Billionaire Morse’s Florida Dirt Bonds Not Tax-ExemptMichael C. Bender, Michelle Kaske and Brendan Coffey
The Internal Revenue Service ruled that bonds sold by a Florida community-development district that issued $426 million of debt aren’t tax-exempt, a decision with potential implications for hundreds of similar entities.
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, according to an IRS memo dated May 30. The document was provided by Perry Israel, a lawyer for the district.
Florida’s community-development districts have sold $6 billion in municipal bonds, according to Richard Lehmann, publisher of the Distressed Debt Securities newsletter in Miami Lakes, Florida. Similar obligations are issued in other states to help finance property development and the IRS decision may apply to them, said Scott Lilienthal, president of the National Association of Bond Lawyers.
“This could create some widespread problems,” said Lilienthal, whose Washington-based group includes about 3,000 municipal-finance attorneys. “Special districts are a pretty widely used method of financing in various states.”
Eric Smith, an IRS spokesman, didn’t respond to a telephone call seeking comment on the memo. The IRS opened its investigation of the district in 2008.
The IRS ruling may not have a widespread effect on other community development districts in Florida, said John Miller of Chicago-based Nuveen Asset Management, which holds $10 million of Village Center’s 2003 recreational-revenue bonds. In projects such as these, he said, control of the board has typically transferred to the residents.
The developer made “unbelievable efforts” to ensure “these assets did not go to the community,” Miller said. “But it’s supposed to be a community bond and that’s why it’s tax-free. So this is very unique.”
Land-secured debt is the riskiest part of the $3.7 trillion municipal-bond market, accounting for almost half of nonpayment default filings, Matt Fabian, a managing director at Concord, Massachusetts-based Municipal Market Advisors, said in a June 5 report. Defaulted land-secured debt totals about $3.5 billion, according to the report.
Village Center revenue bonds maturing November 2032 and rated three steps above non-investment grade by Moody’s Investors Service traded June 5 at an average yield of about 5 percent, or about 2 percentage points above an index of benchmark municipal bonds with similar maturities, data compiled by Bloomberg show.
Holders of the bonds include Goldman Sachs Asset Management and Nuveen Asset Management, as of April 30, according to data compiled by Bloomberg. Mackay Shields LLC holds the bonds, as of March 31.
The IRS ruling may require municipal investors to further research bonds before purchases to determine whether the earnings on the debt will remain tax-free, Fabian said in an interview.
“If there’s a permutation of the structure in these bonds that could undermine the exemption, investors will need to be more careful about the structure,” Fabian said in the interview. “So there’s more due diligence required in new acquisitions.”
The district in Florida has been issuing debt since it was created in 1992 with approval from a board of supervisors controlled by the developer, according to the IRS memo. The agency said that state law intends for community-development districts to be turned over to residents.
“We believe that an entity that is organized and operated in a manner intended to perpetuate private control, and to avoid indefinitely responsibility to a public electorate, cannot be a political subdivision of a state,” according to the IRS memo.
Israel, who is based in Sacramento, California, disputed the finding and said in an interview that the jurisdiction was considering its options. Debbie Arceneaux, the IRS agent listed on the memo as a contact, didn’t immediately respond to a voice message seeking comment on the memo.
U.S. Representative Richard Nugent, a Florida Republican who counts Morse among his constituents, said “any change in the tax-exempt status of these bonds would likely have a harmful impact on Florida homeowners already burdened by a weak economy,” according to a March 5 letter to the IRS.
Nugent, a member of the Tea Party Caucus in the House and co-sponsor of legislation to abolish the IRS, received $19,400 in contributions from the Morse family during his 2010 and 2012 campaigns, according to campaign finance records.
U.S. Senator Bill Nelson, a Florida Democrat, wrote to the IRS on Oct. 26, warning that an agency conclusion that the district isn’t a political subdivision could “paralyze bond markets for new CDD issuers and create a chilling effect on investment in my state.” The Morse family backed Nelson’s Republican opponent last year, then-U.S. Representative Connie Mack, with $62,500 in contributions.
Joseph Grant, then acting IRS commissioner for tax-exempt and government entities, wrote back to Nugent on April 5 that the investigation was “not part of any general guidance project we are considering at this time.”
Morse, 76, is the developer of The Villages, one of the world’s largest retirement communities, located on 33 square-miles (85 square-kilometers) in central Florida. Through his fully owned Holding Company of The Villages, Morse has built and sold more than 44,400 homes since 1983 and controls more than 4.5 million square-feet (418,000 square-meters) of commercial space in the development.
Morse has a personal fortune of $2.6 billion derived from profits selling the homes as well as related business such as issuing mortgages to buyers, according to the Bloomberg Billionaires Index.
At least $955 million of Morse’s fortune comes directly from money paid to him from the issuance of tax-free municipal bonds -- including the bonds ruled taxable by the IRS, according to data compiled by Bloomberg from an analysis of 38 bond-offering statements since 1992.
Under Florida’s community-development district arrangement, Morse built amenities in The Villages -- primarily golf courses, pools and guard houses -- and sold them to residents through district boards that decided how much to pay for the assets. The boards were appointed by Morse, as state law allows, and in every case the majority of the members worked for Morse; one board included Morse, according to Bloomberg’s analysis.
Gary Lester, a Villages spokesman, didn’t respond to an e-mail seeking comment on the IRS memo.
Morse was a co-chairman of 2012 Republican presidential nominee Mitt Romney’s Florida finance committee. With his company and three children, Morse donated $180,000 to Florida Governor Rick Scott’s election campaign last year, state records show, as Scott initiated a review of Florida’s special taxing districts, including community development districts.
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