How to Invest a Construction (Project) Fund: Draws, Terms and Exceptions

A construction fund, often called a project fund, is the fund that holds bond proceeds earmarked for construction expenditures until the issuer draws them out to pay construction costs.

Investing one comes down to two questions: how long each dollar will sit in the fund, which the draw schedule answers, and how long the tax rules let it earn above the bond yield, which the temporary periods and spending exceptions answer.

It is one of the funds described in the guide to bond proceeds funds; the permitted-investment provisions of the bond documents, state law and the federal tax rules can each limit what may be bought and how long it can run, and the final legal and tax determinations belong to bond counsel and tax counsel.

What is a project fund and how do draws work?

A project fund holds the proceeds allocated to constructing the financed project, and a draw is the issuer's withdrawal from the fund to pay construction costs as they come due.

Interest during construction can be funded through capitalized interest, which the MSRB glossary defines as a portion of the proceeds of an issue set aside to pay interest on the securities for a specified period and describes as commonly used during construction of a revenue-producing project so that debt service does not begin until the project is expected to be operating.

That money sits in its own fund, covered in the guide to the capitalized interest fund.

The expected pace of spending is written down as a draw schedule, and the guide to building a draw schedule covers how one is put together.

Why does the draw schedule drive the investment term?

The draw schedule drives the term because maturities and withdrawal rights are only useful if they land where the spending actually falls.

GFOA makes the point directly: "Make certain that the drawdown of proceeds is planned and recorded, and that the investment duration is no longer than the expected drawdown schedule."

GFOA also suggests staging bond issues over the construction period rather than issuing well before spending begins, to limit both arbitrage liability and negative arbitrage.

The tax regulations build the same input into bidding: Treasury Regulation §1.148-5(d)(6)(iii)(A)(5) requires that, for purchases of guaranteed investment contracts, the terms of the solicitation take into account the issuer's reasonably expected deposit and drawdown schedule for the amounts to be invested.

When schedule and term line up, no dollar is locked past its draw date; when they do not, the fund can be left holding investments it cannot use or cash that sits uninvested, the mismatch covered in the guide to negative arbitrage.

State law can end the term first

A state's statute can shorten the term before the federal rules come into play.

New York's General Municipal Law §11 provides that obligations purchased with the proceeds of bonds or notes must be payable or redeemable in any event, at the owner's option, within two years of purchase, and it counts repo-purchased obligations as payable on their scheduled repurchase date; that is a maturity limit rather than the federal temporary period, and the New York state guide covers the statute's investment provisions.

Massachusetts reaches the same money by name: General Laws c. 44 §55 provides that a city, town, district or regional school district treasurer may invest bond or note proceeds before they are applied to the authorized purposes, in a statutory list that includes term deposits and certificates of deposit maturing in up to three years, obligations guaranteed by the United States or an agency maturing within one year of purchase, and units of the state combined investment fund under c. 29 §38A, among other instruments.

Guaranteed investment contracts are not on that list, and the Massachusetts state guide covers the statute's remaining provisions.

GIC vs flex repo vs Treasury ladder for construction money

The three structures mGIC evaluates and competitively bids for construction money are a guaranteed investment contract, a full-flex repurchase agreement and a structured portfolio of U.S. Treasury securities, the last with a money-market allocation for faster spend-down.

The SEC has described municipal reinvestment products such as guaranteed investment contracts, repurchase agreements and forward purchase agreements as instruments tailored to a municipality's specific collateral and spend-down needs.

The tax regulations define a guaranteed investment contract broadly for arbitrage purposes: any nonpurpose investment with specifically negotiated withdrawal or reinvestment provisions and a specifically negotiated interest rate, including any agreement to supply investments on two or more future dates, such as a forward supply contract (Treasury Regulation §1.148-1(b)).

Those negotiated withdrawal provisions are what a GIC with flexible withdrawals is built around, because a construction fund's deposits and withdrawals both move; a full-flex repurchase agreement is contracted for on the repo side, and a structured portfolio of U.S. Treasury securities is owned outright rather than contracted for.

