Hypothesizing the Effects of an IRS Victory

[jrjr729]

I have been avidly reading everything I can concerning the IRS inquiry including the thirty-four page letter by the agent in charge, Dominick Savardio.

I have seen numerous opinions on the matter from numerous individuals and organizations. I think it boils down to two key issues.

1. Are the CDD's in TV true government entities? At issue, according to the IRS agent, is how the CDD board is created. The IRS contends that since the board is appointed rather than elected it is not a true government entity and therefore cannot issue tax free municipal bonds. Further since the appointments are linked directly to the developer, conflicts of interest play a major role in actions taken by the board with respect to the developer. (incidentally, this is the position of the POA It states in effect that there exists a situation of taxation without representation.)

2. The VCCDD issued tax free municipal bonds to fund the purchase of certain community assets from the developer. The IRS contends that the VCCDD overpaid by a substantial amount and never had a valid and reliable property appraisal done to determine their true value. It contends that this was done in insure a windfall profit for the developer.

With regard to the first issue The Villages responds that it followed Florida State law with respect to CDDs and special districts Chapter 190 of the Florida code and that therefore the IRS complaint has no standing. The IRS responds that the issuance of federally tax free municipal bonds falls under the purview of federal law not state law.

With regard to the second issue The Villages argues that the amount of money in question was payment for the actual cost of building the assets plus an amount that represents the potential future revenue inflows from residents' activities fees. Therefore, it is not a windfall for the developer but rather an appropriate payment.

Ok what happens if the IRS prevails? Good question. My guess would be that there would be no immediate effect on homeowners. I believe The Villages is telling the truth about that. However, there is the possibility that future amenities fees would have to rise. This is because one proposal stated in the IRS settlement offer requires the CDD's to forgo the issuance of future municipal bonds. If that were to come to pass CDD's would be forced to issue taxable bonds to raise money. Taxable bonds require a higher interest payment and that money would have to come from somewhere.

Another possibility would be the reorganization of the CDD's to include direct election by the residents. I suspect that would require a lot of work but it is possible. If the CDD's were more directly elected by the homeowners, conflicts of interest would be greatly reduced.

My question to you is have I summarized the issues correctly and are there any other possible effects?

One can hold the opinion that the whole problem is the result of ignorance, greed, patronage, biased reporting, envy, or something else. Those positions are generally self defeating. the important question is what is likely to happen?

[The Shadow]

Ok what happens if the IRS prevails? Good question. My guess would be that there would be no immediate effect on homeowners. I believe The Villages is telling the truth about that. However, there is the possibility that future amenities fees would have to rise. This is because one proposal stated in the IRS settlement offer requires the CDD's to forgo the issuance of future municipal bonds. If that were to come to pass CDD's would be forced to issue taxable bonds to raise money. Taxable bonds require a higher interest payment and that money would have to come from somewhere.



The tax free bonds having been issued several years ago are probably at a higher interest rate than taxable bonds issued today. That could be a savings and could result in a savings to the homeowner. Interest rates are going up so timing is important.

[Bogie Shooter]

no one knows ! ! !

[The Shadow]

no one knows ! ! !

I did not say they did ! ! !:agree:

[l2ridehd]

There are several possible outcomes, none of which I believe would have a big impact on the homeowners.

1. The IRS wins. The bond interest becomes taxable. The bonds must be called, re-issued, different rate, but probably not a lot higher then today. Past interest rate deductions denied, which bond holders might do a class action suit against the CDD's and that cost would be paid by the homeowners. Worst case maybe $600 to $800 per home.

2. The IRS settles for some compromise position, probably a similar course as above but with about half as much impact to homeowners.

3. The IRS loses and nothing changes.

4. There is some agreement that whats in the past stays in the past, but going forward it has to change. Either elected boards, no more tax exemptions, or some other agreement and this would only impact new CDD's and new homes.

5. There is probably some other combination of events that some lawyer will dream up, but when you look at the total amount at risk, the total number of homes, the willingness of the bond holders to sue vs settle, even the worst case scenario is not all that bad.

Any agreement or settlement would have to be paid over time and in a manner so that everyone could still pay or the agreement would fail. Elected officials would step in before great numbers of retired people lose their homes or standard of living. None of want to pay an extra several hundred $$$, but it probably wouldn't change what we have for dinner tonight or where we play golf tomorrow. So life is still good.

[ricthemic]

Very interesting post. Makes us feel a little better regarding the possible worst case scenarios.
Having read all the post including the 32 page IRS response we are very, very concerned about the existing amenities, especially pools and golf courses, now being open to anyone and everyone like a public bath room.
PS:
I understand if no own answers this post on TOTV... I am getting use to it.

[Taj44]

I did not say they did ! ! !:agree:

Funny!!!! I love it....

[batman911]

There could be a significant cost savings if the boards were elected and the developer was paid for the actual cost of building the ammenities (without adding the excessive profit). That savings would directly affect the ammenities fee. Just a thought.

