*** The Villages under IRS investigation ***

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OrlandoSentinel.com
COMMENTARY Special report
IRS trying to get to bottom of Villages bond-financing history
Lauren Ritchie
September 7, 2008


Sixty-two pages of questions and answers tell the tale: The Villages retirement community is on the verge of making an IRS agent's head implode. Soon, his brain will begin to drain out his ears.

An agent auditing tax-exempt bonds sold by the mirror government behind The Villages first began asking questions on Jan. 7 as part of what he described as a routine examination.

Since then, his questions about $64 million worth of "recreational" revenue bonds -- sold in 2003 to buy golf courses, cart paths, ball washers, a clubhouse sound system, pool tables, guardhouses, postal facilities, pump houses and more -- have grown more complex and pointed.

You can see what the agent is thinking by the questions and can almost picture him turning this Rubik's cube of financing genius over and over as he tries to wrap his mind around the most clever scheme since carpetbaggers realized they could charge old ladies in Jersey $10 a month for swamp lots. It's like he just can't believe it's true.

Welcome to Florida, Agent Dominick Servadio Jr. Sit back and marvel about how business is done in a state where we affix our lips to every developer fanny within reach.


The inception

Here's the short version of how The Villages developed -- with the help of a state law that spurs growth:

The developer builds a community. The law lets him create his very own government, which has the power to borrow breathtaking sums of cash by selling bonds. The developer-controlled government uses the bond money -- bonds are nothing more than loans -- to buy the developer's investment in amenities such as golf courses and pools. But the biggest percentage of the cash from recreational bonds goes to purchase the right to collect fees every month from residents. For example, of the $64 million worth of bonds the IRS is examining, $53.1 million bought nothing concrete. It went to purchase the rights to the future amenity fees.

As of Aug. 31, 10 of the 12 governments in The Villages owed a stunning $709 million on outstanding loans they took out partly to pay developer Gary Morse for everything from future fee collections to retention ponds, sewer plants, clubhouses, swimming pools and golf courses. A developer typically wraps the cost of amenities and infrastructure such as sewer lines into the price of a house. Morse didn't do that, which is why residents are paying now, according to the manager of The Villages' governments.

Well, at least that's the theory. If so, residents should have gotten pretty sweet deals on the prices of their homes, shouldn't they?

Morse becomes almost unfathomably rich from the bond proceeds. And residents are saddled with 30 years of payments on $709 million worth of loans.


Was this legitimate?

Now, along comes the IRS in a quest to answer just a single question: Was this one particular developer-controlled government, the Village Center Community Development District, qualified to issue tax-exempt bonds? In other words, is this a cross-your-heart legitimate government? Or just a fiendishly brilliant legal dodge designed to enrich the developer?

The answer could rock the municipal bond world if the ruling goes against The Villages governments. Aside from the Village Center district, another 578 of these governments operate in Florida. If the IRS were to impose a different interpretation than in the past, bond buyers could end up having to fork over income tax on the interest from their investment, which they don't have to do now.

So who are these buyers? That isn't easy to discern. But administrators at the districts say some bonds are owned by Villages residents themselves.

The Village Center district has hired a California lawyer to get it through this IRS examination. However, the district's manager is itching to pick up the phone and call Servadio. She thinks if she can just talk to the agent, he'll understand -- and go quietly away, satisfied that everything is on the up-and-up.

"Our frustration is that we don't see it any differently than a utility purchase. The questions he's asking -- he's getting pieces of the pyramid," said Janet Tutt, the manager. "If we all just sat down in a room and created the big picture, and he could see the whole picture, it would be easier."

However, this is not the first time the Village Center district has faced off with the feds over whether its bonds should be tax-exempt and whether it's adhering to the law.


Earlier concerns

Here's what W. Mark Scott, director of the IRS' tax-exempt bond division, wrote to the district on Jan. 29, 2003, when the bonds got a thumbs up after an earlier audit.

"Our closing of these cases, however, should not be construed as an approval of your method of operations. We have concerns regarding: the amount of control the developer has over the issuer; the questions of value of the assets sold by the developer to the issuer as these are not arm's length [transactions]; the treatment of income and expenses (whether income is properly reported and expenses deducted only once); compliance with state law."

Other than that, everything was just peachy. The fact that the IRS thought the deal smelled funky didn't slow down the district when it wanted to issue more bonds. Several months later, it sold the $64 million worth of bonds that the IRS now is looking into.

On Wednesday, we'll take a deeper look at this particular IRS probe and where it might be headed.
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Lauren Ritchie can be reached at lritchie@orlandosentinel.com or 352-742-5918.
First of two parts
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