-established principle of the Invisible Hand, which was conceived of by Adam Smith over two hundred years before.  Smith’s Invisible Hand contemplated that society benefits from the uncoordinated, self-serving actions of individuals rather than a coordinated effort by individuals.  Put another way, relying exclusively on people acting in their own self-interests, Smith posited that market forces would exert an invisible hand to instruct the economy without external intervention.[3]

The Invisible Hand and Tax-Exempt Bonds

A similar concept applies in the area of tax-exempt bonds. The Internal Revenue Code and Treasury Regulations impose limits on the amount of private business use of tax-exempt bond proceeds that may occur (the limit is either 5% or 10% of the proceeds depending on whether the private business use is unrelated or disproportionate to the governmental use of the bond proceeds or whether the bonds are qualified 501(c)(3) bonds rather than governmental use bonds).  Treas. Reg. Section 1.141-3 identifies various arrangements that will result in private business use.  Common examples include leases of bond-financed property to “private persons,” non-qualifying management contracts with “private persons”, and residual contracts entered into with respect to bond-financed property (if the management contact does not satisfy a safe harbor from private business use and results in private business use under a facts-and-circumstances analysis).  Such uses are common and often easily identifiable.

It is exceedingly more difficult to identify another type of private business use that can arise when the “invisible hand” of a private business user exerts control over a bond-financed facility even without using it directly.

In addition to leases, management contracts, and research agreements, Treas. Reg. Section 1.141-3(f)(7) contains a catch-all provision that says that private business use can also arise from “other actual or beneficial use.”  According to the Regulations, such use arises whenever a private person enters into an arrangement with a governmental party (or a qualified 501(c)(3) user in the case of qualified 501(c)(3) bonds) that conveys special legal entitlements for beneficial use of bond-financed property.  Not surprisingly, the arrangements that constitute special legal entitlements are somewhat subjective and are determined on a case-by-case basis.  The Regulations do indicate that special legal entitlements may arise in circumstances where a right similar to a recognized private business use (e.g., ownership, lease, management contract, etc.) is conveyed via an agreement that does not otherwise constitute a recognized private business use.

As the IRS guidance listed below suggests, a special legal entitlement can occur without any physical contact with the bond-financed property.  Rather, special legal entitlements may arise when a private person exercises sufficient control or influence over bond-financed property.  Because it is subjective, the best course to determine if such an entitlement arises is by analogy to situations where the IRS has identified a special legal entitlement of bond-financed property.   Of course, there may be many instances where there is some entitlement that is not sufficient to constitute a special legal entitlement.  Until more examples are available, the analysis may be difficult.  For your reference, a few of those scant existing examples are as follows:


Special Legal Entitlement


Treas. Reg. § 1.141-3(f) (Ex.5)

Approval of parking rates

After conveying property to a city for the construction of a parking lot, the retention by the corporation of the ability to control the rates charged by the city is a special legal entitlement.
PLR 200347009

License to intellectual property and/or right to income from intellectual property

A tax-exempt research institute used bond funding to construct a laboratory complex and then entered into an exclusive license agreement with a corporation to market and commercialize the research.  The Corporation’s right to market and commercialize research was tantamount to an ownership interest.
PLR 199928036

Various elements of control discussed, including approval authority over agreements entered into by Issuer

A private sports team had sufficient control over a bond-financed stadium to constitute a special legal entitlement notwithstanding that use (and possession) of the stadium was leased to public universities pursuant to a lease agreement.
PLR 200323006 (discussed on a prior post here)

The right to require a bond-financed facility to be referred to by a particular name for a term of years 

A city-owned convention center attempted to sell its naming rights to a private party.  The IRS found that because the contract provided specific rules regarding the manner in which the convention center would be operated, it gave the private party a special legal entitlement.  Compare PLR 201049003, discussed on a prior post here, which did not find a special legal entitlement in facts somewhat similar to those in PLR 200323006.
CCA 200143031

Interest in net profits earned from bond-financed facility

A private air carrier’s terminal lease payments were adjusted downward based on net profits received from a bond-financed parking garage that was operated and owned by the airport authority.


Outside of examples like the above, it is very difficult to definitively conclude that certain arrangements do or do not bestow upon private persons sufficient control to result in private business use.  A special legal entitlement may arise from a contract that gives a private business user the exclusive right to distribute a particular product (e.g., pouring rights) or to provide a particular service (e.g., catering).  Suffice it to say, in addition to the common examples such as a lease or a management contract, private business use might occur anytime a private person’s invisible hand exerts sufficient control over bond-financed space, even if that user does not directly use or possess the bond-financed space.

[1]               Nash shared the award with two other economists, John Harsanyi and Reinhard Selten.

[2]               Sylvia Nasar’s book with the same title is a fantastic, if not slightly darker, depiction of Nash’s life.

[3]               I am a 103 Lawyer…not an economist.