The BIG OUCH! -- Explained by Lauren Ritchie

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OrlandoSentinel.com

'What ifs' for The Villages in IRS fight

Lauren Ritchie

COMMENTARY

May 31, 2009


Don't even ask, Villagers.

Of course you want to know how your pocketbook will fare in the latest exchanges in the IRS dispute with the government that runs your community. The answer is it's too early to tell.

However, a recent series of letters from the Internal Revenue Service did reveal how the agency wants to solve its problems with the tax-exempt bonds that built much of The Villages and made its developer fabulously rich.

The IRS thinks $448 million borrowed through tax-exempt bonds since 1993 should be taxable. That's because, the agency contends, the community-development districts, which run operations at the retirement community and sold the bonds, don't qualify as "real" governments and shouldn't get tax-free loans as cities and counties do.

District officials say the governments are being operated according to state law, but the IRS contends that the districts are controlled by the developer and the bonds benefited him, not residents. In addition, the transactions were far too cozy and fail to meet federal tests of an "arm's length" transaction.

"If I was a resident of The Villages, I would be outraged," agent Dominick Servadio Jr. wrote to the chairman of the Village Center Community Development District on May 4.

Dramatic and costly step

Finally, someone has just out and said it. The agent is right. Developer Gary Morse's use of the districts over the years could end up crippling the community and tormenting decent people who just want to retire quietly and play golf.

A spokesman for the developer did not return calls for comment.

In the revenue agent's May 18 letter, he urged the districts to take a dramatic and enormously costly step: recall and pay off $355 million worth of outstanding tax-free bonds that paid Morse for everything from golf courses to swimming pools, utility plants to guard houses.

The agency also wants back taxes from one bond issue amounting to

$2.8 million, chump change for the company that posted 2008 revenues of

$696 million, up 9 percent from last year.

And the IRS wants the districts to promise never again to issue tax-free bonds, which would suddenly and drastically turn off the cash tap for Morse and his family, who own The Villages and are still developing it.

Whoa.

Things could be worse

Servadio's suggestion is staggering. But his alternative is even more chilling.

If the two districts — Village Center and Sumter Landing — decide to appeal, the agency will begin officially examining eight more bonds, deepening the districts' possible tax liability to

$16.5 million.

While you're calming the heart rate and sucking down the Valium, here are a few things to consider:

First, this IRS examination is in the negotiation stage. Shortly, however, the agency likely will put its conclusions firmly in writing, starting a 90-day clock for the districts.

District officials then will have to decide whether to appeal the ruling, risking even more extensive IRS scrutiny, or negotiate a settlement that will be expensive.

At the moment, the official word from Village Center District Administrator Janet Tutt is that the district (politely, of course) thinks that the agent is all bluster. It's way too early to even talk about what the district might do, Tutt said.

"The District continues to believe there will be a positive resolution to this issue and at this time there are no further developments to change that belief," Tutt wrote in an e-mail.

OK, now the fantasy portion of the program is concluded.

Incredulous agent

Servadio's recent letters show a degree of disgust with The Villages and its lawyers that is more than warranted.

In the May 4 letter, he accused the district of making a "misleading and incomplete disclosure" in bond documents for a $64 million issue in 2003. He remarked at one point that Villages residents "let the district and the developer off easy" when last year they settled a lawsuit over amenity fees for

$40 million.

And he poked fun at the district's high-paid tax-controversy lawyer who he said submitted to the IRS "a sort of sophisticated version of the I-did-the-homework-but-my-dog-ate- it excuse" when he was forced to admit that appraisers who valued the properties for the sales could not provide backup documents. The California lawyer then asked the appraisers to "recreate" their calculations.

"Issuers of tax-exempt bonds don't get 'do-overs,'" Servadio fired back.

At one point, the agent suggested The Villages engage in a "reality check" when trying to determine whether the Village Center District is a valid issuer of tax-exempt bonds.

"What is the "district?" ... It's really nothing more than a five-member governing board populated with developer employees or related parties that have a history of approving an unlimited amount of tax-exempt bonds to purchase assets from the developer in transactions that in the real world would never pass scrutiny as arm's length transactions.

"This doesn't sound like an entity that the Service wants to be considered as a valid issuer of tax-exempt bonds."

Servadio is no renegade revenuer out to get the Big Republican Money of the Morse family. IRS officials have said publicly and in published documents that one of the agency's goals this year is to closely examine tax-exempt bonds from governments such as the community-development districts of The Villages. So, the orders are coming from the top down, not vice versa. If they weren't, this touchy investigation would have vanished months ago.

Exploring what-ifs

So what might happen if the district takes the IRS suggestion and decides to recall the $355 million that the agency wants out of the bond market?

Bond experts asked earlier this week about the situation were flabbergasted by the amount of money involved. Expect repercussion in the bond markets, they said, if the IRS stands firm. The availability of money to such districts likely would drop and the interest rate that such districts would have to pay would rise, they speculated.

Typically, when the IRS deems tax-exempt bonds as taxable, it demands that bonds be taken off the market. The usual process is that the issuer would go back into the bond market and borrow enough to pay off the first set of bonds. So, theoretically, The Villages could sell, say, $355 million worth of taxable bonds and use the proceeds to pay off the tax-exempt ones.

Two catches: First, is the money available? Bond markets are very tight at the moment, experts said. So maybe, maybe not. Second, do the Village Center and Sumter Landing districts have enough bucks to back the second loan?

The district has two main ways of getting money. First, it receives the amenity fees that residents pay, which totaled $33 million last year.

Second, it has the authority to levy property taxes inside its geographic boundaries. But considering that Morse controls 88 percent of the property in the Village Center District, and the board of supervisors is made up of his employees and business associates, a vote to levy property taxes seems a tad unlikely.

Tricky math

Could the district back a new bond issue using just the $33 million in annual fee collections? Apparently. Consider that roughly half of the amenity fees, about $16 million, go to repay current loans. The other $17 million operates The Villages. The math works only if the new bonds are sold and the old bonds are repaid simultaneously.

Afterward, The Villages likely would have to operate on less money because taxable bonds would cost the district more than tax-free ones.

The other option is that the district decides to get arrogant and fight the IRS. Bond experts didn't even want to speculate what might happen then. Typically, it's just not done for the simple reason that the IRS seldom loses.

God save the golf courses.

What is conspicuously absent from the revenue agent's scenarios is what role Morse might have in this, if any. The agent spent considerable time and energy building a case that the developer is the district, and the district is the developer. If so, shouldn't the developer — the biggest beneficiary in this arrangement by far — bear some responsibility? Or is he absolved by declaring his profits from the bonds as taxable? Morse declared

$53 million as profit in the one issue the IRS examined closely.

No one is saying, especially Morse himself. The developer has kept silent since the examination began in January 2007. Perhaps all will be revealed in time.

Or perhaps this will be settled with a friendly handshake, and we can all just go merrily to our next tee time.

Lauren Ritchie can be reached at Lritchie@orlandosentinel.com or 352-742-5918. Her blog is at OrlandoSentinel.com/

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