A Primer on Tax-Exempt Borrowing

legal By: Walter R. Calvert and Davis V.R. Sherman

Some associations considering large-scale projects such as building construction have the option of borrowing on a tax-exempt basis. Though the process can be complex, the potential savings can make the effort worthwhile.

Section 501(c)(3) organizations are eligible to borrow money on a tax-exempt basis. The more favorable interest rates provided by borrowing on a tax-exempt basis may be worth the additional transactional costs and restrictions imposed by federal income-tax law. But tax-exempt borrowing is more complicated than the typical bank loan. The debt must be issued by a government entity such as a state or local government, with the proceeds reloaned to the exempt organization. This is called "conduit borrowing," because the government entity typically assumes no obligation on the debt. Rather, it serves as a conduit to pass the loan proceeds on to the true borrower, the 501(c)(3)....