IRS scrutiny of down-payment gifts threatens charitable movement
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SACRAMENTO, Calif. -- A decade ago, Don Harris, then a minister at a Baptist church here, came up with a simple idea for helping needy families: Give them down-payment money to buy their own homes.
By late 2001, the nonprofit group he set up to raise and distribute those gifts, now called Nehemiah Corp. of America, had helped 100,000 low- and moderate-income families across the country buy homes. Mr. Harris's "social ministry through affordable housing," as he described it on NBC's "Today" show, became a contributor to the nation's housing boom.
But now, the business model Mr. Harris devised to make that happen is under intense scrutiny from several quarters, plunging Nehemiah and the many other nonprofit groups that copied his formula into uncertainty.
Mr. Harris stands accused of improperly enriching himself at Nehemiah's expense. According to a lawsuit filed against him by Nehemiah in California state court in 2003, a for-profit marketing company partially owned by Mr. Harris collected $42 million in fees from Nehemiah between 1998 and 2002.
Some other down-payment-assistance programs relied on similar business models in which executives had financial relationships with for-profit marketing affiliates, raising questions about whether charity was their main motive. Marvin Friedlander, chief of the Internal Revenue Service unit that issues legal decisions involving tax-exemption issues, says the agency is concerned about the for-profit marketing arrangements and is pursuing a "very active program" to recover any excessive benefits to executives.
The IRS also has raised concerns about how the programs raise down-payment money. Nehemiah and many other programs rely on home sellers -- both home builders and individual homeowners -- to fund the down-payment gifts. The IRS said that practice is benefiting profit-driven sellers and may not qualify as a charitable activity. In May, the IRS said it would review the tax-exempt status of such programs. In Ohio, some home buyers who accepted down payments from a charity are suing the home builder who provided the gifts to the charity, claiming the builder inflated sale prices by adding the cost of the gifts.
Mr. Harris didn't respond to requests for comment. In his answer to the Nehemiah lawsuit, filed in Sacramento County Superior Court, Mr. Harris said the marketing arrangement was approved by Nehemiah and that he acted in "good faith" and with reasonable business judgment. In a court filing in April, Nehemiah indicated that it had reached a confidential settlement with Mr. Harris and that it would seek to dismiss the case in 2007 "if and after the settlement conditions are fulfilled." Nehemiah's lawyer declined to elaborate.
Top executives at Nehemiah and some other large down-payment-assistance groups maintain that they have improved business practices and discontinued controversial marketing arrangements. Scott Syphax, who took over as Nehemiah's chief executive officer in 2002, says he has been pushing for closer oversight of the industry by the federal government, which he says might have prevented some of the early problems.
No one disputes that the down-payment-assistance groups boosted home ownership for lower-income Americans. Between 2000 and 2005, they provided gifts to 625,000 families, several leading groups estimate. During that period, the number of owner-occupied homes increased by about 3.3 million, according to the U.S. Census Bureau. By helping lower-income Americans without tapping government money, the groups seemed to deliver just the kind of assistance the Bush administration was calling for from faith-based and other nonprofit groups.
Some of the nation's largest home builders participated in the programs, including Atlanta-based Beazer Homes USA Inc., Los Angeles-based KB Home, and Dominion Homes Inc. of Dublin, Ohio.
But separate governmental reports have raised two concerns. The inspector general of the U.S. Department of Housing and Urban Development reported in 2000 that default rates on mortgages made through gift programs were well above average. (Nehemiah disputes that finding.) And the Government Accountability Office reported last November that homes purchased with down-payment gifts were priced about 2 percent to 3 percent higher than comparable homes bought without such assistance.
In 1997, Mr. Harris, now 41 years old, was serving as a minister at Antioch Progressive Church in a working-class neighborhood of Sacramento. Mr. Harris, a lawyer, was well-known in town, having worked for the former mayor and at a prominent local law firm, McDonough, Holland & Allen. "He was very knowledgeable about real-estate issues," says Walter Edwards, an original Nehemiah board member, noting that Mr. Harris sat on the board of the Capital Area Development Authority, which was redeveloping large swaths of the city.
