Community Development District Bond's Tax Exempt Status In Jeopardy

This summer the Internal Revenue Service ruled that the bonds sold by a Florida community development district were not tax exempt. According to the article,

Securities issued by Village Center Community Development District, created by billionaire H. Gary Morse, don’t provide tax-free income because the entity isn’t a political arm of the state.

This a huge deal for residential developments in Florida as if these bonds are not considered tax exempt, it will make residential development much more difficult.

Community development districts are a very widely used form of financing for developments in Florida. They are special purpose government frameworks and are used as an alternative to municipal incorporation. Developers love CDDs because the bonds pay for common community infrastructure at no cost to the developer. There is a huge market for these securities as Florida CDD’s have sold over $6 billion worth of CDD bonds. A CDD can reduce the land development costs per lot by several thousand dollars which can juice returns by several hundred basis points. Honestly in the current climate it's really hard to make a deal pencil during underwriting without a CDD. If the tax status of these bonds changes it could have a huge effect on land development in Florida.

The bonds are tax-free because they are designed to provide amenities for the community. Morse apparently took significant strides to make sure that the assets paid for by the bonds were not controlled by the community. He built amenities such as golf courses, pools, and guard houses for the development and then sold them to the residents through district boards that set the prices for the assets. The boards were appointed by Morse and consisted of mostly people who worked for him. Instead of giving over control to the residents of the community he still had control of the boards. The assets were essentially privately run and were kept out of the control of the community which defeats the purpose of the bonds (serviced by the residents) paying for them. While losing the tax status of the bonds may not seem like a big deal, it actually could have a huge impact on developers. To put it in perspective. Morse’s personal fortune is valued at approximately $2.6 billion dollars. Since the community development district was formed in 1992, Morse has received $955 million directly from these tax free bonds.

While it is not yet clear whether this ruling will apply to other developments in Florida. The key is what happens to the board. Morse controls the board, not the residents, which means that the amenities are not given to the community. In most districts control of the board is conveyed to the residents and in these cases the IRS may allow the income from the bonds to remain tax free.