Unspent Bond Proceeds: What Can an Issuer Do When the Project Comes in Under Budget?

Unspent bond proceeds can be spent on the authorized project, applied to redeem or defease the bonds, reallocated to another purpose under the bond documents and state law, or held as an investment once the federal yield restriction rules apply.

Which paths are open depends on the bond authorization, the bond contract, state statute and the federal arbitrage and private-use rules; the legal and tax calls belong to bond counsel and tax counsel.

This page sits in the guide to funds that hold bond proceeds; the table maps the main options to the rules behind them.

Why do proceeds end up unspent?

Proceeds end up unspent when the project costs less than its authorization: for example, bids come in under the estimate, planned work is reduced or dropped, or the schedule shortens.

GFOA's typical investment horizons run 12 to 36 months for a construction fund, 6 to 18 months for a capitalized interest fund, usually 6 months for an interest account and usually 12 months for a principal account, and GFOA notes these are typical ranges and that issuers should consult their advisory team and investment policy.

The arbitrage rules judge the issue on expectations set at closing: whether an issue consists of arbitrage bonds is judged on the issuer's reasonable expectations as of the issue date, which an officer of the issuer responsible for issuing the bonds must certify in good faith, and no certificate is required if no unspent gross proceeds, other than a bona fide debt service fund, are expected after the issue date or the issue price does not exceed $1,000,000 (Treas. Reg. §1.148-2(b)).

What happens to investments the issuer already holds?

If the balance is already invested, the exit mechanics matter as much as the rate it entered at.

A SLGS Time Deposit cannot be redeemed on demand: a note or bond can be redeemed no earlier than 30 days after issue, the request must reach Treasury 14 to 60 days before the redemption date, and requests received within 14 days of the issue date are rejected (31 CFR 344.6(a), (c)).

Early redemption also reprices the security: for subscriptions on or after October 28, 1996, remaining payments are discounted at the current Treasury borrowing rate, which may result in a premium or discount to the issuer (31 CFR 344.6(d)).

Demand Deposit redemptions take 1 business day's notice for $10 million or less, 3 for over $10 million and under $500 million, and 5 for $500 million or more, with requests due by 3 PM Eastern and no cancellation (31 CFR 344.9(a), (c)).

Money market funds add their own mechanics: the SEC's July 12, 2023 reforms require institutional prime and institutional tax-exempt funds to charge a liquidity fee when daily net redemptions exceed 5% of net assets unless liquidity costs are de minimis, remove redemption gates, and leave government money market funds outside the mandatory fees (SEC Press Release 2023-129).

Instrument-level detail lives on the SLGS and money market fund pages.

Redeeming or defeasing bonds

A balance can often go to the bonds themselves, by retiring principal at a call or maturity date or by defeasing bonds through an escrow funded with the unspent proceeds.

For arbitrage purposes, the term sinking fund includes a debt service fund, redemption fund, reserve fund, replacement fund or any similar fund, to the extent it is reasonably expected to be used to pay principal or interest on the issue (Treas. Reg. §1.148-1(c)(2)).

Applying proceeds of one issue to the debt of another raises the refunding rules, because a refunding issue is one whose proceeds are used to pay principal, interest or redemption price on another issue, subject to exceptions in the definition (26 CFR 1.150-1(d)(1)).

The MSRB glossary separates legal defeasance, which ends the bondholders' rights and lien under the bond contract, from economic or financial defeasance, in which the issuer remains legally obligated if the deposited funds prove insufficient.

The same glossary describes the escrow deposit agreement that sets how escrow funds are invested, generally in eligible securities, along with the schedule of debt service payments and early redemptions; eligible securities often refers to the securities the bond contract allows in a defeasance escrow.

Reallocating to other eligible projects

Redirecting a balance to a different purpose is decided by the bond authorization and state law, and Massachusetts gives a concrete statutory example.

Massachusetts' use-of-proceeds statute says the proceeds of any sale of bonds or notes shall be used only for the purposes specified in the authorization of the loan (MGL c.44 §20).

A balance left after the project may be appropriated for another purpose with an equal or longer borrowing term, and balances of up to $50,000 may pay debt with the chief executive officer's approval, while abandoned projects follow a separate two-thirds-vote path.

That is Massachusetts law only, it governs alongside rather than instead of the federal arbitrage rules, and this page does not cover other states' use-of-proceeds rules.

On the federal side, proceeds must be allocated to expenditures within 18 months after the later of payment or the project's placed-in-service date, and in any event by 60 days after the fifth anniversary of the issue date or 60 days after retirement if earlier (Treas. Reg. §1.148-6(d)(1), as summarized in IRS Publication 4079).

The anti-abuse rule frames timing from the other end: bonds are arbitrage bonds if an abusive arbitrage device is used, meaning an action that both exploits the difference between tax-exempt and taxable rates for a material financial advantage and overburdens the tax-exempt market, and an action overburdens the market if it results in issuing more bonds, issuing bonds earlier, or allowing bonds to remain outstanding longer than is otherwise reasonably necessary; actions expressly permitted by the regulations are generally not abusive (Treas. Reg. §1.148-10(a)).

Yield restriction after the temporary period ends

Once the issue's temporary period ends, a balance still invested generally may not earn a yield materially higher than the bond yield, which for most investments means more than one-eighth of 1 percentage point above it (Treas. Reg. §1.148-2(d)(2)(i)).