Mr. Harris noticed that many community residents had jobs and decent credit, but couldn't come up with enough cash for a down payment on a home. At the time, no-down-payment mortgages -- where home buyers can borrow 100 percent of the purchase price -- were available mainly to people with good credit and fairly high incomes. The Federal Housing Administration, an agency under HUD, insured mortgages for first-time home buyers and those with decent credit, but required them to put up at least 3 percent as a down payment.
Since the 1970s, HUD has permitted buyers to use gifts from family members, employers or charities for down payments. Mr. Harris decided to build a nonprofit group around this provision. His innovation was to persuade home builders and home sellers to put up money for down-payment gifts. Many sellers saw it as a way to boost home sales. Home builders and real-estate agents would steer lower-income buyers to the charity. The charity would provide the down payment as a gift and collect an identical amount, plus a small fee, from the home seller.
Mr. Harris sold Antioch Progressive Church on the idea and formed a nonprofit group called Nehemiah, named after the Old Testament figure who rebuilt Jerusalem. Curtis Mitchell, who is Antioch's pastor and Mr. Harris's stepfather, had raised Mr. Harris and regards him as his own son. The church lent Nehemiah $35,000.
In May 1997, the HUD office in Sacramento cleared Nehemiah's plan to raise down-payment funds from home sellers, on a six-month basis. The group's first gifts allowed about 160 people in Meadowview, a Sacramento neighborhood filled with older rental homes, to purchase mostly duplexes. On average, buyers received gifts equaling 5 percent of a $101,000 purchase price.
Franklin Lue, a real-estate agent and retired auto mechanic who had once sought bankruptcy protection, received a Nehemiah down-payment gift in 1998. It enabled him to buy a three-bedroom house in a Sacramento suburb for $131,000. "I was turned down by all the traditional banks and the credit unions," says Mr. Lue, who says he has never missed a mortgage payment. "It's because of Nehemiah that I am in this home."
In Nehemiah's early days, Mr. Harris met Ron Mellon, a broker and marketer for a local home builder. Mr. Mellon says he was impressed with Mr. Harris and Nehemiah and thought he could help the fledging charity grow.
Mr. Mellon says he had no interest in working for a nonprofit. He formed a company called Invision Marketing & Sales Inc., which Nehemiah retained to help it reach real-estate agents, home builders and other industry professionals. He contended that a for-profit company would perform better than a nonprofit group because marketing representatives who earned commissions would work harder. "Don (Harris) didn't have any marketing experience," he says. "What I offered was a proven commodity."
Home builders typically would pay Nehemiah 6 percent of a home's sales price, which covered a 5 percent down-payment gift and a 1 percent fee. Mr. Mellon says Invision would usually take one-third of the fee.
Mr. Harris persuaded Nehemiah's board in November 1997 to invest $40,000 in the marketing company. Nehemiah received a 51 percent stake, according to the subsequent lawsuit.
In July 1998, Nehemiah's board transferred 3,750 shares of Invision to Mr. Harris as compensation for his work, the lawsuit said. Later, the board transferred 4,900 additional shares to Mr. Harris. According to the lawsuit, Mr. Harris told the board that "such compensation was commonplace in the nonprofit sector as a means to retain effective leadership," and that the share transfers had been reviewed by Nehemiah's lawyer. Craig Allison, a lawyer for the board, says directors "relied on Mr. Harris recommendation and expected that any decisions that were made would be in the best interest of Nehemiah."
In the spring of 1998, HUD's national headquarters approved Nehemiah's program of seller-funding, which allowed the group to offer down-payment grants throughout the nation.
That October, Nehemiah's board agreed to sell its remaining shares in Invision back to the marketing company for less than they were worth, the lawsuit said. Mr. Harris misled the board, the suit alleged, by saying that Invision intended to expand and compete with some companies that participated in Nehemiah programs, and that Nehemiah's remaining involvement would create a conflict. In his answer to the complaint, Mr. Harris said the transactions were "just, fair and reasonable." They left Mr. Harris with 38 percent of Invision, and Mr. Mellon and a third partner divided the remaining 62 percent, the lawsuit said.
After receiving national HUD approval, Nehemiah grew rapidly. For the year ended June 1999, it took in $67 million in down-payment contributions and fees, and in the following year $139 million. Mr. Mellon says he traveled to real-estate conventions continually, and Invision's staff grew to 50. "Our goal was to get the word out to every builder and Realtor in the country," he says.
