In May, the Internal Revenue Service ruled that certain organizations providing down-payment assistance gifts to low-income homebuyers do not qualify for Section 501(c)(3) tax-exempt status.Organizations specifically targeted are those that give a tax-free DA gift to the buyer while requiring the seller to make a non-tax-deductible contribution of the gift amount, plus an additional amount to cover administrative costs.
Unclear in Revenue Ruling 2006-27, however, is whether all such organizations can expect to lose their tax-exempt status, or if the ruling is setting the stage for the IRS to zero in on certain specific organizations.
Earlier this spring, the Justice Department ruled that a down-payment assistance organization in Illinois - Partners in Charity Inc. - was permanently barred from making false and misleading statements regarding its DA program. PIC was accused of promoting its program by advertising that contributions by property sellers that were directly tied to DA gifts given by PIC to property purchasers were tax-deductible contributions.
IRS Publication 526, Charitable Contributions, specifically states that, "If you receive or expect to receive a financial or economic benefit as a result of making a contribution to a qualified organization, you cannot deduct the part of the contribution that represents the value of the benefit you receive."
According to Nancy Mathis, spokeswoman for the IRS, "Contributions are not deductible, even if made to a qualified organization, if the contributor expects to receive a financial or economic benefit from making the contribution."
As a result of United States v. Partners in Charity Inc., the DA organization was not only barred from using the type of promotions that it had been using previously - it was also required to provide the government with a complete list of sellers who had made contributions to the organization, along with their contact information.
Revenue Ruling 2006-27 points to three different types of DA programs in its descriptions of how the tax-exempt status is to be applied to organizations administering these gift payments.
In two of the types of programs, a nonprofit corporation provides monetary assistance to low-income individuals and families trying to buy homes, and the funding for the programs comes from broad-based fundraising programs that solicit donations from foundations, businesses and the general public. No contributions are accepted that are contingent on the sale of a particular property.
In the third type of program, described in the IRS ruling as Situation 2, property sellers are required to make a "charitable gift" to the DA program when the sale of a home is completed. This "gift" equals the amount that the organization gives to the buyer to cover some or all of the buyer's closing costs, as well as an additional fee to cover the administrative costs of the transaction. The buyer's receipt of the gift from the organization is contingent on the organization's receipt of the "gift" from the seller.
Although the DA organizations call these seller payments donations or charitable gifts, they are required payments, not necessarily made in the spirit of charitable giving. Furthermore, the seller directly benefits from giving the money to the organization, because the down-payment assistance facilitates the sale of the property.
The IRS has indicated that DA programs that fall into this group do not qualify as tax-exempt under Section 501(c)(3). However, "The ruling in and of itself does not revoke an organization's tax exemption," said Mathis. "Revocation is a procedure that would occur only if an examination found an organization to not be in compliance with its tax-exempt status."
"Contributions are not deductible, even if made to a qualified organization, if the contributor expects to receive a financial or economic benefit as a result of making the contribution," she said. "Sellers who claimed charitable contributions to facilitate the sale of their house should file an amended tax return and remove the amount of the contribution."
DA providers balk
The DA organizations see themselves as facilitators, working as third parties to provide homebuyers with the funds to make a down-payment on a mortgage, and point out that the down-payments meet the requirements of the Department of Housing and Urban Development.
The Nehemiah Corp. of America describes itself as the nation's leading private homeownership DA provider, having provided more than $825 million in down-payment assistance to more than 212,000 families in the U.S. since its organization in 1998. In a letter that appears on the company Web site, Nehemiah indicated that it plans to contest the IRS opinion. However, the organization points out that it has no plans to close its operations, no matter what the outcome of the ruling might be.
"The Nehemiah Program is not changed in any way by the ruling, other than that Nehemiah may have to pay appropriate business taxes on the revenues generated by its down-payment assistance program," said Nehemiah president Scott C. Syphax, in the letter.
In a letter to Treasury Secretary John Snow, Ann Ashburn, president and chief executive of Gaithersburg, Md.-based AmeriDream, a national DA provider, stated that with Revenue Ruling 2006-27, "The IRS could virtually shut down the DPA industry as it now operates."
"This development will excise a significant part of the housing market and lock countless Americans out of homeownership every year," her letter continued.
"Basically, it would effectively shut down every seller-assisted down-payment assistance program in the nation," agreed Frank Williams, founder, chairman of the board and president of Housing Action Resource Trust, another national DA provider.
Would that be so bad?
Meanwhile, HUD is convinced that properties purchased with the help of DA loans result in more foreclosures. In a study performed by HUD in March 2005, the agency found, "Some mortgage company executives reported, based on their experience, many seller-funded DA loans had lower credit quality and higher default rates than other [Fair Housing Administration] loans."
"I'm not a big fan of it," said Jim Jackson, senior vice president of the residential division at Indianapolis-based F.C. Tucker Co. Inc., a real estate brokerage firm. "In effect, what this really does is it starts people out with negative equity, because they could have bought the house for less money had you not had that program in there."
The assumption is that without the payment that the seller has to make to the DA organization, the seller would otherwise lower the selling price of the house. Instead, the buyer gets third-party assistance with the down-payment, but the house sells at a higher price.
The HUD study agreed with this analysis: "Research shows that the seller's willingness to commit to this arrangement is based upon an increase in the sales price."
Although the buyer is able to own a home he might not otherwise be able to afford, he might end up losing money when he tries to sell the home.
"That's the problem that I see with the program is it started people so far off in the hole, and they are typically first-time homebuyers," explained Jackson. "Typically, they're not going to stay in the home that long. They might be in it three or four years."
Jackson described a typical scenario wherein the buyer tries to sell a house after three years, and the house might have only appreciated to the amount that the buyer paid for it. When the buyer sells the home, the proceeds only clear what the home is worth, but the buyer still has to pay a real estate commission and closing costs. Unless the home is in a rapidly appreciating market, the buyer ends up losing money.
Change of heart?
One pressing issue that concerns many of the DA providers is that these programs were initiated in the late 1990s at the urging of the federal government. "It's the federal government that promoted the darn thing so much," explained Jackson. "The down-payments were historically the biggest impediment to buying a house."
Ashburn explained that her organization received an advance ruling letter and a final determination letter when it was founded in 1999. "We have not changed our program operation at all, and they've signed off on it for almost a decade," Ashburn said.
Others echoed the confusion.
"We've been doing this business for nine years," said Williams of HART. "The irony of all this is that we had government approvals not only from HUD, but we had program-specific approval from the IRS in our designation letters, so for them to arbitrarily come up with a revenue ruling stopping these programs is very unfortunate."
"I think it's a big double-cross," continued Williams. "I think the government led us down this path. They've allowed us to do this, and now they want to get rid of programs that have put almost a million families in homes."
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