[Code of Federal Regulations]
[Title 26, Volume 2]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.148-5]
[Page 682-689]
TITLE 26--INTERNAL REVENUE
CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY
(CONTINUED)
PART 1--INCOME TAXES--Table of Contents
Sec. 1.148-5 Yield and valuation of investments.
(a) In general. This section provides rules for computing the yield
and value of investments allocated to an issue for various purposes
under section 148.
(b) Yield on an investment--(1) In general. Except as otherwise
provided, the yield on an investment allocated to an issue is computed
under the economic accrual method, using the same compounding interval
and financial conventions used to compute the yield on the issue. The
yield on an investment allocated to an issue is the discount rate that,
when used in computing the present value as of the date the investment
is first allocated to the issue of all unconditionally payable receipts
from the investment, produces an amount equal to the present value of
all unconditionally payable payments for the investment. For this
purpose, payments means amounts to be actually or constructively paid to
acquire the investment, and receipts means amounts to be actually or
constructively received from the investment, such as earnings and return
of principal. The yield on a variable rate investment is determined in a
manner comparable to the determination of the yield on a variable rate
issue. For an issue of qualified mortgage bonds, qualified veterans'
mortgage bonds, or qualified student loan bonds on which interest is
paid semiannually, all regular monthly loan payments to be received
during a semiannual debt service period may be treated as received at
the end of that period. In addition, for any conduit financing issue,
payments made by the conduit borrower are not treated as paid until the
conduit borrower ceases to receive the benefit of earnings on those
amounts.
(2) Yield on a separate class of investments--(i) In general. For
purposes of the yield restriction rules of section
[[Page 683]]
148(a) and Sec. 1.148-2, yield is computed separately for each class of
investments. For this purpose, in determining the yield on a separate
class of investments, the yield on each individual investment within the
class is blended with the yield on other individual investments within
the class, whether or not held concurrently, by treating those
investments as a single investment. The yields on investments that are
not within the same class are not blended.
(ii) Separate classes of investments. Each of the following is a
separate class of investments--
(A) Each category of yield restricted purpose investment and program
investment that is subject to a different definition of materially
higher under Sec. 1.148-2(d)(2);
(B) Yield-restricted nonpurpose investments; and
(C) All other nonpurpose investments;
(iii) Permissive application of single investment rules to certain
yield restricted investments for all purposes of section 148. For all
purposes of section 148, if an issuer reasonably expects as of the issue
date to establish and maintain a sinking fund solely to reduce the yield
on the investments in a refunding escrow, then the issuer may treat all
of the yield restricted nonpurpose investments in the refunding escrow
and that sinking fund as a single investment having a single yield,
determined under this paragraph (b)(2). Thus, an issuer may not treat
the nonpurpose investments in a reasonably required reserve fund and a
refunding escrow as a single investment having a single yield under this
paragraph (b)(2)(iii).
(iv) Mandatory application of single investment rules for refunding
escrows for all purposes of section 148. For all purposes of section
148, in computing the yield on yield restricted investments allocable to
proceeds (i.e., sale proceeds, investment proceeds, and transferred
proceeds) of a refunding issue that are held in one or more refunding
escrows, the individual investments are treated as a single investment
having a single yield, whether or not held concurrently. For example,
this single investment includes both the individual investments
allocable to sale and investment proceeds of a refunding issue that are
held in one refunding escrow for a prior issue and the investments
allocable to transferred proceeds of that refunding issue that are held
in another refunding escrow.
(3) Investments to be held beyond issue's maturity or beyond
temporary period. In computing the yield on investments allocable to an
issue that are to be held beyond the reasonably expected redemption date
of the issue, those investments are treated as sold for an amount equal
to their value on that date. In computing the yield on investments that
are held beyond an applicable temporary period under Sec. 1.148-2, for
purposes of Sec. 1.148-2 those investments may be treated as purchased
for an amount equal to their fair market value as of the end of the
temporary period.
(4) Consistent redemption assumptions on purpose investments. The
yield on purpose investments allocable to an issue is computed using the
same redemption assumptions used to compute the yield on the issue.
