AmeriDream Summarizes Issues Concerning Down Payment Assistance Groups

Dear Eric, Michael, Susan and Eric:

Thank you for taking the time to meet with me, Ann Ashburn, President and CEO of AmeriDream, Inc., and my tax partner Matt Dolan yesterday. We appreciate your thoughtful questions and look forward to continuing to work with you to help down payment assistance organizations continue their important work of assisting low- and moderate-income families obtain home ownership. A copy of our outline from the meeting is attached.

Revenue Ruling 2006-27 addresses tax issues relating to down payment assistance (DPA) organizations benefiting low- and moderate-income families. The analysis and conclusion of Situation 2 in the Revenue Ruling is flawed in a number of respects. Most importantly, the Revenue Ruling erroneously fails to recognize that (i) any benefits inuring to sellers, agents, or lenders from down payment assistance programs are incidental to and concomitant with assistance benefiting low-income and distressed buyers; (ii) it would be impossible not to incidentally benefit sellers, agents and lenders when assisting buyers who otherwise would not be in a position to purchase a home; (iii) the benefit to any seller is limited to perhaps selling more quickly (because of an increased pool of potential purchasers resulting from assistance to buyers who otherwise would not qualify to purchase a home) a home that would sell for fair market value in any event; (iv) the benefit to agents and lenders is limited to benefits necessarily resulting from adding low-income and distressed buyers to a market that otherwise would exclude those potential buyers; and (v) federal policy prohibits for-profit organizations from operating in the DPA space. The IRS has approved the exempt status of down payment assistance providers that receive fees from sellers for almost a decade. Revenue Ruling Situation 2 reverses this position based on incorrect factual assumptions and faulty legal reasoning; e.g., by seemingly concluding that DPA organizations impermissibly benefit sellers and impermissibly operate in for-profit space. As a result, Revenue Ruling 2006-27 threatens the continued operation of legitimate programs which have permitted hundreds of thousands of families to own their own homes.

Revenue Ruling 2006-27 should be withdrawn and proposed regulations issued to permit a thorough review of down payment assistance issues.

Background

• FHA loans for low- and moderate-income families generally require the home buyers to make a down payment of at least 3%.

• HUD policy permits home buyers to accept cash gifts from relatives, close friends, employers, labor unions, government entities, and charities to help them make the required down payment. HUD policy does not permit for-profit entities or sellers to provide down payment assistance to HUD borrowers.

• Several organizations granted charitable status by the IRS and operating according to HUD guidelines provide down payment assistance to low- and moderate-income home purchasers in the form of cash gifts. DPA organizations provide financial assistance to approximately 40% of the mortgages that FHA insures.

• For almost a decade, these DPA organizations presented detailed explanations of their operations to the IRS, including the role of seller funding. On that basis, the IRS granted the organizations 501(c)(3) status.

• Approximately 75,000 families receive assistance each year from DPA organizations. Annually, DPA organizations combined contribute over $500 million in the form of gift funds to homebuyers. Property tax revenues generated by DPA homeowners are approximately $550 million per year.

• Down payment gifts made by DPA organizations are made based on the market value of the purchased homes as affirmed by HUD certified appraisers. Those appraisers are chosen by lenders and not by the DPA organizations. Also, HUD regulations require lenders to use many different certified appraisers to ensure the appraisals are as accurate as possible. The appraisal also includes a rigorous inspection of the safety and habitability of the property so that FHA may insure with confidence.

• FHA repeatedly has acknowledged that its down payment requirements present a "major barrier" to families whose limited incomes may permit them to make monthly payments, but not to save for a down payment. Since 2004, FHA has sought statutory authority to offer a "zero down payment" mortgage. However, whereas private sector DPA programs give home buyers the down payment, the proposed FHA "zero down payment" mortgage would require the low- and moderate-income home buyers to repay that amount, with interest. Also, the FHA program would impose higher mortgage insurance premiums.

• On July 24, 2003, Treasury and the IRS designated DPA programs for guidance in the coming fiscal year. Shortly thereafter, DPA organizations wrote to Treasury requesting that any guidance be published in proposed form to allow for public comment, due to the issue's great complexity and significant policy impact. That request was formally restated in early 2006. Until the release of Revenue Ruling 2006-27, no public guidance was given and no response was made to the requests for an opportunity for public comment. The first iteration of the Revenue Ruling was in final form. No proposed text was made available for comment.

