IRS, Villages tangling over maze of bonds
March 1, 2009
Perverted is a word whose use has evolved almost exclusively to have a sexual connotation.
However, Mr. Webster still defines it as "to cause to turn aside or away from what is good or true or morally right: CORRUPT."
And to "pervert" is the verb an IRS agent deliberately chose when he recently issued a preliminary ruling that eventually could shatter the financial stability of the government that runs operations at The Villages retirement community.
For the past year, the IRS has been investigating $64 million worth of tax-free bonds sold in 2003 by the Village Center Community Development District and has concluded that they ought to be taxed.
But that's just the start.
If this ruling were to hold, the Villages government would be staring down staggering financial exposure — it has roughly $200 million more in similar bonds among the total of $700 million outstanding.
The fallout is impossible to predict this early, even though the sums at stake are almost unfathomable.
The money is so much because the 75,000 or so people who live at The Villages have paid developer Gary Morse and his family for everything in the community ranging from the right to collect future fees to retention ponds, sewer plants, clubhouses, swimming pools and golf courses.
Village Center District authorities vehemently disagree with the IRS conclusion, and no wonder. Even settling the matter quietly typically would cost a bond issuer many millions if the IRS stuck to its opinion. The district ultimately could get that kind of cash from one source and one only: Villages residents.
But it's too early to speculate on the various scenarios of how this might play out, said Michael Williams of the Orlando firm of Akerman Senterfitt, the district's bond lawyers.
Williams, who is bond counsel to 20 of the state's 582 community development districts, said he was surprised by the IRS opinion because the agency had not given an "adverse determination" in 2003 after it examined similar bonds.
Technically, that is true.
However, the letter "clearing" the district in the earlier audit wasn't exactly glowing. The Jan. 29, 2003, letter stated, "Our closing of these cases, however, should not be construed as an approval of your method of operations." The agent went on to detail the IRS' concerns — many of the same ones that have emerged in the recent audit.
The scolding didn't slow the Village district any. Several months later, it sold the $64 million worth of bonds that the IRS is now auditing.
Think of bonds as fancy IOUs for gigantic loans. The money the district borrowed six years ago went to buy golf courses, guard houses, an emergency-services station, a golf-ball washer, a clubhouse sound system, pool tables, pump houses, postal facilities, golf-cart paths and more.
Residents pay a monthly amenity fee — it's $135 if you buy a house today — not only to make payments on the loan but to take care of the facilities the district bought.
So far, so good. And easy to understand. Take a deep breath and read on.
Part of what has the IRS piqued is that $53 million of the $64 million worth of public money bought nothing concrete. Rather, it purchased from the developer the right to collect future amenity fees.
To complicate matters, this is not the first time. In six transactions over the years, this method of financing used public funds to pay $271million to Morse for tangible property worth only $51.6 million, IRS Agent Dominick Servadio Jr. calculated.
How could that happen, dear reader? The answer lies in the "perverted" portion of the agent's 104-page report. What follows is what you need to know.
A puppet government?
The Village Center District was set up under Chapter 190 of Florida statutes, which allows developers to create governments to pay for infrastructure and later, for residents to run their own public systems, such as sewer and water. The law anticipates that as time passes, people move into the district and begin serving on the board of trustees, eventually displacing the developer and his representatives. Voilà! Democracy at work.
However, the Village district was set up in a way that allows Morse to stay behind the scenes but still direct the operation, Servadio wrote. It will never have residents, and for as long as Morse wants, it will be controlled by board members he can select. The district and the developer are "almost indistinguishable," Servadio wrote.
That alone makes the Village district seem a puppet government, but then the lawyer-Gods who created it went even further. They sprinkled it with a potent pixie dust that allows it to buy property anywhere in The Villages — and force those who have no representation on the board to pay for the purchase.
That "effectively perverts" the intent of the law and "allows the developer to engage in unchecked self-dealing ... with absolutely no oversight," Servadio wrote. The set-up "disenfranchises" residents who can have no say in the dealings, the agent contended.
No sense of humor, these federales. Just because a developer wants to make an extra couple hundred million by charging unsuspecting retirees is hardly a reason to get worked up in Florida.
The IRS's case
Servadio's report, a public record available to anyone from the Village district office, concluded that the $64 million in bonds should be taxable because:
•The transactions didn't benefit the general public, a requirement of tax-free bonds — only the developer. •The district issued $53 million more than the properties it bought were worth and handed the cash over to Gary Morse, who declared it as a gain on the sale on the corporation's 2003 tax return. Issuing bonds for more than 5 percent over what's needed throws the bonds into the realm of taxable under IRS rules, Servadio contended.
•The firms that set the value of the properties were simply tools of the district who did what they were told. They were not independent appraisers, as required.
One, who listed The Villages on his Web site as a regular client, wasn't qualified to appraise the properties, used only data provided by the district to come up with his "valuation," and employed improper methods in calculating the value, Servadio wrote.
•The bonds somehow made it through the scrutiny of lawyers and were sold, even though roughly two-thirds of the money pledged to repay the loan was already pledged to repay previous bonds.
So what does the Village district have to say about all this? The district administrator declined to discuss Servadio's specific allegations.
The IRS allows the district to respond, and it is in the process of "clarifying all the factual errors, assumptions and interpretations," District Administrator Janet Tutt stated in an e-mail.
The bond lawyer, Williams, said one example of an error in Servadio's report is that the agent appears to assume that roads in the district are limited-access, and that's not true. He said he couldn't remember the other errors.
Tutt wrote in an e-mail: "I believe our response will address any questions you may have."
The district has until March 25 to submit its statement to the IRS.
So what does all this mean? Let's try to sort some of it out Wednesday.
Lauren Ritchie can be reached at email@example.com or 352-742-5918.
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