Section 501 of the Code provides for the exemption from federal income
tax of corporations organized and operated exclusively for charitable or educational
purposes, provided that no part of the net earnings inures to the benefit
of any private shareholder or individual. See § 501(c)(3).
Section 1.501(c)(3)-1(c)(1) of the Income Tax Regulations provides that
an organization operates exclusively for exempt purposes only if it engages
primarily in activities that accomplish exempt purposes specified in § 501(c)(3).
An organization must not engage in substantial activities that fail to further
an exempt purpose. In Better Business Bureau of Washington, D.C.
v. U.S., 326 U.S. 279, 283 (1945), the Supreme Court held that
the “presence of a single . . . [nonexempt] purpose, if substantial
in nature, will destroy the exemption regardless of the number or importance
of truly . . . [exempt] purposes.”
Section 1.501(c)(3)-1(d)(1)(ii) provides that an organization is not
organized or operated exclusively for exempt purposes unless it serves a public
rather than a private interest. To meet this requirement it is necessary
for an organization to establish that it is not organized or operated for
the benefit of private interests.
Section 1.501(c)(3)-1(d)(2) defines the term “charitable”
as used in § 501(c)(3) as including the relief of the poor and distressed
or of the underprivileged, and the promotion of social welfare by organizations
designed to lessen neighborhood tensions, to eliminate prejudice and discrimination,
or to combat community deterioration. The term “charitable” also
includes the advancement of education.
Section 1.501(c)(3)-1(d)(3)(i) provides, in part, that the term “educational”
as used in § 501(c)(3) relates to the instruction of the public
on subjects useful to the individual and beneficial to the community.
Section 1.501(c)(3)-1(e) provides that an organization that operates
a trade or business as a substantial part of its activities may meet the requirements
of § 501(c)(3) if the trade or business furthers an exempt purpose,
and if the organization’s primary purpose does not consist of carrying
on an unrelated trade or business.
In Easter House v. U.S., 12 Cl. Ct. 476, 486 (1987), aff’d,
846 F.2d 78 (Fed. Cir. 1988), the U.S. Court of Federal Claims considered
whether an organization that provided adoption and related health services
to pregnant women who agreed to place their newborns for adoption through
the organization qualified for exemption under § 501(c)(3). The
court concluded that the organization did not qualify for exemption under
§ 501(c)(3) because its primary activity was placing children for
adoption in a manner indistinguishable from that of a commercial adoption
agency. The court rejected the organization’s argument that the adoption
services merely complemented the health-related services to unwed mothers
and their children. Rather, the court found that the health-related services
were merely incident to the organization’s operation of an adoption
service, which, in and of itself, did not serve an exempt purpose. The organization
did not provide health-related services to unwed mothers who wished to keep
their children or who arranged for an adoption independent of the organization.
The organization’s sole source of support was the fees it charged adoptive
parents, rather than contributions from the public. The court also found
that the organization competed with for-profit adoption agencies, engaged
in substantial advertising, and accumulated substantial profits. Accordingly,
the court found that the “business purpose, and not the advancement
of educational and charitable activities purpose, of plaintiff’s adoption
service is its primary goal” and held that the organization was not
operated exclusively for purposes described in § 501(c)(3). Easter
House, 12 Cl. Ct. at 485-86.
