IRS Ruling Endangers Down-Payment Charities

The tax man wants to close a loophole that has allowed hundreds of thousands of families to buy homes without saving for down payments.
The Internal Revenue Service ruled this month that nonprofit down-payment-assistance programs don't qualify for tax exemptions if they transfer money from the seller to the buyer. In the last decade, these nonprofits have helped about 600,000 families buy homes without saving the 3 percent down payment that the Federal Housing Administration, or FHA, requires.

The ruling could lead to the destruction or disruption of the down-payment-assistance industry. IRS examiners will use the ruling to decide whether to strip organizations of their tax-exempt statuses. None have lost that status -- yet. '... huge effect on consumers'"I think it would have a huge effect on consumers, because this has been such a great tool for FHA home buyers," says David Ahrens, president of Buyers Fund, one of the three big nonprofit down-payment-assistance programs. (The others are AmeriDream and the Nehemiah Program, plus about 180 much smaller nonprofits.)

Ahrens adds: "The average first-time home buyer could be really hurt by this and could be pushed into loans, such as 80-20 products or interest-only loans, that would not be as advantageous."
Lenders require mortgage insurance on home loans in which the buyer makes a down payment of less than 20 percent. Some borrowers avoid mortgage insurance by getting two loans -- one for 80 percent of the purchase price, and a second mortgage for up to 20 percent of the price. This so-called "piggyback mortgage" is the 80-20 product that Ahrens speaks of.

The role of down-payment charitiesSome companies will insure a mortgage for 100 percent of the home's value -- in other words, without a down payment. But the FHA requires a down payment of at least 3 percent. FHA borrowers tend to have flawed credit, and a lot of them have trouble saving the minimum down payment. That's where nonprofit down-payment-assistance programs come in.

Unlike private mortgage insurers, the FHA allows borrowers to receive some or all of their down-payment money in the form of gifts from family, government, employers or nonprofit organizations. The down payment can't come directly from the seller. On the other hand, until recently, nothing prevented a nonprofit from giving a down payment to the buyer, and then immediately collecting the money from the seller.
The down-payment-assistance industry was born in the 1990s to exploit the loophole. The buyer and seller would agree to use a down-payment program as a conduit for the money. Everyone benefited: The real estate agents got their commissions, the nonprofit got an administrative fee, the lender got a loan, the seller got the proceeds from the sale and the buyer got a house. In the last year, about 40 percent of FHA-insured loans included down-payment assistance.

Concerns surfaced earlyCritics had concerns from the beginning. Numbers-crunchers from the Department of Housing and Urban Development and the Government Accountability Office concluded that borrowers were more likely to end up falling behind on their monthly payments if they had accepted down-payment money from sellers through nonprofits. They said some buyers ended up paying more than market value for their houses. HUD, of which FHA is a part, made noises about closing the loophole, but didn't.

On May 4, the IRS stepped in with Revenue Ruling 2006-27, which says that a nonprofit which transfers down-payment money from seller to buyer "is not operated exclusively for charitable purposes, and, consequently, does not qualify for exemption from federal income tax."
The ruling doesn't name names, but sets forth guidelines that pin a target on nonprofit down-payment-assistance programs. The IRS says it is examining 185 nonprofits. Anticipating the ruling, a small player, Houston-based United American Housing and Education Foundation, announced that it was terminating its down-payment program to take "a new direction."

Most of the nonprofits -- including AmeriDream, Buyers Fund and Nehemiah -- continue to operate because they still have tax-exempt status while the IRS examines them. In a letter on Nehemiah's Web site, president Scott Syphax writes: "The administrative ruling does not have an instantaneous impact on the tax-exempt status of an entity," and adds that "the ruling is the beginning, not the end of the discussion."
An IRS spokesman confirms that the ruling does not revoke any organization's tax-exempt status. Rather, it serves as guidance for examiners who will decide whether to revoke tax-exempt status.

If the IRS revokes an organization's tax-exempt status, the nonprofit may appeal administratively and in federal courts. The presidents of Nehemiah and Buyers Fund say they will appeal, if it comes to that. A spokesman for AmeriDream says, "We are still in business."
IRS uses the S word: ScamIn a news release announcing the ruling, the IRS refers to the nonprofits as "down payment assistance scams," and quotes IRS commissioner Mark W. Everson as saying: "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 homeownership. 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."

Ahrens says such rhetoric surprises him, because "this administration has placed so much importance on housing." President Bush wants 5.5 million minority households to become homeowners this decade. There has been progress on that front, "and I think we've played a huge role in that," Ahrens says. "They wanted the private sector to step up and provide some solutions, and I think we've done that."
Source from : bankrate.com