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 Thursday.
Down-payment-assistance programs, such as those at Nehemiah Corp. and AmeriDream, provide cash assistance to home buyers who cannot afford to make the minimum down payment or pay the closing costs involved in obtaining a mortgage. The gifts typically range from 2 percent to 5 percent of the purchase price, and home buyers aren’t required to repay the money.
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 Thursday’s ruling, the IRS provides a detailed discussion of the guidelines – including two examples that meet – and one that fails to meet – the tests for exemption, and makes it clear that seller-funded programs are not charities because they do not meet the code requirements.
Down-payment gift programs have been credited with helping to boost the home-ownership rate, but have come under fire after government-issued reports found that such programs have led to underwriting problems and have increased the cost of home ownership.
The IRS said that it has increasingly 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, the agency said. 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, “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations,” commissioned by the U.S. Department of Housing and Urban Development, found that seller-funded down-payment assistance has led to underwriting problems and resulted in an increase in the effective cost of home ownership.
A separate November 2005 report, “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance,” conducted by the U.S. Government Accounting Office found similar results.
Homes bought with seller-funded nonprofit assistance cost 2 percent to 3 percent more and are twice as likely to go into default, according to the reports.
“The IRS is increasingly concerned with organizations that are taking advantage of home buyers who need assistance for a down payment to realize the American dream of home ownership,” said IRS Commissioner Mark W. Everson in a statement. “So-called charities that manipulate the system do more than mislead honest home buyers and ultimately jack up the cost of the home. They also damage the image of honest, legitimate charities.”
Nehemiah Corp. of America, a down-payment-assistance organization launched in 2000, said today that it is studying and evaluating the new IRS ruling. “We are disappointed that a program that has been granted tax-exempt status for more than nine years and has served hundreds of thousands of Americans would have this tax exemption arbitrarily threatened in this fashion. We intend to contest the IRS opinion,” the company said in a statement this morning.
The Nehemiah program has provided more than $825 million in gift funds to more than 212,000 families in 8,500 cities nationwide, the organization said. Also, the Nehemiah Community Reinvestment Fund has generated more than $57 million in investment and lending capital, and funded projects have a total development cost of more than $550 million.
“It is important to note that Nehemiah has not been sanctioned in anyway by any regulatory agency and that Nehemiah continues to serve home buyers by delivering world-class down-payment assistance through the reputable Nehemiah Program,” the organization said.
Officials at AmeriDream, which also operates a down-payment-assistance program, did not provide comment on the new ruling today.
The IRS said it is examining 185 organizations that operate down-payment-assistance programs. A particular organization’s tax-exempt status can be verified using the online database at Irs.gov by clicking on “Charities & Non-Profits” and then clicking on “Search for Charities.”
In addition, the agency said it has denied applications for tax exemption from more than 20 organizations that seek to provide this service and is considering applications from a number of other down-payment assistance organizations.
Revenue Ruling 2006-27 will be published in Internal Revenue Bulletin 2006-21, dated May 22, 2006.