This section will provide you with a brief overview of what arbitrage is and of the arbitrage rebate requirements set forth in the IRS regulations. This is not meant to serve as legal advice. These IRS regulations are very complex and you should consult competent bond counsel concerning the arbitrage requirements. Arbitrage, in the context of municipal bonds, is the difference between the rate at which the proceeds were borrowed and the rate at which the proceeds were invested.
Most local governments can borrow funds at tax-exempt rates by issuing municipal bonds.
They can invest the funds received from issuing bonds into taxable securities such as U.S. Treasury securities, which typically earn higher rates than comparable tax-exempt securities. With the rate advantage offered by taxable securities over tax-exempt securities, the local government issuing municipal bonds could, depending on market conditions, position itself to earn positive arbitrage, or earning a rate higher than the borrowing rate, on the bond proceeds. Proceeds subject to this arbitrage rebate requirement include sale, investment, transferred and replacement proceeds. That may sound flippant but the calculation, monitoring, and reporting of arbitrage is complex and, as with most issues regulated by the IRS, not to be taken lightly. Complying with the legal and administrative requirements of the arbitrage regulations can be complicated and expensive.