Yield on purpose investments allocable to an issue of qualified mortgage
bonds and qualified veterans' mortgage bonds must be determined in a
manner that is consistent with, and using the assumptions required by,
section 143(g)(2)(B).
(5) Student loan special allowance payments included in yield.
Except as provided in Sec. 1.148-11(e), the yield on qualified student
loans is computed by including as receipts any special allowance
payments made by the Secretary of Education pursuant to section 438 of
the Higher Education Act of 1965.
(c) Yield reduction payments to the United States--(1) In general.
In determining the yield on an investment to which this paragraph (c)
applies, any amount paid to the United States in accordance with this
paragraph (c), including a rebate amount, is treated as a payment for
that investment that reduces the yield on that investment.
(2) Manner of payment--(i) In general. Except as otherwise provided
in paragraph (c)(2)(ii) of this section, an amount is paid under this
paragraph (c) if it is paid to the United States at the same time and in
the same manner as rebate amounts are required to be paid
[[Page 684]]
or at such other time or in such manner as the Commissioner may
prescribe. For example, yield reduction payments must be made on or
before the date of required rebate installment payments as described in
Secs. 1.148-3(f), (g), and (h). The provisions of Sec. 1.148-3(i) apply
to payments made under this paragraph (c).
(ii) Special rule for purpose investments. For purpose investments
allocable to an issue--
(A) No amounts are required to be paid to satisfy this paragraph (c)
until the earlier of the end of the tenth bond year after the issue date
of the issue or 60 days after the date on which the issue is no longer
outstanding; and
(B) For payments made prior to the date on which the issue is
retired, the issuer need not pay more than 75 percent of the amount
otherwise required to be paid as of the date to which the payment
relates.
(3) Applicability of special yield reduction rule--(i) Covered
investments. This paragraph (c) applies to--
(A) Nonpurpose investments allocable to proceeds of an issue that
qualified for one of the temporary periods available for capital
projects, restricted working capital expenditures, pooled financings, or
investment proceeds under Sec. 1.148-2(e)(2), (e)(3), (e)(4), or (e)(6),
respectively;
(B) Investments allocable to a variable yield issue during any
computation period in which at least 5 percent of the value of the issue
is represented by variable yield bonds, unless the issue is an issue of
hedge bonds (as defined in section 149(g)(3)(A));
(C) Nonpurpose investments allocable to transferred proceeds of--
(1) A current refunding issue to the extent necessary to reduce the
yield on those investments to satisfy yield restrictions under section
148(a); or
(2) An advance refunding issue to the extent that investment of the
refunding escrows allocable to the proceeds, other than transferred
proceeds, of the refunding issue in zero-yielding nonpurpose investments
is insufficient to satisfy yield restrictions under section 148(a);
(D) Purpose investments allocable to qualified student loans under a
program described in section 144(b)(1)(A);
(E) Nonpurpose investments allocable to gross proceeds of an issue
in a reasonably required reserve or replacement fund or in a fund that,
except for its failure to satisfy the size limitation in Sec. 1.148-
2(f)(2)(ii), would qualify as a reasonably required reserve or
replacement fund, but only to the extent that--
(1) The value of the nonpurpose investments in the fund is not
greater than 15 percent of the stated principal amount of the issue, as
computed under Sec. 1.148-2(f)(2)(ii), or
(2) The amounts in the fund (other than investment earnings) are not
reasonably expected to be used to pay debt service on the issue other
than in connection with reductions in the amount required to be in that
fund (e.g. a reserve fund for a revolving fund loan program);
(F) Nonpurpose investments allocated to replacement proceeds of a
refunded issue as a result of the application of the universal cap to
amounts in a refunding escrow (see Sec. 1.148-11(c)(1)(ii)); and
(G) Investments described in Sec. 1.148-11(f).
(ii) Exception to yield reduction payments rule for advance
refunding issues. Paragraph (c)(1) of this section does not apply to
investments allocable to gross proceeds of an advance refunding issue,
other than--
(A) Transferred proceeds to which paragraph (c)(3)(i)(C) of this
section applies;
(B) Replacement proceeds to which paragraph (c)(3)(i)(F) of this
section applies; and
(C) Transferred proceeds to which paragraph (c)(3)(i)(E) of this
section applies, but only to the extent necessary to satisfy yield
restriction under section 148(a) on those proceeds treating all
investments allocable to those proceeds as a separate class.