• Typically, when an individual decides he or she is ready to purchase a home, the individual visits a lender to help determine the maximum home price they qualify to purchase. Under current law, individuals eligible for FHA financing (i.e., a loan from a lender made pursuant to FHA guidelines and guaranteed by FHA), are required to make a down payment of at least three percent (3%). For example, if a potential buyer qualifies to purchase a home worth $100,000, the buyer is required to make down payment of $3,000. A buyer is not permitted by FHA to locate a home worth $97,000 and then borrow the full purchase price from the lender without making the required 3% down payment.

• If an individual qualifies for a loan but lacks the required down payment, the lender may refer the potential buyer to a DPA organization.

• After the individual identifies a home he or she would like to purchase, the individual and the seller negotiate contract terms, including price. The seller and buyer also execute an addendum pursuant to which the seller agrees to make a payment to a DPA organization (in this example, the payment from the seller to the DPA organization may be $3,000 plus a $500.00 processing fee) after title transfers to the buyer.

• Next, before closing, the property must be appraised and rigorously inspected for safety and habitability by professionals chosen by the lender (and lenders are required to have a lengthy list of FHA qualified appraisers and inspectors and to rotate assignments to help preserve both the independence of such individuals and the quality of their reports).

• After the appraisal and inspection are complete and satisfactory, the DPA organization sends down payment assistance funds to a title company to hold in escrow to be applied for the buyer's benefit toward the purchase price at closing.

• When a seller makes a payment to a DPA organization, the payment is made after the DPA organization makes a gift of down payment assistance to a low- or moderate-income buyer by sending down payment funds to a title company to hold in escrow to be applied toward the purchase price at closing. The payment from any seller is to the DPA organization -- not to any particular buyer. The DPA organization uses the funds both for normal operating expanses and, perhaps more importantly, to enhance the DPA organization's pool of funds from which the DPA organization makes future gifts (i.e., gifts after closing of the sale of the seller's home). As a result, any participation by a seller in the form of a fee paid to a DPA organization is a "cost" to the seller, not a "benefit".

• Sellers also are not entitled under any circumstances to a charitable contribution deduction for a payment made to a DPA organization in connection with the sale of their home.

• Because gifts from DPAs to home purchasers are applied against the contract price based on the fair market value of the homes, the DPA payments create immediate home equity for the purchasers.

• Revenue Ruling 2006-27, dated May 22, 2006, sets forth certain rules for determining whether organizations that provide down payment assistance to home buyers qualify as tax-exempt charities.

• The Revenue Ruling posits three hypothetical sets of facts, and seeks to analyze the legal consequences of each.

• In "Situation 2", the Revenue Ruling describes a hypothetical entity, "Y", that is a non-profit corporation that provides DPA to help low-income families, as determined by HUD standards, to buy "decent, safe and sanitary" homes. Families may receive assistance if they have the employment and financial history to qualify for a mortgage, and would so qualify but for the lack of a down payment. Y also offers financial counseling seminars, and conducts other educational activities to help prepare potential low-income buyers for the responsibility of home ownership. In substantially all cases in which Y provides assistance to a home buyer, Y subsequently receives a payment from the home seller, which is contributed to a pool from which future gifts are made.

• Revenue Ruling 2006-27 rules that, in Situation 2, Y is not operated exclusively for charitable purposes.

• In reaching its conclusions, Revenue Ruling 2006-27 fails to address a number of important facts and legal considerations relevant to the tax status of Y. For example:

• • By characterizing the down payment assistance as a purchase price reduction, the IRS reaches a conclusion inconsistent with the facts and inconsistent with the conclusions reached by HUD and FHA. Both HUD and FHA respect the form of the transaction and accept the fact that any payment from any seller is a payment to the DPA organization and not to the buyer of the seller's home or to any future buyer.

  • The Revenue Ruling's characterization of the transaction as a "purchase price reduction" is not a characterization legally entitled to occur under federal law governing FHA lending.

