What is a Special Valuation Bond?
Special assessment bonds are general obligation bonds, usually issued to fund development projects, where the interest due is paid by taxes levied only on the beneficiaries of that project.
Key points to remember
- Special assessment bonds are general obligation bonds, usually issued to fund development projects, where the interest due is paid by taxes levied only on the beneficiaries of that project.
- Interest on special valuation bonds is exempt from federal and most state and local taxes.
- Special assessment fees cannot exceed the total cost of the project.
Definition of General Obligation (GO) Bonds
Understanding Special Appraisal Bond
A municipal bond is issued by a state or local government to raise capital to finance projects such as highways, sewer systems, amusement parks, public schools, etc. When a municipal bond is issued to sponsor the improvement of properties in a specific area of a city, town, or county, the bond is called a special assessment bond.
Investors who purchase a special valuation bond receive periodic interest from the issuer until the bond matures, at which time the principal will be repaid to bondholders. Payment obligations on the bond are secured by revenue from the portion of taxes levied on residents who directly benefit from the project. In other words, an additional tax is imposed only on those who will directly benefit from the improvement to cover the payments from the bond issue. Special assessment fees cannot exceed the total cost of the project.
For example, if a special assessment bond were issued to pay for sidewalks to be repaved in a certain community, an additional tax would be levied on property owners in the area benefiting from that project. Homeowners in the area benefit from more pleasant walking paths and will likely see their property value increase as a result, but this comes at a price. Their property taxes will increase to pay the interest owed to the bondholders by the municipality. Since the interest on special assessment bonds is paid for by the taxes of the community that benefits from the development, it is not uncommon for members of the beneficiary community to invest in the issue, thus offsetting the additional taxes that are levied to finance the link.
The interest on a special valuation bond can be fixed or variable. The maturity period will vary depending on the complexity of the project, with the typical maturity range being between one and 20 years. Additionally, these bonds may or may not be guaranteed by the full faith and credit of the municipal government. If it is not guaranteed by a guarantee of good faith and credit, it is more risky than a bond of general obligation of the same issuer.
Like most municipal bonds, interest on special assessment bonds is exempt from federal taxes and most state and local taxes if the investor lives in the state or municipality issuing the debt. The higher an investor’s marginal tax rate, the more valuable the bond’s tax exemption and, therefore, more desirable. Therefore, the demand for special valuation bonds is generally higher in states with high tax rates. If a state or the federal government reduces tax rates, bonds lose some of their advantage for people in high tax brackets and, therefore, become less desirable.