Brooklyn arena financing (as well as the two NYC stadiums): an exception to the "exception to the exception" in the tax code

Would you believe that sports facility financing in New York City is so byzantine that it qualifies as an exception to the third power?

Let's go to What’s the Easiest Way to Cheat on Your Taxes?, a column in today's New York Times Magazine about various questions "you always wanted to ask your accountant:

Why is the tax code so complicated?

The answer, according to most accountants, is simple: “exceptions to the exceptions,” which, typically, are extremely complicated. John Yeutter, a C.P.A. who teaches accounting at Northeastern State University in Tahlequah, Okla., offered the following example:

RULE: When you buy a bond, you have to pay taxes on the interest payments you receive.

EXCEPTION: You don’t have to pay taxes on interest from municipal bonds (because the federal government wants to make it easy for local governments to borrow money).

EXCEPTION TO THE EXCEPTION: If a municipal bond is used to finance a professional sports arena, you have to pay taxes on the interest (the government doesn’t want to support a sports team).

Now imagine this times a thousand. “Each step along the way is great,” Yeutter says. “But after 100 years, we have a system that is very, very complex.”

Indeed it is, because there's yet another exception.

The new Yankee Stadium in the Bronx, the Mets' new Citifield in Queens, and the emerging Barclays Center arena (for the Brooklyn Nets) are all financed via a clever scheme, fully tax-exempt.

From the IBO

The New York City Independent Budget Office, in its September 2009 Fiscal Brief on Atlantic Yards:

Access to Tax-Exempt Financing. Much of the construction costs of the arena would be financed through tax-exempt bond to be issued by a special local development corporation formed by the Empire State Development Corporation for this project. Tax-exempt bonds pay lower interest rates than do taxable bonds because investors are willing to accept less income in exchange for paying less income tax. This results in savings for the developer and costs to the public taxing jurisdictions when the income from the bonds is excluded from income subject to personal income tax.

A 1986 amendment to the Internal Revenue Code sponsored by the late Senator Patrick Moynihan sought to make it much harder to use tax-exempt bonds to finance the construction of sports facilities. The intent of the amendment was to require  that jurisdictions using tax-exempt bonds for such a purpose could only do so if the revenue pledged as debt service came from a general revenue source applicable across a jurisdiction. If the debt service was to be paid largely by the owner or operator
of the sports facility, then the bonds would not qualify for tax-exempt status.

In securing tax-exempt financing for most of the construction costs of the new baseball stadiums for the Yankees and the Mets the city and its financial advisors found a way to circumvent these strictures. From a practical perspective, the two new stadiums are privately built and operated facilities with no annual rental payments due to the city, as had been the case in the old stadiums. From a technical perspective, however, they are publicly owned facilities built on land that has been leased to the stadium developers through 99-year ground leases. By structuring the deals so that the new stadiums are publicly owned, the city could offer the teams property tax exemptions, saving each of the teams hundreds of millions of dollars. Although exempt from property tax, the teams make payments in lieu of taxes (PILOTs), but rather than routing them to the city’s General Fund, they are diverted to pay debt service on the tax-exempt construction bonds.

In 2006, when the city completed its negotiations with the two baseball teams, there was some concern that this arrangement would not comply with the Moynihan rules because it appeared that the debt was being serviced with a revenue stream flowing only from the stadiums (the PILOTs) rather than a general revenue source such as the property tax. In order to clarify the issue, the city requested and received a letter ruling from the Internal Revenue service (IRs) stating that the arrangement was acceptable, and financing for the city’s baseball stadiums proceeded as planned. The IRs subsequently reconsidered the matter and issued regulations that effectively prohibit such arrangements in the future.

Nevertheless, the plan is to use the same arrangement for the Atlantic Yards arena, although to do so, the arena bonds must be sold by December 31, 2009. That is because the new IRS regulations provided a grandfather clause that left a temporary window for ESDC and FCRC to use the Yankees/Mets funding arrangement at Atlantic Yards, provided they do so before the deadline. If the bonds cannot be sold before the deadline, the financing costs for the arena would grow substantially. 

IBO estimates that allowing the use of tax-exempt bonds will result in reduced interest expenses that save FCRC $194 million (present value). The total cost (present value) to the public sector would be $200 million, with by far the largest share borne by the federal treasury ($194 million), while the state loses $5 million and the city $2 million. 

[Given that tax-exempt bonds worth $511 million were ultimately sold, rather than the $678 million the IBO assumed, I'd cut the savings by about a quarter.]