Nehemiah and Mr. Harris were lauded for fostering economic development in once-blighted neighborhoods. From the money it made on fees, Nehemiah donated to other charities and lent $12 million to Antioch to build a new church.
Nehemiah's success prompted others to launch similar nonprofit groups -- and for-profit marketing arms. In 1999, two men in Provo, Utah, created Buyer's Fund Inc. and the next year a for-profit marketing firm, Neighborhood Gold. The marketing company received 75 percent of fees paid to Buyer's Fund by home sellers, according to a lawsuit filed in Utah state court by a former president who claims he was forced to resign for raising objections to some of the charity's business practices. The nonprofit group's founders "personally pocketed $12.5 million" in less than four years, the lawsuit alleges. "My clients did nothing wrong," says Stephen Quesenberry, a lawyer for the founders, referring to the plaintiff as a "disgruntled" former employee. The two founders are no longer running the nonprofit.
AmeriDream Inc., based in Gaithersburg, Md., used a marketing firm called Synergistic Marketing Inc., which was started by the charity's founders, according to testimony at a 2004 Senate hearing on charity oversight and reform.
Mr. Friedlander, whose IRS unit is now scrutinizing down-payment assistance groups, says there is concern that fees paid by some down-payment charities to marketing firms may have been excessive. The IRS says its rules prohibit officers of nonprofits from benefiting excessively from charitable activities.
An audit in 2000 by HUD's inspector general concluded that in some cases, home sellers were raising sales prices to recoup down-payment grants. In Columbus, Ohio, homeowners have sued Dominion Homes, alleging it defrauded buyers by not disclosing that the costs of down-payment grants they received from Nehemiah were tacked on to prices of their homes. "In essence, people paid more than fair-market value for their homes," says Edwin Hollern, the home buyers' lawyer.
Cliff Rece, who in 2002 paid $178,000 for a Dominion House in a Columbus suburb, contends the home is now worth less than that because the cost of his down-payment gift was built into the price. "We want to move but we can't without taking a loss," says Mr. Rece, who is part of the lawsuit.
William Cornely, Dominion's chief financial officer, says the lawsuit is "without merit." Dominion still participates in down-payment assistance programs, he says, but less frequently than it used to.
Advocates of down-payment-assistance programs note that some charities have been working to eliminate problems. In January 2001, Mr. Harris hired Mr. Syphax to succeed him as chief executive. Mr. Syphax, a former public-affairs executive at Eli Lilly & Co., had worked as a volunteer and later as a paid consultant to help guide Nehemiah's lobbying efforts in Washington.
In a subsequent court filing, Mr. Harris, who continued as Nehemiah's chairman and general manager, said he began experiencing "extreme difficulties" with Mr. Syphax over Nehemiah's direction and charitable mission. In 2002, Mr. Harris resigned as general manager, then as chairman. Mr. Syphax declines to discuss Mr. Harris's departure.
Mr. Syphax says that when he took the job, he conducted a "mock" IRS audit of the down-payment program. The audit, he says, revealed that "excess benefits" in the form of marketing fees had gone to a "former officer" of Nehemiah, whom he declines to identify. Mr. Syphax says he decided to move marketing in-house, and did not renew a contract with Invision.
Mr. Syphax says he was concerned about losing Nehemiah's tax-exempt status, and through a representative requested help from the IRS with handling the excess-benefit issue. (The IRS declines to comment on Nehemiah.) He says he also alerted HUD about a variety of industrywide problems, including questionable marketing arrangements and inflated sales prices. He says that some other gifting groups, which he declines to identify, complained to him about his contacts with the government.
The chief executive officer of AmeriDream, Ann Ashburn, says her group has gone through a "self-cleansing process." Its founders have resigned and AmeriDream no longer uses their marketing firm, AmeriDream's spokesman says.
Nehemiah sued Mr. Harris in May 2003, accusing him of "unseemly wheeling and dealing in the nonprofit world," according to an amended complaint. It also sued Mr. Mellon, who settled with the charity.
Mr. Mitchell, the pastor of Antioch Progressive Church, says his son is "hurt because of all of the allegations that have been said about his intent." Mr. Mitchell says he remains proud of Nehemiah. "I will never allow anyone to steal God's glory for what has been done in this church and in this ministry," he says.
First Published July 5, 2006 12:00 am