Tax-exempt bonds are a financing tool available to organizations to help raise capital for various capital projects.
Organizations can use tax-exempt bonds to raise capital for any project that “is “for the good of the people.” Project examples include:
- Government buildings
- Hospitals
- Infrastructure
- Power and transmission projects
- Housing
- Roads
- Schools
Only government entities can issue tax-exempt bonds. Nonprofit organizations with federal 501(c)(3) status can only use tax-exempt bonds for capital improvements that involve a state or local government unit and support the public good.
Example:
Suppose a city wants to build a hospital tower in which the first five floors will be for general hospital use and the sixth floor will be medical offices for the doctors. In this case, the city could finance ⅚ of the hospital project as tax-exempt since the general portion of the hospital is “for the “good of the people.” The remaining ⅙ of the financing would be taxable since the sixth floor is for doctors’ offices, which is “for the good of the doctors.”
What’s important here?
Tax-exempt bonds are beneficial for issuers and their residents as these bonds generally fund projects that will support the public good, including government buildings and infrastructure.
501(c)(3) organizations may also issue these bonds if they’re funding a project on behalf of or in coordination with a state or local government entity.
Some states limit what tax-exempt bonds can be used for, such as prohibiting them from being issued for the purpose of working capital or for projects that will not create jobs.
