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 (seller-funded programs). Typically, there is a direct correlation between the amount of down payment assistance provided to the buyer and the payment received from the seller. Moreover, the seller pays the organization only if the sale closes, and the organization usually charges an additional fee for its services. Seller-funded programs are operated to benefit sellers who participate. Thus, such organizations are not operated exclusively for an exempt purpose, a requirement of tax-exemption under section 501(c)(3) of the Internal Revenue Code.

The charitable organization provides the purchaser’s down payment funds to the escrow/closing agent before settlement. At closing, the down payment assistance amount is deducted from the seller’s proceeds and remitted to the organization. Usually, the seller pays a service fee to the organization. If the property is not sold, the seller is not obligated to make any down payment assistance payments and some organizations refund the service fee.

A March 2005 report entitled An Examination of Down payment Gift Programs Administered By Non- Profit Organizations, commissioned by the U.S. Department of Housing and Urban Development (HUD), found that seller-funded -1- down payment assistance has led to underwriting problems and resulted in an increase in the effective cost of homeownership. A report from November 2005 entitled Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance, conducted by the U.S. Government Accounting Office (GAO), found similar results. Moreover, because the service fees generated by property sales keep seller funded down payment assistance organizations financially viable, these organizations may be more interested in closing sales of property to generate service fees than they are in taking responsible steps to ensure that buyers acquire safe, decent, sanitary and affordable housing.

Generally, down payment assistance will not be included in the homebuyer’s gross income for federal income tax purposes. However, if the buyer receives down payment assistance from a seller-funded program, the homebuyer must reduce the cost basis of the home because the down payment assistance represents a rebate or reduction in the purchase price thus lowering the homebuyer’s cost basis under IRC section 1012.