[Hadleyite]

"The Villages argues that the amount of money in question was payment for the actual cost of building the assets plus an amount that represents the potential future revenue inflows from residents' activities fees. Therefore, it is not a windfall for the developer but rather an appropriate payment."

What I haven't been able to understand is how the relationship of the sales price of the building is tied to revenue inflow from amenities money.

Did the VCCDD buy from the developer the right to collect amenities fees and bonded the sale, since the price they paid for buildings was really unrelated to the actual cash value? How much in excess of the cash value of the buildings was spent and bonded? Obviously most purechase buildings generate very little cash revenue.

Does the developer own our amenities fees south off 466 and will the SLCDD/VCCDD have to purchase those rights from him. Aren't amenity fees required to be used for amenities? How can they be used as a item to be purchased?

[katezbox]

Ugh - more bond stuff - but a couple of comments:

1. I feel the summary of the situation by jr is a good one. Ditto i2rdhd.

2. Ric - where did you get the idea that others could use our facilities? That is not an issue of this.

3. Hadley - the bonds are used to raise money (i,e, a form of debt). This allows the amenities to be built in advance of homes (such as the ones south of 466A). The developer takes a risk in doing this and the amount paid to him by the VCDD includes compensation for actual costs of the amenity construction, plus a future earning stream of the amenity fees to pay for this. Without this, the VCDD would need to collect the fees for YEARS and then build out the golf courses, rec centers etc.

The key issues here are 1. Is the VCDD allowed to issue tax free bonds? CDDs throughout the state issue these bonds, but the concern of the IRS is that the developer really controls the VCDD. 2. Is the amount paid to the devloper a fair representation of cost plus the present value of a future earnings stream? If the VCDD is found to be too closely tied to the developer then the transaction would be considered not to be "at arm's length" and therefore the amount of the payment would be suspect.

My personal feelings here are that Gary Morse is a big target and an ambitious IRS agent feels he is a ticket to promotion. (Again, just my personal opinion - reinforced by the tenor of the comments he made to the press and even the mere fact that he spoke to a reporter about an ongoing investigation).

k

[Hadleyite]

Katzebox;

There are two kinds of bonds, those on our homes and those the IRS is contesting the tax free issuance.

The ones on our homes are used to develop infrastructure. Those are not the bonds in dispute.

I haven't heard a really solid explanation as to the inflated purchase prices on facilities which caused the issuing of the tax free bonds being contested by the IRS. I realy would like to underatand what cash flow the VCCDD actually purchased?

[katezbox]

Hadley,

The ones on our homes are used to develop infrastructure related to our homes - roads, utilities, etc.

The others allow the VCDD to reimburse the developer for the cost of amenities - golf courses, rec centers, Savannah, etc. The VCDD can then pay the interest and principal to the bondholders from our amenity fees, paying off the debt over time. Usually a tax free bond is less expensive to issue as an investor is willing to accept a lower rate of interest since the interest income is not taxed.

The reason the price is inflated is this:

Assume you built an amusement park. It cost you $X million to build. It is bringing in revenue today of $Y million. Someone wants you to sell it to him. How would you value it? Would you be willing to sell for your original investment? Probably not. Standard financial practice in evaluating the worth of the business looks at the cost plus a discounted future income stream in today's dollars. In a commercial enterprise like the hypothetical solution above, the difference between the cost of the original investment plus improvements less accumulated depreciation is booked as "Goodwill" and amortized over a reasonable period of time - all determined by the FASB for GAAP (financial statement) reporting and the IRS (for tax reporting).

In our case, the VCDD needs to reimburse the developer for his cost in building out the amenities. Will the developer expect to receive an amount equal to just his cost? Of course not - no more than the guy selling that hypothetical business. He will expect to receive a return on his investment that rewards him for his dollars investment and the risk involved. The issue here is not that he was paid more than he spent - it is HOW much more he was paid and if that valuation was reasonable.

Kate

[downeaster]

Hadley,



The reason the price is inflated is this:

Assume you built an amusement park. It cost you $X million to build. It is bringing in revenue today of $Y million. Someone wants you to sell it to him. How would you value it? Would you be willing to sell for your original investment? Probably not. Standard financial practice in evaluating the worth of the business looks at the cost plus a discounted future income stream in today's dollars. In a commercial enterprise like the hypothetical solution above, the difference between the cost of the original investment plus improvements less accumulated depreciation is booked as "Goodwill" and amortized over a reasonable period of time - all determined by the FASB for GAAP (financial statement) reporting and the IRS (for tax reporting).

In our case, the VCDD needs to reimburse the developer for his cost in building out the amenities. Will the developer expect to receive an amount equal to just his cost? Of course not - no more than the guy selling that hypothetical business. He will expect to receive a return on his investment that rewards him for his dollars investment and the risk involved. The issue here is not that he was paid more than he spent - it is HOW much more he was paid and if that valuation was reasonable.

Kate

Well put, Kate. You have put in a few words the basics of real estate investment taught in real estate investment classes. If one wants to know the details simply sign up for a Real Estate Brokers licensing class.

[jrjr729]

Thank you all for your responses. Most were helpful. Following are a series of random thoughts and free associations on the topic.