In American Campaign Academy v. Commissioner, 92
T.C. 1053 (1989), the court held that an organization that operated a school
to train individuals for careers as political campaign professionals, but
that could not establish that it operated on a nonpartisan basis, did not
exclusively serve purposes described in § 501(c)(3) because it also
served private interests more than incidentally. The court found that the
organization was created and funded by persons affiliated with a particular
political party and that most of the organization’s graduates worked
in campaigns for the party’s candidates. Consequently, the court concluded
that the organization conducted its educational activities with the objective
of benefiting the party’s candidates and entities. Although the candidates
and entities benefited were not organization “insiders,” the court
stated that the conferral of benefits on disinterested persons who are not
members of a charitable class may cause an organization to serve a private
interest within the meaning of § 1.501(c)(3)-1(d)(1)(ii). The court
concluded by stating that even if the political party’s candidates and
entities did “comprise a charitable class, [the organization] would
bear the burden of proving that its activities benefited members of the class
in a non-select manner.” American Campaign Academy,
92 T.C. at 1077.
In Columbia Park and Recreation Association v. Commissioner,
88 T.C. 1 (1987), aff’d without published opinion,
838 F.2d 465 (4th Cir. 1988), the court held that an association formed in
a private real estate development to operate parks, swimming pools, boat docks,
and other recreational facilities did not qualify as a § 501(c)(3)
organization. Although the organization provided some benefit to the general
public, the primary intended beneficiaries were the residents and property
owners of the private development. Thus, the organization operated for a
substantial non-exempt purpose rather than for exclusively charitable purposes.
Rev. Rul. 67-138, 1967-1 C.B. 129, held that helping low-income persons
obtain adequate and affordable housing is “charitable” because
it relieves the poor and distressed or underprivileged. In Rev. Rul. 67-138,
the organization carried on several activities directed to assisting low-income
families in obtaining improved housing, including (1) conducting a training
course relative to various aspects of homebuilding and homeownership, (2)
coordinating and supervising joint construction projects, (3) purchasing building
sites for resale at cost, and (4) lending aid in obtaining home construction
loans.
Rev. Rul. 70-585, 1970-2 C.B. 115, discussed four situations of organizations
providing housing and analyzed whether each organization qualified as charitable
within the meaning of § 501(c)(3). Situation 1 described an organization
formed to construct new homes and renovate existing homes for sale to low-income
families who could not obtain financing through conventional channels. The
organization also provided financial aid to low-income families eligible for
loans under a Federal housing program who did not have the necessary down
payment. The organization made rehabilitated homes available to families
who could not qualify for any type of mortgage. When possible, the organization
recovered the cost of the homes through very small periodic payments, but
its operating funds were obtained from federal loans and contributions from
the general public. The revenue ruling held that by providing homes for low-income
families who otherwise could not afford them, the organization relieved the
poor and distressed.
Situation 2 described an organization formed to ameliorate the housing
needs of minority groups by building housing units for sale to persons of
low and moderate-income on an open-occupancy basis. The housing was made
available to members of minority groups who were unable to obtain adequate
housing because of local discrimination. The housing units were located to
help reduce racial and ethnic imbalances in the community. As the activities
were designed to eliminate prejudice and discrimination and to lessen neighborhood
tensions, the revenue ruling held that the organization was engaged in charitable
activities within the meaning of § 501(c)(3).
Situation 3 described an organization formed to formulate plans for
the renewal and rehabilitation of a particular area in a city as a residential
community. The median income level in the area was lower than in other sections
of the city and the housing in the area generally was old and badly deteriorated.
The organization developed an overall plan for the rehabilitation of the
area, sponsored a renewal project, and involved residents in the area renewal
plan. The organization also purchased an apartment building that it rehabilitated
and rented at cost to low and moderate-income families with a preference given
to residents of the area. The revenue ruling held that the organization was
described in § 501(c)(3) because its purposes and activities combated
community deterioration.
Situation 4 described an organization formed to alleviate a shortage
of housing for moderate-income families in a particular community. The organization
planned to build housing to be rented at cost to moderate-income families.
The Service held that the organization failed to qualify for exemption under
§ 501(c)(3) because the organization’s program was not designed
to provide relief to the poor or further any other charitable purpose within
the meaning of § 501(c)(3) and the regulations.
Rev. Rul. 72-147, 1972-1 C.B. 147, held that an organization that provided
housing to low-income families did not qualify for exemption under § 501(c)(3)
because it gave preference to employees of a business operated by the individual
who also controlled the organization. Although providing housing for low-income
families furthers charitable purposes, doing so in a manner that gives preference
to employees of the founder’s business primarily serves the private
interest of the founder rather than a public interest.
Rev. Rul. 72-559, 1972-2 C.B. 247, held that an organization that subsidized
recent law graduates during the first three years of their practice to enable
them to establish legal practices in economically depressed communities that
have a shortage of available legal services, and to provide free legal services
to needy members of the community, qualified for exemption under § 501(c)(3).