  • Far more important, by concluding that DPA organizations benefit sellers and operate in a "for-profit" manner, the Revenue Ruling seeks to destroy a charitable funding mechanism that has proven to be highly effective in raising funds to promote an exempt purpose. As noted above, the gift from the DPA organization to the buyer occurs before a seller makes a payment to the DPA organization. Further, the price of each home for which Y provides down payment assistance must be supported by a comprehensive appraisal by a HUD-certified appraiser. That appraisal attests that, in the expert opinion of the appraiser, the seller could sell the same home for the full fair market value to any buyer. As a result, the DPA arrangement confers a benefit exclusively upon the low-income buyers, which the Ruling acknowledges is an exempt purpose. The benefit to sellers, agents and lenders is both insubstantial and concomitant (i.e., necessarily existing with the benefit to the purchaser, but in a lesser way). As noted above, it would be impossible not to incidentally benefit sellers, agents and lenders when assisting buyers who otherwise would not be in a position to purchase a home.

  • Any benefit to any seller is limited to perhaps selling their home more quickly (because of an increased pool of potential purchasers resulting from assistance to buyers who otherwise would not qualify to purchase a home). The seller's home certainly would sell for fair market value in any event given sufficient time. As noted above, sellers who make a payment to a DPA in fact receive no "net" benefit; any payment to a DPA is a cost to them.

  • Any benefit to agents or lenders is limited to benefits necessarily resulting from adding low-income and distressed buyers to a market that otherwise would exclude those potential buyers.

  • Federal policy prohibits for-profit organizations from operating in the DPA space so there in fact is never competition with noncharitable entities or "commerciality" with which the IRS needs to be concerned.

  • The Revenue Ruling fails to reconcile its holdings with previous IRS approval of 501(c)(3) status for DPA organizations whose applications detailed proposed operations substantially identical to Y.

• The Revenue Ruling disregards existing IRS guidance. Private benefit should be evaluated based on specific facts and case- by-case.

• • Regulatory Language

  • The Revenue Ruling focuses on the Section 501(c)(3) regulations' terms "exclusively," "primarily," and "insubstantial". Specifically, Section 501(c)(3) provides that a corporation organized and "operated exclusively" for charitable purposes is exempt from taxation. Treas. Reg. Sec. 1.501(c)(3)-1(c)(1) provides that an organization will be regarded as "operated exclusively" for one or more exempt purposes only if it engages "primarily" in activities which accomplish one or more exempt purposes specified in Section 501(c)(3), and that "[a]n organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose."

  • The Regulatory Language is Not Easily Generalized

  • The IRS is well aware of the conceptual problems presented by the terms "exclusively," "primarily," and "insubstantial." See IRS Exempt Organizations Handbook (IRM 7751) Section 341.1(2). The IRS has stated that "[q]uestions involving the application of these terms can more readily be resolved on the basis of the facts of a particular case." Id.

    It is therefore inappropriate to attempt to provide a short-hand conclusion for the broad class of organizations potentially encompassed by Situation 2 in the Revenue Ruling.

    • Situation 2 of Revenue Ruling 2006-27 has created great uncertainty. In turn, that uncertainty impedes the continued operation of programs which have permitted over 625,000 low- and moderate-income families to own their own homes.

• • It seems harsh and unsupported by the facts to treat receipt by a DPA organization of a payment from a seller as a "bad factor" when (i) HUD and FHA policy treat the same fact situation in accordance with its form, (ii) such payments in fact fund future gifts to low- and moderate-income buyers having no relationship (transactional or otherwise) with the seller, (iii) federal policy prohibits for-profit organizations from operating in the DPA space so there in fact is never competition with noncharitable entities, and (iv) any benefit to sellers or agents is incidental to, and concomitant with, the benefit to low- and moderate-income buyers.

• Federal law contemplates that matters as complex and consequential as those relating to DPA organizations are properly addressed through regulations promulgated under the Administrative Procedures Act. That law directs that policy makers develop rules only after public notice and with the benefit of public comment.

• In gray areas that include complexity (and we recognize and respect that this is one of those areas) where there exists no private benefit, no competition with for-profit entities and demonstrable charitable progress in the very tangible form of home ownership by persons without current means to make a required down payment, we urge tax policymakers to err on the side of fostering rather than hindering down payment assistance organizations' efforts to provide home-ownership -- the "American Dream" -- to low- and moderate-income individuals.

• Cutting off fees from sellers to DPA organizations when sellers are happy to support the program by paying a fee in connection with the sale of their home means leaving thousands of low- and moderate-income citizens without home ownership.

• Revenue Ruling 2006-27 should be withdrawn to permit comprehensive regulations relating to DPA organizations to be developed.