Term length has its own federal line: under section 149(g) of the Internal Revenue Code, as summarized in IRS Publication 4079, a bond is a hedge bond unless the issuer reasonably expects at least 85% of spendable proceeds to be used within 3 years and no more than 50% of the proceeds is invested in nonpurpose investments whose yield is substantially guaranteed for four or more years.

Whether a multi-year contract raises hedge bond questions for a particular issue is a tax counsel determination, and the tradeoffs are worked through in the comparisons of a GIC versus a Treasury ladder and a GIC versus a full-flex repo.

For the money that leaves the fund soonest, a portfolio's money-market leg can hold instruments such as SLGS demand deposits, which are one-day certificates that roll over automatically each day until redeemed, at a rate that is an adjustment of the average yield at the most recent 13-week Treasury bill auction under 31 CFR 344.7(a); the rate formula adjusts for an estimated marginal tax rate of tax-exempt bond buyers and Treasury administrative costs, and a negative rate resets to zero, with subscription mechanics covered in the SLGS guide.

mGIC's stated order of priorities for these funds is safety, then liquidity, then yield, and which structure fits a given issue depends on its draw schedule, its permitted-investment list and its tax position; the flex repo versus Treasury portfolio comparison covers the remaining head-to-head.

What happens if spending is faster or slower than planned?

A mismatch cuts in opposite directions: spending faster than planned can leave money invested past the point it is needed, and spending slower than planned can leave unspent proceeds exposed when the temporary period ends.

When draws come early, what can be taken out, on what notice and at what cost follows from the terms the issuer contracted for, such as a guaranteed investment contract's negotiated withdrawal and reinvestment provisions.

When draws come late, unspent proceeds can outlast the temporary period, and the yield restriction rules then limit the fund to yields not materially higher than the issue yield, the meaning of "yield restricted" in Treasury Regulation §1.148-1(b).

GFOA's guidance is to revisit the draw schedule periodically as the project moves and to keep the fund's records for the required period, which it describes as typically the life of the bonds plus three years; the records an issue should assemble are covered in the guide to the compliance file.

The guide to draws that do not match the investment schedule takes the faster and slower cases one at a time.

Temporary period and spending exceptions that apply

Federal rules give construction proceeds a temporary period in which they may be invested above the bond yield, generally 3 years, and a set of spending exceptions that can excuse rebate when the money is actually spent on schedule.

The 3-year temporary period

Treasury Regulation §1.148-2(e)(2)(i) gives net sale proceeds and investment proceeds reasonably expected to be spent on capital projects a 3-year temporary period from the issue date, but only if the issuer reasonably expects to satisfy the expenditure test, the time test and the due diligence test.

The expenditure test requires that at least 85% of net sale proceeds be allocated to capital project expenditures by the end of the 3-year period, measured on the issuer's reasonable expectations at issuance (§1.148-2(e)(2)(i)(A)).

The time test requires that within 6 months of the issue date the issuer incur a substantial binding obligation to a third party to spend at least 5% of net sale proceeds, and an obligation subject to contingencies within the issuer's or a related party's control does not count as binding (§1.148-2(e)(2)(i)(B)).

The due diligence test requires that project completion and the allocation of proceeds proceed with due diligence (§1.148-2(e)(2)(i)(C)).

For capital projects with substantial construction expenditures, §1.148-2(e)(2)(ii) substitutes a 5-year period when both the issuer and a licensed architect or engineer certify that the longer period is necessary to complete the capital project.

Refunding issues do not get this period, because §1.148-9 governs them; the 3-year temporary period guide covers the other periods and what happens when one ends.

The 2-year construction spending exception

Section 148(f)(4)(C)(ii) of the Internal Revenue Code and Treasury Regulation §1.148-7(e)(1) treat available construction proceeds of a construction issue as meeting the rebate requirement if at least 10% is spent within 6 months, 45% within 1 year, 75% within 18 months and 100% within 2 years.

Reasonable retainage, up to 5% of available construction proceeds, may be spent within 3 years (§1.148-7(e)(2), (h)), and where the spending requirements are met, earnings in the bona fide debt service fund are exempt as well (section 148(f)(4)(C)).