(d) Value of investments--(1) In general. Except as otherwise
provided, the value of an investment (including a payment or receipt on
the investment) on a date must be determined using one of the following
valuation methods consistently for all purposes of section 148 to that
investment on that date:
[[Page 685]]
(i) Plain par investment--outstanding principal amount. A plain par
investment may be valued at its outstanding stated principal amount,
plus any accrued unpaid interest on that date.
(ii) Fixed rate investment--present value. A fixed rate investment
may be valued at its present value on that date.
(iii) Any investment--fair market value. An investment may be valued
at its fair market value on that date.
(2) Mandatory valuation of yield restricted investments at present
value. Any yield restricted investment must be valued at present value.
For example, a purpose investment or an investment allocable to gross
proceeds in a refunding escrow after the expiration of the initial
temporary period must be valued at present value. See, however,
paragraph (b)(3) of this section.
(3) Mandatory valuation of certain investments at fair market value-
-(i) In general. Except as provided in paragraphs (d)(2), (d)(3)(ii),
and (d)(4) of this section, an investment must be valued at fair market
value on the date that it is first allocated to an issue or first ceases
to be allocated to an issue as a consequence of a deemed acquisition or
deemed disposition. For example, if an issuer deposits existing
investments into a sinking fund for an issue, those investments must be
valued at fair market value as of the date first deposited into the
fund.
(ii) Exception to fair market value requirement for transferred
proceeds allocations, universal cap allocations, and commingled funds.
Paragraph (d)(3)(i) of this section does not apply if the investment is
allocated from one issue to another issue as a result of the transferred
proceeds allocation rule under Sec. 1.148-9(b) or the universal cap rule
under Sec. 1.148-6(b)(2), provided that both issues consist exclusively
of tax-exempt bonds. In addition, paragraph (d)(3)(i) of this section
does not apply to investments in a commingled fund (other than a bona
fide debt service fund) unless it is an investment being initially
deposited in or withdrawn from a commingled fund described in
Sec. 1.148-6(e)(5)(iii).
(4) Special transition rule for transferred proceeds. The value of a
nonpurpose investment that is allocated to transferred proceeds of a
refunding issue on a transfer date may not exceed the value of that
investment on the transfer date used for purposes of applying the
arbitrage restrictions to the refunded issue.
(5) Definition of present value of an investment. Except as
otherwise provided, present value of an investment is computed under the
economic accrual method, using the same compounding interval and
financial conventions used to compute the yield on the issue. The
present value of an investment on a date is equal to the present value
of all unconditionally payable receipts to be received from and payments
to be paid for the investment after that date, using the yield on the
investment as the discount rate.
(6) Definition of fair market value--(i) In general. The fair market
value of an investment is the price at which a willing buyer would
purchase the investment from a willing seller in a bona fide, arm's-
length transaction. Fair market value generally is determined on the
date on which a contract to purchase or sell the nonpurpose investment
becomes binding (i.e., the trade date rather than the settlement date).
Except as otherwise provided in this paragraph (d)(6), an investment
that is not of a type traded on an established securities market, within
the meaning of section 1273, is rebuttably presumed to be acquired or
disposed of for a price that is not equal to its fair market value. The
fair market value of a United States Treasury obligation that is
purchased directly from the United States Treasury is its purchase
price.
(ii) Safe harbor for establishing fair market value for certificates
of deposit. This paragraph (d)(6)(ii) applies to a certificate of
deposit that has a fixed interest rate, a fixed payment schedule, and a
substantial penalty for early withdrawal. The purchase price of such a
certificate of deposit is treated as its fair market value on the
purchase date if the yield on the certificate of deposit is not less
than--
(A) The yield on reasonably comparable direct obligations of the
United States; and
(B) The highest yield that is published or posted by the provider to
be currently available from the provider
[[Page 686]]
on reasonably comparable certificates of deposit offered to the public.
