The key feature of a private purpose bond is that they are solely used to help finance private investments and amenities. Comparatively, a public purpose bond is exclusively for investments that benefit the public, i.e. public facilities or projects that benefit a sizeable community.

The reason why The Tax Reform of 1986 led to the separation of municipal bonds into two types was for a change in the taxation regulations. The taxation regulations are currently quite clear and state that: Private Purpose Bonds are applicable for taxation unless exempted (which is rare). Public Purpose Bonds are exempt from federal taxation.

The reason why these types of bonds are so popular with investors who have high incomes is because of their extremely favourable tax implications – they are exempt from federal taxes and in most cases state taxes too.

A word on the security attributes of a municipal bond fund – although they are backed by the government and are considered low risk rating, municipalities have in the past declared bankruptcy and avoided payouts altogether. So although they are generally low risk, investors should be aware that there are ways that you could lose out should something inadvertently go wrong.

Breaking this down into more manageable chucks; typically, interest payable on municipal tax bonds is usually exempt from all federal taxes, so too local and state taxes. Of course it does depend on the state that the bonds were initiated in and subject to other restrictions but in essence; municipal bond investing quite often has an attractive tax-exempt quality.

The calculation of whether municipal bonds become taxable is usually through which type of project it is funding. For instance; projects initiated for the greater good of the public, for example; a railway network, would more than likely be a tax free municipal bond as its development is in the best interests of the general public and everyone can benefit from, not just a private citizen or their cause. This compared to projects either partially or fully benefiting an individual or group of private parties, usually called private activity bonds, are usually subject to federal income tax.

As we have already discussed in a previous article, the legislation surrounding the tax-ability of municipal bonds and the income that they provide is extremely complex. As bonds are usually always certified by a professional law company, it should be disclosed whether they are taxable or indeed tax-exempt before they are even offered to the market. You should keep in mind that not all municipal bonds are tax-exempt, some are unfortunately fully taxable. Always check thoroughly before considering investing in municipal bonds.

Investors who agree to buying municipal bonds effectively loan money to the issuer in exchange for an agreed number of payments over a prearranged time period. At the end of this period, the bond reaches what is called the bond maturity date and the investor receives (if all goes well) the return on their investment including the interest allotted over the time period.

There are quite a number of uses for municipal bonds. For example they may be used to finance such developments as the construction of road networks such as highways or academic schooling facilities.
Perhaps the most common reason people invest in “munis” is because of their extremely favourable tax implications. They are most popular with high income earners as the return on their investment is larger due to the rewarding municipal bond rates they are entitled to.