THE SHORT ANSWER
The 18-month spending exception, in Treasury Regulation §1.148-7(d), treats an issue as meeting the arbitrage rebate requirement when all of its gross proceeds qualify for the 3-year capital project temporary period and spending reaches at least 15 percent of gross proceeds within 6 months, 60 percent within 12 months and 100 percent within 18 months. Rebate still applies to amounts not required to be spent, and a reasonable retainage gets 30 months.
The 18-month spending exception treats an issue as meeting the arbitrage rebate requirement when all of its gross proceeds qualify for the 3-year capital project temporary period and spending reaches at least 15 percent of gross proceeds within 6 months of the issue date, at least 60 percent within 12 months and 100 percent within 18 months, under Treasury Regulation §1.148-7(d)(1).
Rebate is still paid on amounts the schedule does not require the issuer to spend, under Treasury Regulation §1.148-7(d).
The schedule sits between the 6-month exception, which requires all specially defined gross proceeds to be spent on the governmental purpose within 6 months, and the 2-year construction exception, which runs a four-benchmark schedule on a construction issue's available construction proceeds.
This page is part of mGIC's guide to arbitrage, yield restriction and rebate and works through the benchmarks, the retainage relief, the consequences of a miss and what the schedule means for the investment holding the proceeds.
The spending exceptions overview compares all three schedules side by side.
What are the 15%, 60% and 100% spending benchmarks?
Treasury Regulation §1.148-7(d)(1) sets three spending periods measured from the issue date: at least 15 percent of gross proceeds within 6 months, at least 60 percent within 12 months and 100 percent within 18 months.
| Spending period | Measured from the issue date | Share of gross proceeds that must be spent |
|---|---|---|
| First | 6 months | At least 15 percent |
| Second | 12 months | At least 60 percent |
| Third | 18 months | 100 percent |
At the first two benchmarks the regulation says "at least," so spending ahead of the schedule does not breach it, and the third benchmark is simply 100 percent.
What conditions attach to the exception?
The exception is available only when all gross proceeds of the issue qualify for the 3-year capital project temporary period, the window described in the guide to temporary periods.
It is not available if any portion of the issue uses the 2-year construction exception, under Treasury Regulation §1.148-7(d)(4).
For the first two spending periods, the investment earnings counted in gross proceeds are based on the issuer's expectations as of the issue date, under Treasury Regulation §1.148-7(d)(3)(ii).
Refunding issues cannot use the schedule at all: the regulations state that the only spending exception applicable to refunding issues is the 6-month exception, under Treasury Regulation §1.148-7(b)(1)(ii)(A), a point the Form 8038-T instructions repeat.
The 18-month exception appears in the regulations rather than in the statute, so the operative text is §1.148-7(d), while the 6-month and 2-year exceptions are written into section 148(f)(4) of the Internal Revenue Code.
What counts as reasonable retainage?
A reasonable retainage does not cause the issue to fail the third spending period if it is allocated to expenditures within 30 months of the issue date, under Treasury Regulation §1.148-7(d)(2).
The size of a reasonable retainage is measured against net sale proceeds as of 18 months after the issue date, a different base from the gross-proceeds benchmarks above.
A construction contract may hold back part of each payment until the work is accepted, so proceeds can remain unspent at month 18 even though the project itself is moving as planned.
Whether a particular holdback is a reasonable retainage is a determination for bond counsel.
What happens if the issue misses a benchmark?
A shortfall at the final spending requirement is not automatically fatal, because Treasury Regulation §1.148-7(b)(4) disregards a failure to meet the final spending requirement of the 18-month or 2-year exception when the issuer used due diligence to complete the project and the amount of the failure is no more than the lesser of 3 percent of the issue price or $250,000.
When a miss falls outside that relief, the issue is not treated as meeting the rebate requirement under the 18-month exception.
The 2-year construction exception has a separate, elective accommodation: on or before the issue date, the issuer of a construction issue may irrevocably elect, under section 148(f)(4)(C)(vii) and Treasury Regulation §1.148-7(k), to pay a penalty of 1.5 percent of the underexpended proceeds for each 6-month spending period that misses the 2-year schedule in place of rebate on available construction proceeds.
The election is irrevocable once made, and whether to make it is a determination for tax counsel.
The 2-year construction exception page covers that election's mechanics.
What does the 18-month schedule mean for investing the proceeds?
The third spending period sets the outer date for the fund: whatever is not spent by month 18 counts against the 100 percent benchmark, apart from a reasonable retainage allocated by month 30 or a shortfall inside the relief in Treasury Regulation §1.148-7(b)(4).
A construction fund runs on the same calendar: expected draws against the 6-, 12- and 18-month benchmarks, with withdrawal terms matched to the project's draw schedule.
When draws run behind what the issuer expected, the gap between the fund's calendar and the actual spending becomes its own question, covered in the guide to spend-down mismatch.
Earnings tracking does not stop at the benchmarks either, because rebate must still be paid on amounts not required to be spent, and the rebate page covers that computation.
For an issue that has already closed, mGIC can check your proceeds against the rules in a free, no-obligation reinvestment review that sets the investment against the fund's draw schedule and the dates the exception sets.
To start that review, or to talk through the schedule before an issue closes, use the contact page.
Whether an issue satisfies the benchmarks, how the amount of a failure is measured and how a shortfall or a retainage is treated are legal and tax determinations that belong to bond counsel and tax counsel.
Frequently asked questions
Does the 18-month exception appear in the Internal Revenue Code?
No. Its benchmarks come from Treasury Regulation §1.148-7(d)(1); the 6-month and 2-year exceptions are written into section 148(f)(4) of the Internal Revenue Code, but the 18-month schedule exists in the regulations only.
What happens to earnings on proceeds the schedule does not require the issuer to spend?
Rebate still applies to them. Treasury Regulation §1.148-7(d) pairs the spending benchmarks with payment of rebate on amounts not required to be spent, so those earnings stay inside the rebate computation.
How are investment earnings counted for the first two spending periods?
Treasury Regulation §1.148-7(d)(3)(ii) bases the investment earnings counted in gross proceeds for the first two spending periods on the issuer's expectations as of the issue date.
Does the retainage rule move the 18-month deadline for other proceeds?
No. Treasury Regulation §1.148-7(d)(2) applies to a reasonable retainage, measured against net sale proceeds 18 months after the issue date and allocated to expenditures within 30 months. The benchmarks for the rest of the gross proceeds stay at 6, 12 and 18 months.
Sources
This page is general educational information about municipal finance and federal and state rules as of the date shown. It is not legal, tax or investment advice, and it is not a recommendation about any particular investment. Product availability, legality and suitability depend on the issuer, jurisdiction, governing documents and transaction-specific facts. Final legal and tax determinations remain with the issuer's bond counsel, tax counsel and other advisors.