(iii) Safe harbor for establishing fair market value for guaranteed
investment contracts and investments purchased for a yield restricted
defeasance escrow. The purchase price of a guaranteed investment
contract and the purchase price of an investment purchased for a yield
restricted defeasance escrow will be treated as the fair market value of
the investment on the purchase date if all of the following requirements
are satisfied:
(A) The issuer makes a bona fide solicitation for the purchase of
the investment. A bona fide solicitation is a solicitation that
satisfies all of the following requirements:
(1) The bid specifications are in writing and are timely forwarded
to potential providers.
(2) The bid specifications include all material terms of the bid. A
term is material if it may directly or indirectly affect the yield or
the cost of the investment.
(3) The bid specifications include a statement notifying potential
providers that submission of a bid is a representation that the
potential provider did not consult with any other potential provider
about its bid, that the bid was determined without regard to any other
formal or informal agreement that the potential provider has with the
issuer or any other person (whether or not in connection with the bond
issue), and that the bid is not being submitted solely as a courtesy to
the issuer or any other person for purposes of satisfying the
requirements of paragraph (d)(6)(iii)(B)(1) or (2) of this section.
(4) The terms of the bid specifications are commercially reasonable.
A term is commercially reasonable if there is a legitimate business
purpose for the term other than to increase the purchase price or reduce
the yield of the investment. For example, for solicitations of
investments for a yield restricted defeasance escrow, the hold firm
period must be no longer than the issuer reasonably requires.
(5) For purchases of guaranteed investment contracts only, the terms
of the solicitation take into account the issuer's reasonably expected
deposit and drawdown schedule for the amounts to be invested.
(6) All potential providers have an equal opportunity to bid. For
example, no potential provider is given the opportunity to review other
bids (i.e., a last look) before providing a bid.
(7) At least three reasonably competitive providers are solicited
for bids. A reasonably competitive provider is a provider that has an
established industry reputation as a competitive provider of the type of
investments being purchased.
(B) The bids received by the issuer meet all of the following
requirements:
(1) The issuer receives at least three bids from providers that the
issuer solicited under a bona fide solicitation meeting the requirements
of paragraph (d)(6)(iii)(A) of this section and that do not have a
material financial interest in the issue. A lead underwriter in a
negotiated underwriting transaction is deemed to have a material
financial interest in the issue until 15 days after the issue date of
the issue. In addition, any entity acting as a financial advisor with
respect to the purchase of the investment at the time the bid
specifications are forwarded to potential providers has a material
financial interest in the issue. A provider that is a related party to a
provider that has a material financial interest in the issue is deemed
to have a material financial interest in the issue.
(2) At least one of the three bids described in paragraph
(d)(6)(iii)(B)(1) of this section is from a reasonably competitive
provider, within the meaning of paragraph (d)(6)(iii)(A)(7) of this
section.
(3) If the issuer uses an agent to conduct the bidding process, the
agent did not bid to provide the investment.
(C) The winning bid meets the following requirements:
(1) Guaranteed investment contracts. If the investment is a
guaranteed investment contract, the winning bid is the highest yielding
bona fide bid (determined net of any broker's fees).
(2) Other investments. If the investment is not a guaranteed
investment contract, the following requirements are met:
(i) The winning bid is the lowest cost bona fide bid (including any
broker's
[[Page 687]]
fees). The lowest cost bid is either the lowest cost bid for the
portfolio or, if the issuer compares the bids on an investment-by-
investment basis, the aggregate cost of a portfolio comprised of the
lowest cost bid for each investment. Any payment received by the issuer
from a provider at the time a guaranteed investment contract is
purchased (e.g., an escrow float contract) for a yield restricted
defeasance escrow under a bidding procedure meeting the requirements of
this paragraph (d)(6)(iii) is taken into account in determining the
lowest cost bid.
(ii) The lowest cost bona fide bid (including any broker's fees) is
not greater than the cost of the most efficient portfolio comprised
exclusively of State and Local Government Series Securities from the
United States Department of the Treasury, Bureau of Public Debt. The
cost of the most efficient portfolio of State and Local Government
Series Securities is to be determined at the time that bids are required
to be submitted pursuant to the terms of the bid specifications.
