Investing Bond Proceeds for P3 and Private Activity Bond Projects

P3 and private activity bond projects financed with tax-exempt bonds, including qualified private activity bonds, invest their bond proceeds under the federal arbitrage rules, with two sector wrinkles: where the financing is a conduit issue, the conduit borrower is liable for the debt service, and where the issue is a private activity bond, the private use tests drive the tax analysis.

This is mGIC's sector guide for public-private partnerships and private activity bond (PAB) projects; the sector hub covers the other issuer types, and the private activity bonds guide carries the general explainer.

What financing structures do P3 and private activity bond projects use?

Two financing structures matter for these projects: the conduit financing and the private activity bond, and the two overlap, since the MSRB's conduit types include qualified 501(c)(3) bonds, which are also a qualified bond category under §141(e).

In a conduit financing, as the MSRB glossary describes it, a governmental issuer issues bonds to finance a project used mainly by a third party, the conduit borrower, and the conduit borrower is liable for making the debt service payments on the bonds.

The MSRB lists industrial development bonds, multifamily housing revenue bonds and qualified 501(c)(3) bonds among the common conduit types.

Under 26 U.S.C. §141(a), a bond is a private activity bond if its issue meets both the private business use test and the private security or payment test, or if it meets the private loan financing test.

Whether a given issue is a private activity bond is a determination for bond counsel, not a call the investment team makes.

That split matters for the reinvestment: the conduit borrower carries the debt service, while the conduit issuer carries the responsibilities IRS Publication 5005 describes.

The conduit issuer guide covers the structure from the issuer's side in detail.

What funds hold P3 and PAB proceeds, and how do the draws run?

The proceeds sit in the fund types the funds guide describes: a construction or project fund, a capitalized interest fund, and debt service and reserve funds.

The MSRB describes capitalized interest as proceeds set aside to pay interest for a set period, commonly during construction of a revenue-producing project so debt service does not begin until the project is expected to be operating.

GFOA's guidance on investing bond proceeds lists typical investment horizons by fund.

GFOA calls these typical ranges rather than rules and points issuers to their advisory team and investment policy.

GFOA also recommends making certain that the drawdown of proceeds is planned and recorded, and that the investment duration is no longer than the expected drawdown schedule, which makes the draw schedule the input that sets an investment's term and withdrawal terms.

Federal arbitrage rules tie what proceeds may earn to when they are spent: under Treasury Regulation §1.148-2(e)(2), for instance, net sale proceeds and investment proceeds reasonably expected to be spent on capital projects get a 3-year temporary period from the issue date, which does not apply to refunding issues and applies only if the issuer reasonably expects to satisfy the expenditure test, the time test and the due diligence test.

The arbitrage rules measure all of it against gross proceeds, which Treasury Regulation §1.148-1(b) defines as all proceeds plus all replacement proceeds of an issue.

Sale proceeds are amounts actually or constructively received from selling the issue, including amounts used to pay underwriters' discount and accrued interest other than pre-issuance accrued interest.

Investment proceeds are amounts received from investing proceeds, net sale proceeds subtract amounts invested in a reasonably required reserve or replacement fund and the minor portion, and transferred proceeds are proceeds of a refunded issue that become proceeds of the refunding issue under §1.148-9.

Each spending exception uses its own modified definition of gross proceeds, not the general definition above.

Which reinvestment products fit P3 and PAB proceeds?

The product set is the one the reinvestment products guide describes, and mGIC evaluates and competitively bids all three while selling none of them.

A guaranteed investment contract is an investment, secured by a contract with a financial institution, that guarantees a fixed rate of return and a fixed maturity, in the MSRB glossary's general definition; bond-proceeds GICs often have flexible draw schedules rather than one fixed maturity.

A full-flex repurchase agreement is a repo, a sale of securities combined with an agreement to repurchase them at a prearranged price, with the withdrawal provisions negotiated to the draw schedule.

A structured Treasury portfolio holds U.S. Treasury securities matched to the fund's anticipated cash needs, with a money-market fund allocation for faster-than-expected spend-down.

What differs for these projects is not the product list but the shape of the cash flows behind the products: the cash flows follow the project's draw schedule, which is why the withdrawal terms matter as much as the rate.

