As the modular industry moves towards offering more permanent classrooms, there seems to be a greater desire for public school systems to acquire modular classrooms through financing. This may be the result of better planning by the school systems, realizing at the beginning that ownership is more cost effective than a long-term rental, or lease. It may be that the schools want eventual ownership since the modular industry is building a better product, which is less prone to defects, which can be better used as a "permanent" solution. Or it may be that there is a better understanding of the benefits of this low-interest method of financing that has gained over other methods of financing. Here's a quick overview, incorporating the most often asked questions.

"What is a tax-exempt lease?"

This is a financing transaction also known as a conditional sales contract where the interest earned by the lessor is not subject to federal taxes. The lessor, since they do not pay federal taxes on the interest income can offer a lower interest rate to the lessee. The exclusion from federal taxes is where the "tax-exempt lease" name comes from.

"Who is eligible?"

The lessee must be a state or possession of the US, or a political subdivision thereof. Political subdivisions include cities, towns, counties, as well as other entities, which have sovereign powers that include taxation, eminent domain, and police power. These entities include school districts, water districts, hospitals and others.

"Who isn't eligible?"

Most charter schools (excluding Ohio, Colorado, and some other states), "not-for-profit" entities also known as 501(c) 3, federal agencies, and public "affiliate" (not run by) entities.

Modular building dealers and manufacturers may offer tax-exempt lease/purchase financing to qualified customers even if financing is not part of the bid request. This can streamline the documentation process. Often, municipal customers are already bidding the financing separately. It varies from customer to customer. If you do choose this type of financing, make sure to note that the appropriate documentation will be necessary. A set of sample tax-exempt documents may be included with your bid response, as you would be surprised how many purchasing agents still aren't familiar with this type of financing.

"Is it always a Dollar ($1.00) Purchase Option?"

The IRS Code requires a nominal purchase option at the end of the lease term. This small amount is typically one dollar, but can be slightly higher.

"OK, I'm getting there, just how cumbersome are municipal documents?"

The IRS Code requires a few very basic provisions be included to qualify the lease as tax-exempt. This document has been standardized by the industry and using the document from a financing source will have a favorable effect the interest rate. These documents include but aren't limited to:

Master Lease/Purchase Agreement
This spells out the terms of the financing. This also includes a "non-appropriations clause," which states the lessee can terminate the lease at the end of the current fiscal year, and return the equipment if they are unable to obtain sufficient funds to meet future lease payments.

Legal Opinion
This comes from the lessee's counsel, and states proper procedures were followed in executing the documents.

Essential Use Certificate
The lessee states that the modular equipment is necessary and essential to the on-going operations of the lessee. This is important in light of the "non-appropriations" clause.

Insurance Certificate

8038-G or GC IRS Form
This is an IRS form and requires specific information to be filed. Failure to do so may result in the transactions loss of its tax-exempt treatment.

Payment Schedule
Represents payments due under the lease and also breaks out the interest and principle components of the lease payment, which is required by the IRS code.

Acceptance Certificate
Clearly specifies the lease start date

"Who is responsible for maintenance, property taxes, insurance, and other operating expenses?"

A tax-exempt lease is a "net lease" and the lessee is responsible for all operating expenses. The lessee may contract with a modular dealer/manufacturer to provide such services as maintenance, but these are paid outside the scope of the tax-exempt financing.

"Why would I enter into a tax-exempt lease?"

There are a few obvious benefits to this type of financing which include:

• A lower interest rate than a taxable finance lease resulting in lower lease payments.
• The school district only carries the current operating expense of the lease on its books. In most states a tax-exempt lease subject to annual appropriations is not included in the debt calculations and will not affect the debt ceiling.
• Traditional means of tax-exempt debt, or the issuance of bonds, are not economically feasible for individual projects. Bond issues start to make sense for more than $5,000,000 for small issuers and $10,000,000 for larger issuers.
• Avoidance of a large capital expenditure, where the lessee may not have available funds. Allows the user to pay for the buildings through their use, over time. This is common in a fast growing school district, which may need "emergency" modular classrooms.
• Flexible terms, with equity building in the buildings with each payment
• Simple, quick, inexpensive means of financing for qualified Lessees.

"Should the dealer/manufacturer act as the lessor in the lease? How does this affect the lessee?"

Most financing sources will let the modular dealer/manufacturer act as the lessor in the lease and take a non-recourse assignment of that lease to others. The lessor and lessee both retain any obligations they have in the lease and do provide warrants and representations of such to the financing source.

"Can they finance modular equipment/furniture?"

Other equipment can be added to the tax-exempt financing in addition to the modular equipment. This may include furniture and fixtures for new modular classrooms, computers, or HVAC equipment. The list is almost endless. The important thing is that this equipment must be "essential" to the operations of the lessee. A classroom desk and chair is obviously essential to teaching a child in your modular classroom.

"How does credit approval work?"

Most lessors like to see three years of audited financial statements for credit consideration. Obviously, the risk of a school district going away is minimal, but if they are having budget problems the lease needs to be priced accordingly. There are financing sources for all types of credits and circumstances. If the lessor knows the circumstances and has the information, the proper lease can be tailored, with the proper rate.

"Who owns the equipment?"

In most cases the title, or MSO, is passed to the lessee, with the lessor holding a security interest in the equipment.

That's the quick overview. A good quote to a qualified customer should include this type of offering whether tax-exempt lease/purchase financing is requested or not.

The prospective buyer may decide that the quote, with its tax-exempt offering, is more cost effective than other financing options.

John Kennedy serves Tatonka Capital Corporation headquartered in Denver, CO. Email: jkennedy@tatonkacapital.com.

Copyright © Modular Building Institute, June 2002.