Although the recipients of the subsidies were not themselves members of a
charitable class, the resulting benefit to them did not detract from charitable
purposes. Rather, the young lawyers were merely the instruments by which
the organization accomplished the charitable purpose of providing free legal
services for those unable to pay for, or obtain, such services.
Rev. Rul. 74-587, 1974-2 C.B. 162, held that an organization providing
low-cost or long-term loans to, or equity investments in, businesses operating
in economically depressed areas qualified for exemption under § 501(c)(3).
The organization provided financial assistance only to businesses that were
unable to obtain funds from conventional sources, and gave preference to businesses
that would provide training and employment opportunities for unemployed or
under-employed area residents. Although some of the individual business owners
receiving financial assistance from the organization were not themselves members
of a charitable class, the benefit to them did not detract from the charitable
character of the organization’s program. As in Rev. Rul. 72-559, the
recipients of aid were instruments for accomplishing the organization’s
charitable purposes.
Rev. Rul. 76-419, 1976-2 C.B. 146, held that an organization that converts
blighted land in an economically depressed community to an industrial park
and leases space on favorable terms to businesses that agree to hire a significant
number of unemployed area residents and train them in needed skills qualifies
for exemption under § 501(c)(3). The organization furthered charitable
purposes by improving economic conditions for the poor and distressed and
combating community deterioration. The organization offered inducements to
businesses solely for the purpose of advancing charitable goals.
Section 61 provides that, except as otherwise provided in subtitle A
(relating to income taxes), gross income means all income from whatever source
derived.
Section 1012 provides, generally, that the basis of property shall be
its cost to the taxpayer.
Section 1016(a)(1) provides that proper adjustment shall be made to
the basis of property for expenditures, receipts, losses, or other items properly
chargeable to capital account.
Section 1001(a) provides that the gain from the sale or other disposition
of property is the excess of the amount realized over the adjusted basis for
determining gain provided in § 1011. Section 1011(a) provides generally
that the adjusted basis for determining gain from the sale or other disposition
of property is the basis determined under § 1012, adjusted as provided
in § 1016.
Section 102 provides that the value of property acquired by gift is
excluded from gross income. A gift “proceeds from a ‘detached
and disinterested generosity,’. . . ‘out of affection, respect,
admiration, charity or like impulses.’” Commissioner
v. Duberstein, 363 U.S. 278, 285 (1960). Payments that proceed
from “the constraining force of any moral or legal duty,” or from
“‘the incentive of anticipated benefit’ of an economic nature,”
are not gifts. Duberstein, 363 U.S. at 285. Thus, payments
attendant to ordinary business or commercial transactions, or that proceed
primarily from the moral or legal obligations attendant such transactions,
are not gifts. However, a payment made to an individual that responds to
the individual’s needs, that is made without economic or other consideration
being received by the donor, and that does not proceed from any moral or legal
duty, is motivated by detached and disinterested generosity, and may be excluded
from gross income as a gift under § 102. See, e.g.,
Rev. Rul. 99-44, 1999-2 C.B. 549.
In Situation 1, X’s purposes and activities
relieve the poor, distressed and underprivileged by enabling low-income individuals
and families to obtain decent, safe and sanitary homes. The way X conducts
its down payment assistance program establishes that X’s
primary purpose is to address the needs of its low-income grantees. See Rev.
Rul. 70-585, Sit. 1. As a condition of providing assistance, X requires
a home inspection to ensure that the house the applicant intends to buy will
be habitable. X’s financial counseling seminars
and other educational programs help to prepare potential home buyers for the
responsibility of home ownership. See Rev. Rul. 67-138.
X conducts a broad based fundraising program, and X receives
support from a wide array of sources. X’s policies
of ensuring that its grantmaking staff does not know the identity or contributor
status of the party selling the home to the grant applicant (or any other
party who may receive a financial benefit from the sale), and of not accepting
contributions contingent on the sale of any particular properties, ensure
that X is not beholden to any particular donors or other
supporters whose interest may conflict with that of the low-income buyers X is
working to help.
