By Emmet R. Wood
Director, Audits and Investigations
The Internal Revenue Service has just issued a ruling (Rev. Rule 2006-27) on organizations that provide seller-funded down-payment assistance to home buyers.
Down-payment-assistance programs provide cash assistance to home buyers who cannot afford to make the minimum down payment or pay closing costs involved in obtaining a mortgage. Such programs can qualify as tax-exempt charitable and educational organizations when properly structured and operated. In the ruling, the IRS provides a detailed discussion of the guidelines-including two examples that meet and one that fails to meet the test for exemption.
The ruling makes it clear that seller-funded programs are not charities because they do not meet the requirements of section 501 (c)(3). Increasingly, the IRS has 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. Moreover, the seller pays the organization only if the sales closes, and the organization usually charges an additional fee for its services.
What happens when an organization does not qualify as a tax-exempt organization? No tax deduction will be allowed to the seller for a charitable contribution. The home buyers may not be able to include the amount of the assistance in the cost basis of their home. The assistance will probably no longer qualify as a third-party gift for the purposes of the buyer’s loan application. Consequently, the lender will have to treat the payment as a seller concession, deduct the concession from the value of the property and recalculate the buyer’s loan-to-value ratio. If the buyer cannot come up with the required down-payment another way, his/her loan application will be denied.
Brokers are cautioned to be wary of any down-payment assistance program in which the home seller makes a gift to a purported charity and the buyer receives a gift of roughly the same amount from the charity (minus fees and expenses) to use as a down-payment to buy the seller’s house. Such programs may not be what they claim to be and may violate the IRS ruling. Misrepresentation of such a program to a lender or party in a real estate transaction would be a violation of the North Carolina Real Estate License Law and may constitute loan fraud.
You can find the news release and the ruling at www.irs.gov/newsroom, click on “News Releases”, then on “IRS Targets Down-Payment Assistance Scams”.
This article came from the June 2006-Vol37-1 edition of the bulletin.