Revenue Bonds are one of the types of municipal bonds in which the bond holders are repaid their principal amount and interest through the revenue earned by a particular revenue generating activity or project for which loan has been taken.
Unlike the general Obligation Municipal bonds in which the bond issuer does the repayment to bond holders from his kitty, in revenue bonds, only the source of revenue mentioned in the agreement between the bond issuer and the bond holders is used to repay the principal amount and interest to the bond holders and no other sources of income are touched for repayment. If a city Revenue or municipality issues revenue bonds for construction of a toll bridge, then repayment would be made only through the revenue earned from toll taxes. Since repayment of revenue bonds depend on the revenue earned by that particular project or activity, these bonds may provide high interest rate when compared to general obligation bonds.
Cities or municipalities can issue revenue bonds for construction / expansion / up gradation of various entities like power plants, toll roads and bridges, water facilities, airports, seaports , hospitals etc. Generally, a feasibility study is conducted to assess the project’s feasibility and the revenue it is expected to generate beforehand so that the municipality does not face any problem in repaying the principal amount and the interest to the bond holders. Special assessment bonds, Moral Obligation bonds, Industrial Development Revenue bonds, New Housing Authority bonds and Lease rental bonds are some of the examples of revenue Bonds. Like General Obligation bonds, revenue bond holders do not have to pay tax whether federal, state or local on the interest earned. However, taxes have to be paid on the capital gains
Types of Revenue Bonds:
Industrial Revenue Bonds: Industrial revenue Bonds or IRBs as they are known are issued by the local Industrial Development Boards for collecting funds for construction or expansion of manufacturing and other facilities for a private company. If the company, for which the bonds have been issued, is credit worthy in the eyes of the financial institutions, financial institutions give letter of credit to the company supporting the bonds through IRBs, funds for land, equipment and building for manufacturing plants, which are new or in expansion mode. Though the bond-financed facility is owned by IRB, it is given on lease to the company for which IRBs were issued at a price from which the principal amount and interest could be repaid to the industrial revenue bond holders. During the lease period which is generally 20 years, the company may get many tax exemptions like sales tax on the construction material. Taxable IRB bonds earn higher rate of interest when compared to the bonds which are exempted from tax. On the other hand, the company for which the bonds have been issued can enjoy tax exemption even if they buy their own bonds.
IRB bonds are issued in both taxable and tax-exempt category. For tax –exempt IRBs, 10 million dollar is the limit while there is no limit on the taxable IRBs.
IRBs that are exempted from tax are issued at a lower interest rate as these are exempted from federal and state income tax. The company for which the IRB has been issued cannot invest more than 10million dollar at a particular location for three years preceding the issue and three years, post the issuance of the bonds. If the amount to be raised is less than one million dollars, the IRB would not be cost effective since the fees involved in issuing a bond is high. The local industrial development board has to give a letter of inducement to the company for it to become eligible for issuance of Industrial Revenue Bonds. In the case of IRBs that are tax-exempt, the cost of land acquisition should be less than 25% of the total bond issue. If the funds from the bonds are used to purchase an existing building, 15% of the funds should used within two years for building’s renovation. Funds from the bond could not be used to purchase second hand equipments or machines.
IRBs can be used to finance the whole project.
Tax Exempt Revenue Bonds: Municipal bonds and Treasury Securities are the most common tax-exempt revenue bonds. Municipal bond holders are exempted from paying federal tax while treasury securities holders are exempted from paying state and local tax. In United States, treasury securities are the safest among the tax-exempt revenue bonds since the US Revenue issues and support these securities. Since they are risk-free, the rate of interest provided by the US treasury securities is less as compared to the other securities and bonds.
Mortgage Revenue Bonds: Mortgage Revenue Bonds are used to fund home mortgages. Funds from such bonds help people from lower and middle income group to buy homes by offering mortgages for long term at rates which are below the market level. The mortgage revenue bonds are issued by the state Revenue which uses the funds collected from the bonds to invest in the Revenue- sponsored home loan program. In order to be eligible, prospective home buyer’s income should be less than a specified amount. The Revenue –sponsored home loan program generally targets particular areas or neighborhoods. Also, the prospective home buyers should not own a home as such programs are specially meant for first time home buyers.