(iii) If State and Local Government Series Securities from the
United States Department of the Treasury, Bureau of Public Debt are not
available for purchase on the day that bids are required to be submitted
pursuant to terms of the bid specifications because sales of those
securities have been suspended, the cost comparison of paragraph
(d)(6)(iii) (C)(2)(ii) of this section is not required.
(D) The provider of the investments or the obligor on the guaranteed
investment contract certifies the administrative costs that it pays (or
expects to pay, if any) to third parties in connection with supplying
the investment.
(E) The issuer retains the following records with the bond documents
until three years after the last outstanding bond is redeemed:
(1) For purchases of guaranteed investment contracts, a copy of the
contract, and for purchases of investments other than guaranteed
investment contracts, the purchase agreement or confirmation.
(2) The receipt or other record of the amount actually paid by the
issuer for the investments, including a record of any administrative
costs paid by the issuer, and the certification under paragraph
(d)(6)(iii)(D) of this section.
(3) For each bid that is submitted, the name of the person and
entity submitting the bid, the time and date of the bid, and the bid
results.
(4) The bid solicitation form and, if the terms of the purchase
agreement or the guaranteed investment contract deviated from the bid
solicitation form or a submitted bid is modified, a brief statement
explaining the deviation and stating the purpose for the deviation. For
example, if the issuer purchases a portfolio of investments for a yield
restricted defeasance escrow and, in order to satisfy the yield
restriction requirements of section 148, an investment in the winning
bid is replaced with an investment with a lower yield, the issuer must
retain a record of the substitution and how the price of the substitute
investment was determined. If the issuer replaces an investment in the
winning bid portfolio with another investment, the purchase price of the
new investment is not covered by the safe harbor unless the investment
is bid under a bidding procedure meeting the requirements of this
paragraph (d)(6)(iii).
(5) For purchases of investments other than guaranteed investment
contracts, the cost of the most efficient portfolio of State and Local
Government Series Securities, determined at the time that the bids were
required to be submitted pursuant to the terms of the bid
specifications.
(e) Administrative costs of investments--(1) In general. Except as
otherwise provided in this paragraph (e), an allocation of gross
proceeds of an issue to a payment or a receipt on an investment is not
adjusted to take into account any costs or expenses paid, directly or
indirectly, to purchase, carry, sell, or retire the investment
(administrative costs). Thus, these administrative costs generally do
not increase the payments for, or reduce the receipts from, investments.
(2) Qualified administrative costs on nonpurpose investments--(i) In
general. In determining payments and receipts on nonpurpose investments,
qualified administrative costs are taken into account. Thus, qualified
administrative
[[Page 688]]
costs increase the payments for, or decrease the receipts from, the
investments. Qualified administrative costs are reasonable, direct
administrative costs, other than carrying costs, such as separately
stated brokerage or selling commissions, but not legal and accounting
fees, recordkeeping, custody, and similar costs. General overhead costs
and similar indirect costs of the issuer such as employee salaries and
office expenses and costs associated with computing the rebate amount
under section 148(f) are not qualified administrative costs. In general,
administrative costs are not reasonable unless they are comparable to
administrative costs that would be charged for the same investment or a
reasonably comparable investment if acquired with a source of funds
other than gross proceeds of tax-exempt bonds.
(ii) Special rule for administrative costs of nonpurpose investments
in certain regulated investment companies and commingled funds.
Qualified administrative costs include all reasonable administrative
costs, without regard to the limitation on indirect costs under
paragraph (e)(2)(i) of this section, incurred by:
(A) Regulated investment companies. A publicly offered regulated
investment company (as defined in section 67(c)(2)(B)); and
(B) External commingled funds. A widely held commingled fund in
which no investor in the fund owns more than 10 percent of the
beneficial interest in the fund. For purposes of this paragraph
(e)(2)(ii)(B), a fund is treated as widely held only if, during the
immediately preceding fixed, semiannual period chosen by the fund (e.g.,
semiannual periods ending June 30 and December 31), the fund had a daily
average of more than 15 investors that were not related parties, and the
daily average amount each investor had invested in the fund was not less
than the lesser of $500,000 and 1 percent of the daily average of the
total amount invested in the fund. For purposes of this paragraph
(e)(2)(ii)(B), an investor will be treated as owning not more than 10
percent of the beneficial interest in the fund if, on the date of each
deposit by the investor into the fund, the total amount the investor and
any related parties have on deposit in the fund is not more than 10
percent of the total amount that all investors have on deposit in the
fund. For purposes of the preceding sentence, the total amount that all
investors have on deposit in the fund is equal to the sum of all
deposits made by the investor and any related parties on the date of
those deposits and the closing balance in the fund on the day before
those deposits. If any investor in the fund owns more than 10 percent of
the beneficial interest in the fund, the fund does not qualify under
this paragraph (e)(2)(ii)(B) until that investor makes sufficient
withdrawals from the fund to reduce its beneficial interest in the fund
to 10 percent or less.