For balances outside those three, the product guide also covers SLGS and money market funds.

The fit turns on the draw schedule, the issue's temporary periods and the policy the issuer has adopted, and the choice belongs to the issuer and its financing team; mGIC's GIC-versus-repo comparison shows how the tradeoffs are laid out side by side.

mGIC's stated order of priorities runs safety first, then liquidity, then yield.

How does private use shape compliance for these issues?

The tests that decide whether a bond is a private activity bond turn on how the financed facility is used and paid for, and the arbitrage limits then run against gross proceeds, so the same proceeds face both sets of rules.

The first two tests each turn on a 10% threshold: under 26 U.S.C. §141(b)(1), the private business use test is met if more than 10% of the proceeds of the issue are to be used for private business use, and the private security or payment test uses the same 10% threshold.

A separate 5% threshold applies to private business use that is unrelated or disproportionate to the governmental use.

Private business use means use in a trade or business by a non-governmental person, not counting use as a member of the general public, under 26 U.S.C. §141(b)(6)(A).

The private loan financing test is met when proceeds used to make or finance loans to non-governmental persons exceed the lesser of 5% of proceeds or $5 million, and §141(c)(2) excepts certain loans, including those for general-application taxes or assessments and nonpurpose investments.

A private activity bond can still be tax-exempt if it is a qualified bond under §141(e): an exempt facility bond, qualified mortgage bond, qualified veterans' mortgage bond, qualified small issue bond, qualified student loan bond, qualified redevelopment bond or qualified 501(c)(3) bond, provided the issue also meets the applicable volume cap in §146 and the requirements of §147.

IRS Publication 4078 lists the exempt facility categories under §142, including airports and spaceports, docks and wharves, mass commuting, water, sewage, solid waste, qualified residential rental, local electric and gas facilities, and qualified highway or surface freight transfer facilities.

Publication 4078 also notes that qualified private activity bonds generally must use 95% or more of net proceeds for the qualified purpose.

The arbitrage rules apply to these issues as well, with differences Publication 4078 notes.

One concerns the late-rebate penalty: when the correct rebate is not paid on time, the bonds become arbitrage bonds unless the failure was not due to willful neglect and the issuer promptly pays a penalty plus interest, and the penalty is 50% for governmental and qualified 501(c)(3) bonds and 100% for other bonds under Treasury Regulation §1.148-3(h).

The yield limits also reach the loan itself: IRS Publication 5005 notes that conduit issuer fees can raise the effective yield on the conduit loan, which is a purpose investment, and Section 148 generally limits purpose-investment yield to the bond yield plus a permitted spread.

For program investments the spread is 1.5 percentage points under Treasury Regulation §1.148-2(d)(2), with 2 percentage points for qualified student loans that are program investments, while purpose investments not otherwise described in that paragraph fall under the general one-eighth of 1 percentage point tolerance covered in the yield restriction guide.

All of these limits run against gross proceeds, so replacement proceeds as well as the original proceeds of the issue are in scope under §1.148-1(b).

That is why the compliance calendar matters to the investment decision: the same proceeds face the use tests, the spending schedule and the yield limits at once, and which tests apply to a given issue is a determination for bond counsel and tax counsel.

What are mGIC's representative transactions?

mGIC is an independent, SEC-registered municipal advisor that sells no proprietary investment product and acts as no principal in the investments it evaluates, and its record spans more than $60 billion in bond proceeds invested and swap notional executed across more than 1,000 transactions for issuers in more than 40 states.

Its representative transactions include Pocahontas Parkway in Virginia, the Grand River Dam Authority in Oklahoma, Prairie State Energy Campus, Cardinal Stadium in Louisville, the DHL air cargo hub at CVG, Miami Air Cargo at MIA, the JFK International Air Cargo Center, Delta Cargo at JFK, aircraft FBOs at Westchester County Airport and Hobby Airport, Birmingham Water Works and OSU Village F student housing.

The case studies carry each engagement's description.

When mGIC serves as Bidding Agent, its fee is paid by the winning provider rather than the issuer, at or below the safe-harbor maximum in the Treasury arbitrage regulations, and it is disclosed.

If you are weighing the reinvestment for a P3 or private activity bond issue, you can talk to mGIC about a free, no-obligation reinvestment review.

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.