[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.148-0]

[Page 675-678]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.148-0  Scope and table of contents.

    (a) Overview. Under section 103(a), interest on certain obligations 
issued by States and local governments is excludable from the gross 
income of the owners. Section 148 was enacted to minimize the arbitrage 
benefits from investing gross proceeds of tax-exempt bonds in higher 
yielding investments and to remove the arbitrage incentives to issue 
more bonds, to issue bonds earlier, or to leave bonds outstanding longer 
than is otherwise reasonably necessary to accomplish the governmental 
purposes for which the bonds were issued. To accomplish these purposes, 
section 148 restricts the direct and indirect investment of bond 
proceeds in higher yielding investments and requires that certain 
earnings on higher yielding investments be rebated to the United States. 
Violation of these provisions causes the bonds in the issue to become 
arbitrage bonds, the interest on which is not excludable from the gross 
income of the owners under section 103(a). The regulations in Sec. Sec. 
1.148-1 through 1.148-11 apply in a manner consistent with these 
purposes.
    (b) Scope. Sections 1.148-1 through 1.148-11 apply generally for 
purposes of the arbitrage restrictions on State and local bonds under 
section 148.
    (c) Table of contents. This paragraph (c) lists the table of 
contents for Sec. Sec. 1.148-1, 1.148-2, 1.148-3, 1.148-4, 1.148-5, 
1.148-6, 1.148-7, 1.148-8, 1.148-9, 1.148-10 and 1.148-11.

Sec. 1.148-1 Definitions and elections.
    (a) In general.
    (b) Certain definitions.
    (c) Definition of replacement proceeds.
    (1) In general.
    (2) Sinking fund.
    (3) Pledged fund.
    (4) Other replacement proceeds.
    (d) Elections.
    (e) Investment-type property.
    (1) In general.
    (2) Prepayments.
    (3) Certain hedges.
Sec. 1.148-2 General arbitrage yield restriction rules.
    (a) In general.
    (b) Reasonable expectations.
    (1) In general.
    (2) Certification of expectations.
    (c) Intentional acts.
    (d) Materially higher yielding investments.
    (1) In general.
    (2) Definitions of materially higher yield.
    (3) Mortgage loans.
    (e) Temporary periods.
    (1) In general.
    (2) General 3-year temporary period for capital projects and 
qualified mortgage loans.
    (3) Temporary period for restricted working capital expenditures.
    (4) Temporary period for pooled financings.
    (5) Temporary period for replacement proceeds.
    (6) Temporary period for investment proceeds.

[[Page 676]]

    (7) Other amounts.
    (f) Reserve or replacement funds.
    (1) General 10 percent limitation on funding with sale proceeds.
    (2) Exception from yield restriction for reasonably required reserve 
or replacement funds.
    (3) Certain parity reserve funds.
    (g) Minor portion.
    (h) Certain waivers permitted.
Sec. 1.148-3 General arbitrage rebate rules.
    (a) In general.
    (b) Definition of rebate amount.
    (c) Computation of future value of a payment or receipt.
    (d) Payments and receipts.
    (1) Definition of payments.
    (2) Definition of receipts.
    (3) Special rules for commingled funds.
    (e) Computation dates.
    (1) In general.
    (2) Final computation date.
    (f) Amount of required rebate installment payment.
    (1) Amount of interim rebate payments.
    (2) Amount of final rebate payment.
    (3) Future value of rebate payments.
    (g) Time and manner of payment.
    (h) Penalty in lieu of loss of tax exemption.
    (1) In general.
    (2) Interest on underpayments.
    (3) Waivers of the penalty.
    (4) Application to alternative penalty under Sec. 1.148-7.
    (i) Recovery of overpayment of rebate.
    (1) In general.
    (2) Limitations on recovery.
    (j) Examples.
    (k) Bona fide debt service fund exception.
Sec. 1.148-4 Yield on an issue of bonds.
    (a) In general.
    (b) Computing yield on a fixed yield issue.
    (1) In general.
    (2) Yield on certain fixed yield bonds subject to mandatory or 
contingent early redemption.
    (3) Yield on certain fixed yield bonds subject to optional early 
redemption.
    (4) Yield recomputed upon transfer of certain rights associated with 
the bond.
    (5) Special aggregation rule treating certain bonds as a single 
fixed yield bond.
    (6) Examples.
    (c) Computing yield on a variable yield issue.
    (1) In general.
    (2) Payments on bonds included in yield for a computation period.
    (3) Example.
    (d) Conversion from variable yield issue to fixed yield issue.
    (e) Value of bonds.
    (1) Plain par bonds.
    (2) Other bonds.
    (f) Qualified guarantees.
    (1) In general.
    (2) Interest savings.
    (3) Guarantee in substance.
    (4) Reasonable charge.
    (5) Guarantee of purpose investments.
    (6) Allocation of qualified guarantee payments.
    (7) Refund or reduction of guarantee payments.
    (g) Yield on certain mortgage revenue and student loan bonds.
    (h) Qualified hedging transactions.
    (1) In general.
    (2) Qualified hedge defined.
    (3) Accounting for qualified hedges.
    (4) Certain variable yield bonds treated as fixed yield bonds.
    (5) Contracts entered into before issue date of hedged bond.
    (6) Authority of the Commissioner.
Sec. 1.148-5 Yield and valuation of investments.
    (a) In general.
    (b) Yield on an investment.
    (1) In general.
    (2) Yield on a separate class of investments.
    (3) Investments to be held beyond issue's maturity or beyond 
temporary period.
    (4) Consistent redemption assumptions on purpose investments.
    (5) Student loan special allowance payments included in yield.
    (c) Yield reduction payments to the United States.
    (1) In general.
    (2) Manner of payment.
    (3) Applicability of special yield reduction rule.
    (d) Value of investments.
    (1) In general.
    (2) Mandatory valuation of yield restricted investments at present 
value.
    (3) Mandatory valuation of certain investments at fair market value.
    (4) Special transition rule for transferred proceeds.
    (5) Definition of present value of an investment.
    (6) Definition of fair market value.
    (e) Administrative costs of investments.
    (1) In general.
    (2) Qualified administrative costs on nonpurpose investments.
    (3) Qualified administrative costs on purpose investments.
Sec. 1.148-6 General allocation and accounting rules.
    (a) In general.
    (1) Reasonable accounting methods required.
    (2) Bona fide deviations from accounting method.
    (b) Allocation of gross proceeds to an issue.
    (1) One-issue rule and general ordering rules.
    (2) Universal cap on value of nonpurpose investments allocated to an 
issue.
    (c) Fair market value limit on allocations to nonpurpose 
investments.