1. Since the original IRS complaint concerns the VCDD is there any direct effect on LSCDD other than the possible restructuring of future bond offerings?

2. Is the correct term VCDD for Villages Community Development District or is it VCCDD for Villages Center Community Development District? I have no idea.

3. If some of the bond money or amenities fees are used for the repair or maintenance of existing community facilities is that portion enumerated anywhere? The reason I ask is that I just finished reading IRS publication 530. It appears to indicate that a non-advalorem tax may be deductible on your federal return if it is paid for the repair or maintenance of existing facilities that increase the value of your home. But the taxpayer has to be able to provide proof. I got the idea of checking this out from reading one of your posts and so looked it up. It is not my intent to hijack the thread.

4. Is it likely that either outcome; the IRS wins, or the IRS loses, will be positive. For example; The IRS wins and as a result TVs CDDs are more directly elected by homeowners and amenities fees drop, the IRS loses and everything remains status quo which in this economy would be fine with me.

5. Having only been a Villager for a little while I have no idea of the tenacity of The Villages. I do know that they settled a lawsuit brought by certain residents. I have heard that they have had similar problems with the IRS some time ago that were resolved but do not know the details. So my question is will The Villages CDD's fight it out with the IRS or are they likely to settle? I know that Janice Tutt refused to even discuss the first settlement offer put forth by the IRS.

[iaudit]

Katzebox wrote:

"In our case, the VCDD needs to reimburse the developer for his cost in building out the amenities. Will the developer expect to receive an amount equal to just his cost? Of course not - no more than the guy selling that hypothetical business. He will expect to receive a return on his investment that rewards him for his dollars investment and the risk involved."

I guess I have a problem with this statement. Are we really talking about a hypothetical business being sold? Who else would be willing to buy the assets that he is selling? Doesn't seem to me that there would much of a demand for the use of these assets, other than by the residents of the Villages.

[Hadleyite]

Good point, but raises a question. Would the developer have been entitled to sell the amenities income to anyone? That is the justification for the inflated purchase price of the physical assets.

[katezbox]

Katzebox wrote:

"In our case, the VCDD needs to reimburse the developer for his cost in building out the amenities. Will the developer expect to receive an amount equal to just his cost? Of course not - no more than the guy selling that hypothetical business. He will expect to receive a return on his investment that rewards him for his dollars investment and the risk involved."

I guess I have a problem with this statement. Are we really talking about a hypothetical business being sold? Who else would be willing to buy the assets that he is selling? Doesn't seem to me that there would of a demand for the use of these assets, other than by the residents of the Villages.

iaudit,

I was using the hypothetical situation as an illustration only. If you read through the hundreds of bond posts, there are many that don't see why the VCDD pays more than book value to the developer.

My illustration may have oversimplified things, but I think it explains the concept. The Sentinel and some posters seem to think that this is a shady business practice - like keeping multiple sets of books (how many people think that is something fishy)? This is a valid business practice used to value income producing assets.

Of course, if the transaction is deemed not at arm's length, then the valuation may be suspect in terms of the true value of that future income stream and/or the cost of capital rate utilized in the discounting.

[spk7951]

Good point, but raises a question. Would the developer have been entitled to sell the amenities income to anyone? That is the justification for the inflated purchase price of the physical assets.

Why could he not sell the management rights if he so desired to a company outside of TV? There are companies that do business in managing amenities such as we have but for my money I prefer things as they are. I know of one 55 plus community that recently had the management company for their amenities go bankrupt and another community is involved in a lawsuit with their management company.

[Advogado]

There are several possible outcomes, none of which I believe would have a big impact on the homeowners.

1. The IRS wins. The bond interest becomes taxable. The bonds must be called, re-issued, different rate, but probably not a lot higher then today. Past interest rate deductions denied, which bond holders might do a class action suit against the CDD's and that cost would be paid by the homeowners. Worst case maybe $600 to $800 per home.

2. The IRS settles for some compromise position, probably a similar course as above but with about half as much impact to homeowners.

3. The IRS loses and nothing changes.

4. There is some agreement that whats in the past stays in the past, but going forward it has to change. Either elected boards, no more tax exemptions, or some other agreement and this would only impact new CDD's and new homes.

5. There is probably some other combination of events that some lawyer will dream up, but when you look at the total amount at risk, the total number of homes, the willingness of the bond holders to sue vs settle, even the worst case scenario is not all that bad.

Any agreement or settlement would have to be paid over time and in a manner so that everyone could still pay or the agreement would fail. Elected officials would step in before great numbers of retired people lose their homes or standard of living. None of want to pay an extra several hundred $$$, but it probably wouldn't change what we have for dinner tonight or where we play golf tomorrow. So life is still good.

I agree that there are various possible outcomes, but I wonder if you would explain your assumptions and math for your worst-case scenario, i.e., #1?
In addition, how and on what legal basis, could the Center Districts pass the costs on to the residents since the Center Districts can only tax within their boundaries and increases in the amenities fees are limited to the CPI?