A government can use private-activity bonds to give economic incentives to targeted activities or geographic areas. The purpose of private-activity bonds must be defined specifically and must be used according to the limitations of the state and federal statutes. The numerous and strict limitations on private activity bonds make them inflexible. Changes in their purpose may make them taxable. Volume caps limit the availability of private activity bonds.
Expedient financing is difficult due to the annual application and approval process.
Private Activity Bonds Private activity bonds are used either entirely or partially for private purposes and are given federal tax-exempt status. Section 141 of the Internal Revenue Code qualifies a bond as tax- exempt if it meets the private business test and falls within one of the seven categories. The 1986 Tax Reform Act placed substantial limitations on the use of private activity bonds. In addition, bondholders must not be substantial users of the facility. Qualification also depends on the issue's average maturity not being longer than 120 percent of the economic life of the facility.