X’s grantmaking procedures combined with
its efforts to educate home buyers ensure that X is operated
primarily to benefit the low-income beneficiaries of its downpayment assistance.
The low-income beneficiaries constitute a charitable class. Any benefit
to other parties (such as home sellers, real estate agents, or developers)
who participate in the transactions does not detract from the charitable purpose
of relieving the poor and distressed. See Rev. Ruls.
72-559, 74-587, 76-419. Because X is operated exclusively
for charitable purposes, X qualifies for exemption from
federal taxation as an organization described in § 501(c)(3).
By contrast, in Situation 2, Y does not qualify
as an organization described in § 501(c)(3). To finance its down
payment assistance activities, Y relies on sellers and
other real-estate related businesses that stand to benefit from the transactions Y facilitates.
Furthermore, in deciding whether to provide assistance to a low-income applicant, Y’s
grantmaking staff knows the identity of the home seller and may also know
the identities of other interested parties and is able to take into account
whether the home seller or another interested party is willing to make a payment
to Y. Y’s receipt of a payment
from the home seller corresponding to the amount of the down payment assistance
in substantially all of the transactions, and Y’s
reliance on these payments for most of its funding indicate that the benefit
to the home seller is a critical aspect of Y’s
operations. In this respect, Y is like the organization
considered in Easter House, which received all of its
support from fees charged to adoptive parents, so that the business purpose
of the adoption service became its primary goal and overshadowed any educational
or charitable purpose. Like the organization considered in American
Campaign Academy, Y is structured and operated
to assist private parties who are affiliated with its funders. Like the organizations
considered in American Campaign Academy, Easter
House, and Columbia Park Recreation Association, Y also
serves an exempt purpose, but because Y is not operated
exclusively for exempt purposes, Y does not qualify
for exemption from federal income tax as an organization described in § 501(c)(3).
In Situation 3, although Z does not limit its down
payment assistance program to low-income recipients, Z’s
down payment assistance program still serves a charitable purpose described
in § 501(c)(3) because it combats community deterioration in a specific,
economically depressed area that has suffered a major loss of population and
jobs. Through a combination of counseling and financial assistance, Z helps
low and moderate-income families in that area to acquire decent, safe and
sanitary housing and to prepare for the responsibilities of home ownership.
In this respect, Z is like the organization described
in Situation 3 of Rev. Rul. 70-585. Because Z is operated
exclusively for charitable purposes, Z qualifies for
exemption from federal taxation as an organization described in § 501(c)(3).
Down payment assistance payments for home buyers in Situations 1 and
3 are made by those organizations out of a detached and disinterested generosity
and from charitable or like impulse, rather than to fulfill any moral or legal
duty, and thus qualify for exclusion from such home buyers’ gross incomes
as “gifts” under § 102. The benefits provided to the
home buyers in these circumstances are sufficiently removed from the interests
of any home sellers or sales agents that they proceed from a detached and
disinterested generosity on the part of the donor organization, and such grants
lack the indicia of a rebate, price adjustment, or quid
pro quo incident to a sale. Favorable treatment under § 102
is thus appropriate. The home buyer’s payment of such amount toward
the purchase of the residence will be included in his or her cost basis under
§ 1012.
In Situation 2, in substantially all of the cases in which Y provides
down payment assistance to a home buyer, Y receives a
payment from the home seller that directly correlates to the amount of the
down payment assistance Y provides to the home buyer.
In those cases, the payments received by the home buyers do not qualify for
exclusion from gross income as gifts under § 102. The payments
do not proceed from detached and disinterested generosity, but rather are
in response to an anticipated economic benefit, namely facilitating the sale
of a seller’s home. Under Duberstein, supra,
such payments are not gifts for purposes of § 102. Unlike in Situations
1 and 3, in Situation 2, the down payment assistance received by those home
buyers represents a rebate or purchase price reduction. As a rebate or purchase
price reduction, the down payment assistance is not includible in a home buyer’s
gross income under § 61 and the amount of the down payment assistance
is not included in the home buyer’s cost basis under § 1012,
as adjusted under § 1016.
