rr-06-27.pdf

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Part I

Section 501.--Exemption From Tax on Corporations, Certain Trusts, Etc.

26 CFR 1.501(c)(3)-1: Organizations organized and operated for religious, charitable,
scientific, testing for public safety, literary, or educational purposes, or for the prevention
of cruelty to children or animals.
(Also §§ 61, 102, 1012.)

Rev. Rul. 2006-27

ISSUES:

1. Whether organizations that otherwise meet the requirements of
§ 501(c)(3) of the Internal Revenue Code and are described in the situations below
operate exclusively for charitable purposes.
2. Whether home buyers who receive down payment assistance from the
organizations may exclude the amount of the assistance from their gross income as
gifts under § 102.
3. Whether home buyers who receive down payment assistance from the
organizations may include the amount of the assistance in the cost basis of their homes
under § 1012.

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FACTS

Situation 1
X is a non-profit corporation that helps low-income individuals and families
purchase decent, safe and sanitary homes throughout the metropolitan area in which X
is located. As a substantial part of its activities,
X makes assistance available
exclusively to low-income individuals and families to provide part or all of the funds they
need to make a down payment on the purchase of a home.
X uses standards set by
Federal housing statutes and administered by the Department of Housing and Urban
Development to determine who is a low-income individual. Individuals are eligible to
receive assistance from
X’s program if they are low-income individuals, have the
employment history and financial history necessary to qualify for a mortgage, and would
so qualify but for the lack of a down payment.
X also offers financial counseling
seminars and conducts other educational activities to help prepare potential low-income
home buyers for the responsibility of home ownership.

X will consider applications for assistance in connection with an applicant’s
purchase of any home that meets
X’s standards for habitability. Before making a grant
of down payment assistance,
X requires a home inspection report for the property that
the applicant intends to buy to ensure that the house will be habitable.
To fund its down payment assistance program and other activities,
X conducts a
broad based fundraising program that attracts gifts, grants and contributions from
several foundations, businesses and the general public.

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X’s grantmaking process is structured to ensure that X’s staff awarding grants on
behalf of
X does not know the identity of the party selling the home to the grant
applicant or the identities of any other parties, such as real estate agents or developers,
who may receive a financial benefit from the sale. The staff also does not know
whether any of the interested parties to the transaction have been solicited for
contributions to
X or have made pledges or actual contributions to X. Further, X does
not accept any contributions contingent on the sale of a particular property or properties.
Situation 2
Y is a nonprofit corporation that is like X in all respects as set forth in Situation 1,
except as follows. Under Y’s grantmaking procedures, Y’s staff considering a particular
applicant’s application knows the identity of the party selling the home to the grant
applicant and may also know the identities of other parties, such as real estate agents
and developers, who may receive a financial benefit from the sale. Moreover, 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. Further, there is a direct correlation
between the amount of the down payment assistance provided by
Y in connection with
each of these transactions and the amount of the home seller’s payment to
Y. Finally, Y
does not conduct a broad based fundraising campaign to attract financial support.
Rather, most of
Y’s support comes from home sellers and real estate-related
businesses that may benefit from the sale of homes to buyers who receive
Y’s down
payment assistance.
Situation 3

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Z is a nonprofit corporation formed to combat community deterioration in an
economically depressed area that has suffered a major loss of population and jobs.
Studies have shown that the average income in the area is below the median level for
the State.
Z cooperates with government agencies and community groups to develop
an overall plan to attract new businesses to the area and to provide stable sources of
decent, safe and sanitary housing for the area residents without relocating them outside
the area. As part of the renewal project,
Z receives funding from government agencies
to build affordable housing units for sale to low and moderate-income families. As a
substantial part of its activities,
Z makes down payment assistance available to eligible
home buyers who wish to purchase the newly-constructed units from Z. Z also offers
financial counseling seminars and conducts other educational activities to help prepare
potential low and moderate-income home buyers for the responsibility of home
ownership.
To fund its down payment assistance program and other activities, Z conducts a
broad based fundraising program that attracts gifts, grants and contributions from
several foundations, businesses and the general public.
LAW
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

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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

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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.

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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

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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

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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

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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

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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.

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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.
ANALYSIS
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

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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 homebuyers
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

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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
contributions 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

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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

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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.
HOLDINGS
1. In Situations 1 and 3, the organization is operated exclusively for
charitable purposes and qualifies for exemption from federal income tax as an
organization described in § 501(c)(3). In Situation 2, the organization is not operated
exclusively for charitable purposes, and consequently, does not qualify for exemption
from federal income tax as an organization described in § 501(c)(3).
2. In Situations 1 and 3, the home buyers may exclude the down payment
assistance from their gross income as gifts under § 102. In Situation 2, the home
buyers may not exclude the down payment assistance as gifts under § 102. However,
in Situation 2, the down payment assistance is excluded from the gross income of home
buyers because it represents a rebate or purchase price reduction.
3. In Situations 1 and 3, the home buyers may include the down payment
assistance in the cost basis of their homes under § 1012. In Situation 2, the home
buyers may not include the amount of the down payment assistance in the cost basis of

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their homes under § 1012. Rather, the amount of the down payment assistance
represents a rebate or purchase price reduction that is excluded from the home buyer’s
cost basis under § 1012.
DRAFTING INFORMATION
The principal author of this revenue ruling is Elizabeth C. Kastenberg of Exempt
Organizations, Tax Exempt and Government Entities Division. For further information
regarding this revenue ruling, contact Elizabeth C. Kastenberg on (202) 283-9468 (not a
toll-free call).