Real Estate - Washington Post - IRS Ruling Imperils 'Gift Fund' Charities For Home Buyers

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IRS Ruling Imperils 'Gift Fund' Charities For Home Buyers

By Jacqueline L. Salmon and Kirstin Downey
Washington Post Staff Writers

Friday, June 2, 2006; A01

A ruling by the Internal Revenue Service threatens to extinguish a fast-growing -- but controversial -- charitable industry that has funneled hundreds of millions of dollars in cash to first-time home buyers for their down payments.

The unexpected IRS edict throws into question a practice that has helped boost national home ownership rates to a near-record 69 percent in the past six years.

Almost 200 charities, such as AmeriDream, based in Gaithersburg, and Nehemiah Corp. in California, have acted as cash conduits between home sellers and buyers.

Under the system, sellers provide cash to the charities, which then give it to home buyers for their down payments. The sellers, who pay the charities a service fee, often recoup their money by charging a higher price for the homes -- usually 2 or 3 percent more, or an amount equal to the down payment, says a Government Accountability Office study.

Federal authorities have raised concerns, because the mortgages are insured by the Federal Housing Administration. When a home buyer defaults, the FHA loan fund suffers. Home buyers receiving assistance from the charities were more than twice as likely to default or become delinquent in their payments as those who used FHA loans without the charities' assistance, according to a GAO study last year.

Although the system has helped hundreds of thousands of low-income households buy their first homes, it is riddled with abuse, according to the IRS and a variety of government studies. The IRS called the programs "scams" in its ruling last month and said that by providing down payments, the charities actually inflated home prices, making it more likely that homeowners would default on their loans.

Sen. Charles E. Grassley (R-Iowa), chairman of the Senate Finance Committee, who is pushing for charitable reform measures, blasted the down payment assistance charities and praised the IRS ruling.

"Unfortunately, this sector of charities is riddled with individuals who believe their role is to help themselves, not to lend a helping hand," he said. "Some so-called charities need a wake-up call that their business is charitable work."

The IRS's "revenue ruling," issued May 4, states that charities that dole out cash to home buyers that comes from sellers do not qualify as tax-exempt organizations because they benefit private interests, such as builders and other home sellers. The IRS expects to begin revoking some charities' tax-exempt status as it finishes audits, said Marvin Friedlander, chief of the IRS's exempt-organizations technical branch. The IRS also could assess the organizations millions of dollars in income taxes if it decides they are for-profit organizations, not charities.

Executives at the charities say they have helped renters who would not otherwise have been able to buy homes because they were unable to afford the down payment. They dispute the GAO study and disagree with the IRS findings.

Last week, a coalition of the charities asked the Treasury Department to suspend the IRS ruling and solicit public comment before issuing a final decision.

"This could have a sweeping impact on the whole housing industry," said Ann Ashburn, chief executive of AmeriDream, the nation's second-largest down payment assistance charity, and the coalition chair.

The IRS action has also roiled the real estate industry, which depends on the charities as a way to move cash-poor home buyers into the housing market. The charities say they move $500 million a year from sellers to buyers -- money that would disappear if many down payment assistance charities were put out of business.

"Almost anybody building for the first-time home buyer is using these programs," said David Ledford, staff vice president for housing finance and housing policy with the National Association of Home Builders. "Builders are concerned about what would happen not just in the future but for buyers who have already qualified and are going through a sale but who have not closed yet."

Among those who have benefited are Beverly and Kevin Queen, who used $2,500 they received through the AmeriDream down payment program to move their five children out of an Anacostia apartment to a four-bedroom single-family home they bought in Fort Washington in 2000. The only cash the couple had at the time, Beverly Queen said only half-jokingly, "was the $5 holding our bank account open."

Their brick-front home sits on a half-acre backing up to farmland. "This is what I wanted," said Beverly Queen, 44.

The Queens said they have faced no problems keeping up with their mortgage payments.

But consumer advocate Allen Fishbein, director of housing and credit policy with the Consumer Federation of America, said some borrowers have been financially damaged when they fell behind on their mortgages but could not sell the houses because they paid inflated prices.

"Our concern is that people who became homeowners will have trouble making payments," which he said could cause them to lose their homes and wreck their credit.

The IRS has discovered other irregularities in the down payment charities. Although the organizations are meant for home buyers of modest means, the IRS has found that affluent home buyers have improperly taken advantage of them -- even using the "gift funds" to buy vacation residences, Friedlander said.

The charities have also lavished perks on themselves, according to the IRS. Recent audits of 15 of the largest down payment organizations have raised questions about extravagant pay to executives, problematic ties to for-profit companies and inflated prices to low-income buyers that the charities were purporting to help, Friedlander said.

As a result, the IRS has widened its investigation to include an additional 170 charities -- virtually all of the down payment assistance charities that use seller funds.

The "gift fund" mechanism was devised by Don Harris, a Sacramento lawyer and minister who in the late 1990s found a loophole in the rules governing FHA mortgages that generally forbade home sellers from helping customers directly with down payments. He devised the idea of establishing a charity as a go-between for buyers and sellers.

The group Harris started, then called Nehemiah Home Ownership, gave buyers cash for the down payment on an FHA mortgage, generally 3 percent of the purchase price. The sellers then paid the charity an equal amount toward the down payment plus a service fee, typically 0.75 percent of the down payment.

Harris got a ruling from HUD approving the arrangement, and others copied Nehemiah's concept. Within a few years, a multibillion-dollar charitable industry was born, with about 200 nonprofits offering the service. In all, the industry says, it has given down payments to 625,000 households.

These loans make up an increasing amount of the FHA's volume. In 2006, about 28 percent of households receiving FHA loans got their down payments from the charities, up from 1.7 percent in 2000.

http://www.washingtonpost.com/wp-dyn/content/article/2006/06/01/AR2006060101969_pf.html

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