IRS Targets Down-Payment-Assistance Scams; Seller-Funded Programs Do Not Qualify As Tax Exempt

WASHINGTON, DC – Organizations that provide seller-funded down-payment assistance to home buyers do not qualify as tax-exempt charities, the Internal Revenue Service said in a ruling released today. Source - Community Dispatch Down-payment-assistance programs provide cash assistance to homebuyers who cannot afford to make the minimum down payment or pay the closing costs involved in obtaining a mortgage. Such programs can qualify as tax-exempt charitable and educational organizations under Internal Revenue Code section 501(c)(3) when properly structured and operated. In Revenue Ruling 2006-27, released today, the IRS provides a detailed discussion of the guidelines – including two examples that meet – and one that fails to meet – the tests for exemption. The ruling makes it clear that seller-funded programs are not charities because they do not meet the requirements of section 501(c)(3). Increasingly, the IRS has found that organizations claiming to be charities are being used to funnel down-payment assistance from sellers to buyers through self-serving, circular-financing arrangements. In a typical scheme, there is a direct correlation between the amount of the down-payment assistance provided to the buyer and the payment received from the seller. Moreover, the seller pays the organization only if the sale closes, and the organization usually charges an additional fee for its services. A March 2005 report entitled, “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations,” commissioned by the U.S. Department of Housing and Urban Development (HUD), found that seller-funded down-payment assistance has led to underwriting problems and resulted in an increase in the effective cost of homeownership. A report from November 2005 entitled, “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance,” conducted by the U.S. Government Accounting Office (GAO) found similar results. “The IRS is increasingly concerned with organizations that are taking advantage of homebuyers who need assistance for a down payment to realize the American dream of homeownership,” said IRS Commissioner Mark W. Everson. “So-called charities that manipulate the system do more than mislead honest homebuyers and ultimately jack up the cost of the home. They also damage the image of honest, legitimate charities.” The IRS is examining 185 organizations that operate down-payment-assistance programs. A particular organization’s tax-exempt status can be verified using the on-line database at irs.gov (click on “Charities & Non-Profits” and then click on “Search for Charities”). In addition, the agency has denied applications for tax exemption from over 20 organizations that seek to provide this service and is considering applications from a number of other down-payment assistance organizations. The Where Most Needed blog, a charity industry observer, says the "IRS belatedly denies charity status to organizations that provide down payment assistance—funded by home builders and home sellers." A new IRS revenue ruling has closed off charity status to nonprofits that provide downpayment assistance to home buyers, in cases where the home sellers (builiders and private sellers) have provided the funding for the downpayment grant.

"We discussed these organizations not long ago in connection with a GAO report criticizing these schemes because they encouraged home purchase via FHA loan by unqualified buyers and increased the price of homes. FHA, unlike conventional lenders, permitted the practice of seller-funded downpayment assistance."

The organizations involved have become huge. Nehemiah Corporation of America (EIN 52-2145694 Form 990) reports income of $143 million, AmeriDream (EIN 52-2145694 Form 990) reports $97 million, and The Buyers Fund (EIN 87-0635224 Form 990) $167 million. All of these organizations follow the buyer-funded model, and the bulk of their income appears as fees rather than contributions. The revenue ruling allows organizations that raise money from sources other than sellers to continue as charities. Such organizations, like Family Housing Resources (EIN 86-0750139 Form 990), are much smaller. Phoenix-based FHR has a $1.2 million assistance program alongside its $8.2 million in low-income rental properties. One lesson here is that rapid growth of a charity is not necessarily a sign of health. Growth may be because an organization (or in this case a whole industry) has found a loophole that allows it to operate a business scheme as a charity. It is also heartening that the IRS is showing some life in curbing these schemes, as it recently did with credit counsellors. Revenue Ruling 2006-27 will be published in Internal Revenue Bulletin 2006-21, dated May 22, 2006. Links: Rev. Rule 2006-27 HUD/FHA Non-Profit Program Appraisal , Real Estate , Appraiser , USPAP , RESPA , FHA , Regulation Illinois , Realtor