(iii) Special rule for guaranteed investment contracts. For a
guaranteed investment contract, a broker's commission or similar fee
paid on behalf of either an issuer or the provider is treated as an
administrative cost and, except in the case of an issue that satisfies
section 148(f)(4)(D)(i), is a qualified administrative cost to the
extent that the present value of the commission, as of the date the
contract is allocated to the issue, does not exceed the lesser of a
reasonable amount within the meaning of paragraph (e)(2)(i) of this
section or the present value of annual payments equal to .05 percent of
the weighted average amount reasonably expected to be invested each year
of the term of the contract. For this purpose, present value is computed
using the taxable discount rate used by the parties to compute the
commission or, if not readily ascertainable, the yield to the issuer on
the investment contract or other reasonable taxable discount rate.
(iv) Special rule for investments purchased for a yield restricted
defeasance escrow. For investments purchased for a yield restricted
defeasance escrow, a fee paid to a bidding agent is a qualified
administrative cost only if the following requirements are satisfied:
(A) The fee is comparable to a fee that would be charged for a
reasonably comparable investment if acquired with a source of funds
other than gross proceeds of tax-exempt bonds, and it is reasonable. The
fee is deemed to be comparable to a fee that would be charged for a
comparable investment
[[Page 689]]
acquired with a source of funds other than gross proceeds of tax-exempt
bonds, and to be reasonable if the fee does not exceed the lesser of
$10,000 or .1% of the initial principal amount of investments deposited
in the yield restricted defeasance escrow.
(B) For transactions in which a guaranteed investment contract and
other investments are purchased for a yield restricted defeasance escrow
in a single investment (e.g., an issuer bids United States Treasury
obligations and an escrow float contract collectively), a broker's fee
described in paragraph (e)(2)(iv)(A) of this section will apply to the
initial principal amount of the investment deposited in the yield
restricted defeasance escrow, and a broker's fee described in paragraph
(e)(2)(iii) of this section will apply only to the guaranteed investment
contract portion of the investment.
(3) Qualified administrative costs on purpose investments--(i) In
general. In determining payments and receipts on purpose investments,
qualified administrative costs described in this paragraph (e)(3) paid
by the conduit borrower are taken into account. Thus, these costs
increase the payments for, or decrease the receipts from, the purpose
investments. This rule applies even if those payments merely reimburse
the issuer. Although the actual payments by the conduit borrower may be
made at any time, for this purpose, a pro rata portion of each payment
made by a conduit borrower is treated as a reimbursement of reasonable
administrative costs, if the present value of those payments does not
exceed the present value of the reasonable administrative costs paid by
the issuer, using the yield on the issue as the discount rate.
(ii) Definition of qualified administrative costs of purpose
investments--(A) In general. Except as otherwise provided in this
paragraph (e)(3)(ii), qualified administrative costs of a purpose
investment means--
(1) Costs or expenses paid, directly or indirectly, to purchase,
carry, sell, or retire the investment; and
(2) Costs of issuing, carrying, or repaying the issue, and any
underwriters' discount.
(B) Limitation on program investments. For a program investment,
qualified administrative costs include only those costs described in
paragraph (e)(3)(ii)(A)(2) of this section.
[T.D. 8476, 58 FR 33529, June 18, 1993; 58 FR 44452, Aug. 23, 1993, as
amended by T.D. 8538, 59 FR 24044, May 10, 1994; T.D. 8718, 62 FR 25511,
May 9, 1997; T.D. 8801, 63 FR 71751, Dec. 30, 1998]