The rule rests on section 148, which makes a bond an arbitrage bond if proceeds are reasonably expected at issuance to be used to acquire higher yielding investments, but not solely because proceeds are invested at a higher yield for a reasonable temporary period until they are needed (26 U.S.C. §148(a), (c)(1)).

Other allowances sit alongside the temporary periods, including reserve funds and the minor portion, under which gross proceeds up to the lesser of 5% of sale proceeds or $100,000 may be invested at a higher yield without making the bonds arbitrage bonds, although the minor portion is not an exception to rebate (Treas. Reg. §1.148-2(g)).

Yield restriction and rebate are two independent sets of rules, and an issuer can satisfy one and still have arbitrage bonds because it failed the other (IRS Publication 5271).

The converse matters too: even when the yield restriction rules allow an issuer to invest above the bond yield, the rebate rules may still require those earnings to be paid to the U.S. Treasury (IRS Publication 5271).

A yield-restricted balance can still be an eligible source of funds for SLGS: 31 CFR 344.1 lists gross proceeds of tax-advantaged bonds, amounts held with them in refunding or defeasance escrows, parity reserve funds or commingled funds, and other amounts subject to yield limits, and whether a particular fund qualifies is a question for bond counsel.

What if a small balance is left when the spending period ends?

A small remainder does not by itself defeat the 18-month or 2-year spending exception, because Treasury Regulation §1.148-7(b)(4) disregards a shortfall on the final spending requirement if the issuer used due diligence to complete the project and the shortfall does not exceed the lesser of 3% of the issue price or $250,000.

That de minimis rule speaks only to the final spending requirement of those two exceptions, which the guide to the spending exceptions covers in detail.

Yield reduction payments as an option

A yield reduction payment is an amount paid to the United States, including a rebate amount, that is treated as a payment for the investment and reduces its yield, so an issuer can satisfy yield restriction without restricting the investment's actual rate (Treas. Reg. §1.148-5(c)(1)).

The payments are available only for the categories in §1.148-5(c)(3), which include nonpurpose investments of proceeds that qualified for the capital project, working capital, pooled financing or investment-proceeds temporary periods, reserve fund investments within the 15%-of-stated-principal limit, and investments made when SLGS sales were suspended, and the paragraph generally excludes advance-refunding gross proceeds except as expressly provided.

Payments follow the rebate installment schedule, and for purpose investments nothing is due until the earlier of the end of the 10th bond year or 60 days after the issue is retired, with interim payments that need not exceed 75% (Treas. Reg. §1.148-5(c)(2)).

Payments are reported on Form 8038-T, one form per issue, with a check payable to United States Treasury sent to the IRS service center in Ogden, Utah (Instructions for Form 8038-T).

In the rebate computation, yield reduction payments are among the payments and the investment's earnings and principal returns are among the receipts, and the Form 8038-T instructions warn that a contrary cash flow representation may understate the rebate amount (Treas. Reg. §1.148-3(d)(1)-(2)).

The SLGS-suspension category has a practical trigger: investments an issuer agrees to buy on a day Treasury has suspended SLGS sales are eligible for yield reduction payments, and the fair-market-value safe harbor's lowest-cost-versus-SLGS comparison is not required for them (Treas. Reg. §1.148-5(c)(3)(viii), (d)(6)(iii)(C)(2)(iii)).

Remedial action under the private-use rules

Remedial action is a published self-correction method for nonqualified bonds (IRM 7.2.3.1.9), and the question arises when a balance drifts into private business use, because the private-activity tests are measured on how proceeds are used.

Under section 141(b), the private business use test is met if more than 10% of proceeds are used for private business use, meaning use in a trade or business by a non-governmental person other than as a member of the general public, and a 5% threshold applies to private business use that is unrelated or disproportionate to the government use.

An issue meeting both the private business use test and the private security or payment test, or the private loan financing test, is a private activity bond, and the private loan test is met when proceeds loaned to non-governmental persons exceed the lesser of 5% of proceeds or $5,000,000 (26 U.S.C. §141(a), §141(c)).

The IRS asks about readiness at issuance: Form 8038-G line 43 asks whether the issuer has written procedures for timely remedial action on nonqualified bonds, and line 44 asks the same about procedures for monitoring the arbitrage, yield restriction and rebate requirements (Instructions for Form 8038-G, Rev. 10/2021).

Where a problem exceeds self-correction, the Tax Exempt Bonds Voluntary Closing Agreement Program is for issuers that voluntarily come forward to resolve violations that cannot be fixed under self-correction programs, and it is generally unavailable when the issuer can fix the violation by remedial action or another published self-correction method (IRM 7.2.3.1.9; IRS Publication 4079).

Which remedial actions fit a given issue, and whether bonds are nonqualified at all, are conclusions for bond counsel and tax counsel.

If the balance has been sitting in an investment chosen years earlier, mGIC offers a free, no-obligation reinvestment review that looks at fund objectives, permitted investments, draw schedules, credit terms, market conditions and timing, and the conversation can start on the contact page.

mGIC is an independent, SEC-registered municipal advisor and Bidding Agent that helps issuers structure, competitively bid and close investments of bond proceeds, and it sells none of the products it evaluates.

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.