[[Page 677]]

    (d) Allocation of gross proceeds to expenditures.
    (1) Expenditures in general.
    (2) Treatment of gross proceeds invested in purpose investments.
    (3) Expenditures for working capital purposes.
    (4) Expenditures for grants.
    (5) Expenditures for reimbursement purposes.
    (6) Expenditures of certain commingled investment proceeds of 
governmental issues.
    (7) Payments to related parties.
    (e) Special rules for commingled funds.
    (1) In general.
    (2) Investments held by a commingled fund.
    (3) Certain expenditures involving a commingled fund.
    (4) Fiscal periods.
    (5) Unrealized gains and losses on investments of a commingled fund.
    (6) Allocations of commingled funds serving as common reserve funds 
or sinking funds.
Sec. 1.148-7 Spending exceptions to the rebate requirement.
    (a) Scope of section.
    (1) In general.
    (2) Relationship of spending exceptions.
    (3) Spending exceptions not mandatory.
    (b) Rules applicable for all spending exceptions.
    (1) Special transferred proceeds rules.
    (2) Application of multipurpose issue rules.
    (3) Expenditures for governmental purposes of the issue.
    (4) De minimis rule.
    (5) Special definition of reasonably required reserve or replacement 
fund.
    (6) Pooled financing issue.
    (c) 6-month exception.
    (1) General rule.
    (2) Additional period for certain bonds.
    (3) Amounts not included in gross proceeds.
    (4) Series of refundings.
    (d) 18-month exception.
    (1) General rule.
    (2) Extension for reasonable retainage.
    (3) Gross proceeds.
    (4) Application to multipurpose issues.
    (e) 2-year exception.
    (1) General rule.
    (2) Extension for reasonable retainage.
    (3) Definitions.
    (f) Construction issue.
    (1) Definition.
    (2) Use of actual facts.
    (3) Ownership requirement.
    (g) Construction expenditures.
    (1) Definition.
    (2) Certain acquisitions under turnkey contracts treated as 
construction expenditures.
    (3) Constructed personal property.
    (4) Specially developed computer software.
    (5) Examples.
    (h) Reasonable retainage definition.
    (i) Available construction proceeds.
    (1) Definition in general.
    (2) Earnings on a reasonably required reserve or replacement fund.
    (3) Reasonable expectations test for future earnings.
    (4) Issuance costs.
    (5) One and one-half percent penalty in lieu of arbitrage rebate.
    (6) Payments on purpose investments and repayments of grants.
    (7) Examples.
    (j) Election to treat portion of issue used for construction as 
separate issue.
    (1) In general.
    (2) Example.
    (k) One and one-half percent penalty in lieu of arbitrage rebate.
    (1) In general.
    (2) Application to reasonable retainage.
    (3) Coordination with rebate requirement.
    (l) Termination of 1\1/2\ percent penalty.
    (1) Termination after initial temporary period.
    (2) Termination before end of initial temporary period.
    (3) Application to reasonable retainage.
    (4) Example.
    (m) Payment of penalties.
Sec. 1.148-8 Small issuer exception to rebate requirement.
    (a) Scope.
    (b) General taxing powers.
    (c) Size limitation.
    (1) In general.
    (2) Aggregation rules.
    (3) Certain refunding bonds not taken into account.
    (d) Pooled financings.
    (1) Treatment of pool issuer.
    (2) Treatment of conduit borrowers.
    (e) Refunding issues.
    (1) In general.
    (2) Multipurpose issues.
Sec. 1.148-9 Arbitrage rules for refunding issues.
    (a) Scope of application.
    (b) Transferred proceeds allocation rule.
    (1) In general.
    (2) Special definition of principal amount.
    (3) Relation of transferred proceeds rule to universal cap rule.
    (4) Limitation on multi-generational transfers.
    (c) Special allocation rules for refunding issues.
    (1) Allocations of investments.
    (2) Allocations of mixed escrows to expenditures for principal, 
interest, and redemption prices on a prior issue.
    (d) Temporary periods in refundings.
    (1) In general.
    (2) Types of temporary periods in refundings.
    (e) Reasonably required reserve or replacement funds in refundings.