The exception presupposes a construction issue: a non-refunding issue whose issuer reasonably expects, as of the issue date, that at least 75% of available construction proceeds will be allocated to construction expenditures for property owned by a governmental unit or a 501(c)(3) organization (§1.148-7(f)(1)), and any private activity bonds in the issue must be qualified 501(c)(3) bonds or private activity bonds financing property with that ownership.

Available construction proceeds are the issue price plus earnings on it and on certain reserve funds, reduced by the issue price in a reasonably required reserve fund and by issuance costs financed by the issue (section 148(f)(4)(C)(vi); §1.148-7(i)); the 2-year construction spending exception guide works through the schedule and the retainage rule.

The 18-month spending exception

Treasury Regulation §1.148-7(d)(1) provides a parallel 18-month exception, at least 15% of gross proceeds spent within 6 months, 60% within 12 months and 100% within 18 months, on tighter conditions: rebate must be paid on amounts not required to be spent, all of the gross proceeds must fit the 3-year capital-project temporary period, earnings for the first two spending periods are computed on issue-date expectations, and the exception is unavailable if any portion of the issue uses the 2-year exception (§1.148-7(d)).

Unlike the 2-year exception, it appears in the regulations rather than the statute; the 18-month spending exception guide covers it, and the spending exceptions hub lists the shorter ones.

Elections and smaller issuers

On or before the issue date, the issuer of a construction issue may make an irrevocable election to pay a penalty in lieu of rebate on available construction proceeds: 1.5% of the underexpended amount for each 6-month spending period that misses the 2-year schedule, due within 90 days after the period it relates to and reported on Form 8038-T, with a separate form for each period (section 148(f)(4)(C)(vii); §1.148-7(k)).

Form 8038-G line 40 records the election; whether to make it is a question for tax counsel, because the election cannot be undone.

Smaller issuers have a separate route outside the construction provisions: under section 148(f)(4)(D)(i), a governmental unit with general taxing powers is treated as meeting the rebate requirement if no bond is a private activity bond, 95% or more of net proceeds go to the unit's local governmental activities, and the unit reasonably expects to issue no more than $5 million of tax-exempt governmental bonds in the calendar year, an amount that increases by up to $10 million more for bonds attributable to public school facility construction.

IRS Publication 4079 notes that this exception runs to rebate only and not to the arbitrage rules altogether, so yield restriction still applies and the project fund still needs its temporary period; the small issuer exception guide covers the aggregation rules.

Example: matching investments to a 36-month draw schedule

This illustration takes one 36-month draw schedule and reads it against the spending exceptions and the temporary period, using illustrative amounts rather than market data.

GFOA puts a typical construction fund's investment horizon at 12 to 36 months and describes these as typical ranges, deferring to each issuer's advisory team and investment policy, so a 36-month schedule sits at the top of that range.

The matching exercise on these numbers would layer maturities or negotiated withdrawal rights against each cumulative draw line, the kind of expected deposit and drawdown schedule that the GIC solicitation rule in §1.148-5(d)(6)(iii)(A)(5) requires the solicitation to take into account.

A faster version of the same issue changes the answer: if its available construction proceeds, which count investment earnings and so are not simply the $60 million issue amount, were spent 10% by 6 months, 45% by 12 months, 75% by 18 months and 100% by 24 months, spending would track the 2-year construction schedule's spending points, with the longer-dated pieces sized to a 24-month horizon instead, though whether the exception applies still depends on the issue being a construction issue and is a determination for tax counsel.

mGIC is an independent municipal advisor that helps issuers structure, competitively bid and document investments of construction and project funds; it sells none of the structures on this page, and its fee is paid by the winning provider at or below the safe-harbor maximum in the Treasury arbitrage regulations, with the fee disclosed.

Issuers with a construction fund already invested can ask mGIC for a free reinvestment review of how the current investments line up with the draw schedule and the rules, through the contact page.

Final determinations about temporary periods, spending exceptions and elections for a particular issue belong to bond counsel and tax counsel.

Last updated 2026-10-06.

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.