Build America Bonds (Direct Payment)1 (BABs), authorized by the American Recovery and Reinvestment Act of 2009 (ARRA), provide a new financing vehicle to public housing authorities and housing finance agencies for government-owned affordable and workforce housing without the tenant income constraints imposed by the federal tax code on low-income housing tax credits and multifamily private activity bonds. BABs provide significant flexibility in financing rental housing that addresses specific local housing needs, such as workforce housing and housing targeted toward first responders, teachers, firefighters, police officers, and hospital workers.   
BABs are taxable bonds that may be issued by a governmental entity for any purpose for which tax-exempt governmental bonds can be issued, including rental housing. Because BABs cannot be private activity bonds, rental housing financed with BABs must be owned by a governmental entity. BABs may be secured by the same sources the governmental entity would use if issuing tax-exempt governmental bonds for affordable housing, such as public housing capital fund and ARRA capital fund grants. In addition, other funding sources available to public housing authorities and housing finance agencies, such as CDBG, NSP, HOME, and Section 108 funds, may be utilized to provide "gap financing" in the form of soft subordinate loans.

To offset the cost of the higher taxable interest rate on BABs, ARRA provides for a direct payment by the U.S. Treasury to the BABs issuer (Direct Payment) equal to 35 percent of the interest paid to the holders of the bonds. On April 3, 2009, Treasury issued Notice 2009-26 (Notice) that provides guidance for, among other matters, the permitted uses of BABs and the procedures for applying for the Direct Payments.  The BABs issuer must apply for the Direct Payment each time an interest payment is made to bondholders by filing Form 8038-CP with the Internal Revenue Service. The Notice also provides that the BABs issuer may designate another party, such as the bond trustee, to receive the Direct Payments. For example, if the issuer pledges the 35 percent Direct Payments as security for the bonds, bondholders may require that the Direct Payments be made by the U.S. Treasury directly to the bond trustee.

Although each Direct Payment is in the nature of a grant, projects financed with BABs are not required to meet the Davis-Bacon prevailing wage rules or the Buy American rules of ARRA. The Direct Payments are, for tax purposes, a "refund" of taxes and, therefore, can be offset by amounts owed by the BABs issuer to the federal government, including taxes such as payroll taxes.

The following parameters apply to BABs as indicated in the Notice:

    1. BABs must be issued in 2009 or 2010;
    2. BABs proceeds may be used only for the following purposes: 
      1. capital expenditures (not working capital or operating deficits), including reimbursements otherwise permitted under tax-exempt bond rules;
      2. establishment of a reasonably required reserve (not to exceed 10 percent of proceeds); and
      3. costs of issuance up to 2 percent of bond proceeds;
      4. BABs proceeds may not be used to refund obligations, other than short-term bridge financings issued after February 17, 2009; and
      5. BABs may be issued with no more than a de minimis bond premium.

    To discuss how public housing authorities and housing finance agencies might use Build America Bonds (Direct Payment) to finance affordable or workforce housing, please call any of the attorneys in Ballard Spahr's Housing Group for assistance.

    Click on each link for the following:

    IRS News Release (IR-2009-33) dated April 3, 2009

    Notice 2009-26

    Form 8038-CP

    A chart illustrating use of Build America Bonds and other financing sources authorized under ARRA to assist in financing governmental housing

    1. ARRA also authorized Build America Bonds (Tax Credit) that offer financing opportunities for affordable and workforce housing by providing a bondholder with taxable interest and a tax credit against federal income tax liability. To date, the market for these bonds has not developed. This alert discusses only Build America Bonds (Direct Payment).

    Ballard Spahr's Housing Group comprises more than 80 attorneys who represent a broad range of clients in every major sector of the housing industry. Our mission: To provide comprehensive legal services and innovative solutions to enable clients to develop, finance, and preserve affordable and market-rate housing nationwide. For more information, please contact the group's co-chairs, Mary Jo George at / 202.661.2208 or Paul K. Casey at / 410.528.5694.

    Copyright © 2009 by Ballard Spahr LLP.
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    This newsletter is a periodic publication of Ballard Spahr LLP and is intended to alert the recipients to new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your situation and specific legal questions you have.