Harbor Bancorp & Subsidiaries - Page 1


          105 T.C. No. 19                                                             

                               UNITED STATES TAX COURT                                

                      HARBOR BANCORP & SUBSIDIARIES, Petitioner                       
                   v. COMMISSIONER OF INTERNAL REVENUE, Respondent                    
                    EDWARD J. KEITH AND ELENA KEITH, Petitioners                      
                   v. COMMISSIONER OF INTERNAL REVENUE, Respondent                    

               Docket Nos.  24112-92, 5857-93.      Filed October 16, 1995.           

                    The Housing Authority of Riverside County,                        
               California, issued revenue bonds to finance the                        
               construction of multifamily housing for families of low                
               and moderate incomes.  Ps purchased some of these bonds                
               and, believing that the bonds were tax exempt, did not                 
               include the interest received thereon in income.  Sec.                 
               103(a), I.R.C., generally provides a tax exemption for                 
               interest earned on bonds issued by State and local                     
               governments.  This exemption does not apply to                         
               "arbitrage bonds".  Sec. 103(c), I.R.C.  Under sec.                    
               148(f), I.R.C., a bond is treated as an "arbitrage                     
               bond" if (1) the bond proceeds are used to purchase                    
               investments that are not acquired to carry out the                     
               governmental purpose of the bond issue; (2) the                        
               investment of the bond proceeds produces an excess                     
               amount of earnings described in sec. 148(f)(2), I.R.C.;                
               and (3) the bond issuer fails to pay such excess amount                
               to the United States.  The Commissioner determined that                
               the bonds should be treated as arbitrage bonds pursuant                

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