The time has come, friends. The Rebate Series ends with this post. At least for a little while. So far we’ve covered the basics of arbitrage and rebate and two key timing-based spending exceptions: the 6-Month Exception and the 18-Month Exception. This party bus now comes to a halt with the Two-Year Spending Exception, the last and longest of the timing-based exceptions to the rebate requirement. If you’ve made it this far, thank you. If this is your first rebate-related post, please read the previous posts setting the stage. 

Episode 3: Rebate & Arbitrage 101 – Two-Year Spending Exception

Like its name suggests, the Two-Year Spending Exception provides an exception to the rebate requirement for certain non-refunding issues when net proceeds of such bonds are spent within two years of the issue date of the bonds.  This exception is only available for: (1) governmental bonds, (2) qualified 501(c)(3) bonds, and (3) private activity bonds that finance property owned by a governmental unit or a 501(c)(3) organization.

Additionally, and unlike the 6- and 18-Month Exceptions, to qualify for the Two-Year Exception, an issuer must reasonably expect at least 75% of the “Available Construction Proceeds” of the issue will be used for construction expenditures. Construction expenditures are those capital expenditures allocable to the cost of real property or constructed personal property, which may include rehabilitation costs.  Available Construction Proceeds are defined as…

[issue price + investment earnings on entire issue price + earnings and investment earnings on any reasonably required reserve or replacement fund[1] – costs of issuance – amounts deposited in a reasonably required reserve or replacement fund]

Investment earnings include actual earnings up to the end of each 6-month spending period (shown below) and the reasonably expected earnings thereafter, unless the issuer elects on or before the issuance date to apply actual facts, rather than reasonable expectations, to ascertain the investment earnings. If the issuer does not make this election, the issuer must evaluate and reevaluate its earnings expectations every six months during the two-year construction period to recalculate the Available Construction Proceeds to ensure that the issue is still eligible for this exception to rebate.[2]  

Just like with the other two spending exceptions, there are certain spending benchmarks an issuer must hit to qualify for the Two-Year Spending Exception:

  • At least 10% of Available Construction Proceeds allocated to expenditures within 6 months after the issuance date;
  • At least 45% of Available Construction Proceeds allocated to expenditures within 12 months after the issuance date;  
  • At least 75% of Available Construction Proceeds allocated to expenditures within 18 months after the issuance date, and
  • 100% of Available Construction Proceeds allocated to expenditures within two years after the issuance date, subject to reasonable retainage and de minimis exceptions.

The reasonable retainage and de minimis exceptions, which were discussed in the previous post, allow an issuer to still qualify for the Two-Year Spending Exception if (1) unspent amounts retained for reasonable business purposes (think costs associated construction compliance or funds to cover potential construction-related disputes), not to exceed 5% of the Available Construction Proceeds, are spent within three years of the issue date and/or (2) proceeds equal to the lesser of 3% of Available Construction Proceeds or $250,000 (a so-called de minimis amount in the IRS’s eyes) remain unspent and the issue exercised due diligence to complete the project within the two-year time frame.


[1] These earnings are included in Available Construction Proceeds for the period from the issue date until the earlier of the date construction is substantially complete or two years from the issue date. On or before the issue date, an issuer may elect to exclude these earnings from being considered Available Construction Proceeds, which will then subject the earnings to rebate.

[2] To make things a little bit easier, issuers can use reasonably expected earnings as of the issue date to determine the Available Construction Proceeds for the first three semiannual spending periods.