[[Page 678]]

    (f) Minor portions in refundings.
    (g) Certain waivers permitted.
    (h) Multipurpose issue allocations.
    (1) Application of multipurpose issue allocation rules.
    (2) Rules on allocations of multipurpose issues.
    (3) Separate purposes of a multipurpose issue.
    (4) Allocations of bonds of a multipurpose issue.
    (5) Limitation on multi-generation allocations.
    (i) Operating rules for separation of prior issues into refunded and 
unrefunded portions.
    (1) In general.
    (2) Allocations of proceeds and investments in a partial refunding.
    (3) References to prior issue.
Sec. 1.148-10 Anti-abuse rules and authority of Commissioner.
    (a) Abusive arbitrage device.
    (1) In general.
    (2) Abusive arbitrage device defined.
    (3) Exploitation of tax-exempt interest rates.
    (4) Overburdening the tax-exempt market.
    (b) Consequences of overburdening the tax-exempt bond market.
    (1) In general.
    (2) Application.
    (c) Anti-abuse rules on excess gross proceeds of advance refunding 
issues.
    (1) In general.
    (2) Definition of excess gross proceeds.
    (3) Special treatment of transferred proceeds.
    (4) Special rule for crossover refundings.
    (5) Special rule for gross refundings.
    (d) Examples.
    (e) Authority of the Commissioner to clearly reflect the economic 
substance of a transaction.
    (f) Authority of the Commissioner to require an earlier date for 
payment of rebate.
    (g) Authority of the Commissioner to waive regulatory limitations.
Sec. 1.148-11 Effective dates.
    (a) In general.
    (b) Elective retroactive application in whole.
    (1) In general.
    (2) No elective retroactive application for 18-month spending 
exception.
    (3) No elective retroactive application for hedges of fixed rate 
issues.
    (4) No elective retroactive application for safe harbor for 
establishing fair market value for guaranteed investment contracts and 
investments purchased for a yield restricted defeasance escrow.
    (c) Elective retroactive application of certain provisions.
    (1) Retroactive application of overpayment recovery provisions.
    (2) Certain allocations of multipurpose issues.
    (3) Special limitation.
    (d) Transition rule excepting certain state guarantee funds from the 
definition of replacement proceeds.
    (1) Certain perpetual trust funds.
    (2) Permanent University Fund.
    (e) Transition rule regarding special allowance payments.
    (f) Transition rule regarding applicability of yield reduction rule.
    (g) Provisions applicable to certain bonds sold before effective 
date.
    (h) Safe harbor for establishing fair market value for guaranteed 
investment contracts and investments purchased for a yield restricted 
defeasance escrow.
    (i) Special rule for certain broker's commissions and similar fees.
    (j) Certain prepayments.

[T.D. 8476, 58 FR 33515, June 18, 1993, as amended by T.D. 8538, 59 FR 
24041, May 10, 1994; T.D. 8718, 62 FR 25506, May 9, 1997; T.D. 9085, 68 
FR 45775, Aug. 4, 2003; T.D. 9097, 68 FR 69022, Dec. 11, 2003]