Private Activity Bonds

What Are Private Activity Bonds?

Most municipal bonds pay for public projects such as schools, and their interest is free of federal income tax. A private activity bond (PAB) is a bond issued by a government body whose proceeds mainly benefit a private party. Under Section 141 of the Internal Revenue Code, a bond is a private activity bond if more than 10% of the proceeds go to private business use and more than 10% of repayment comes from private sources. A bond also counts if more than 5% of its proceeds, or more than $5 million if that is less, is lent to private borrowers.

Only certain “qualified” types can be tax-exempt, including:

• Exempt facility bonds, which cover qualified residential rental projects as well as airports, water systems, and other facilities
• Qualified mortgage bonds, which fund below-market mortgages, mainly for first-time homebuyers (see mortgage revenue bonds)

Because the interest is tax-free, bondholders accept a lower rate, and the savings pass to the borrower.

How Private Activity Bonds Work for Rental Housing

A state housing finance agency or a local issuer sells the bonds and lends the money to a developer. The government acts as a conduit: the property’s income, not taxpayers, repays the bonds. See tax-exempt multifamily housing bonds for how the program works.

Under Section 142(d), the issuer elects one of two income tests, which apply for a qualified project period of at least 15 years:

• 20–50 test: at least 20% of units are occupied by households at or below 50% of area median income
• 40–60 test: at least 40% of units are occupied by households at or below 60% of area median income

The Volume Cap

Congress caps the dollar amount of these bonds each state can issue each year. For 2026, IRS Revenue Procedure 2025-32 sets each state’s ceiling at the greater of $135 per resident or $397,625,000. Rental housing and mortgage bonds count against the cap. Bonds for nonprofit organizations’ facilities and some exempt facility bonds, such as those for airports, do not.

Private Activity Bonds and the 4% Credit

Many developers seek PABs mainly to unlock the 4% tax credit. A building financed substantially with tax-exempt bonds receives 4% credits without drawing on the state’s competitive credit ceiling. Traditionally, the bonds had to finance at least 50% of the building and land basis, a rule known as the 50% test.

Public Law 119-21, signed in July 2025, added a 25% threshold for projects where at least one bond issue is dated after December 31, 2025 and finances at least 5% of the basis. That lets each dollar of cap support more homes.

Why It Matters for Workforce Housing

Because only part of a building must be income-restricted, bonds leave room for mixed-income projects. But the restricted units serve renters at or below 50% or 60% of AMI, not the higher workforce-housing band.