Payments from neighborhood restoration program taxable.

To restore and preserve older neighborhoods, city (C) operates a program (P) to convert property with multiple dwelling units, originally developed as either single-family residences or duplexes, back to their original use. Owners qualifying for benefits under P receive payments to compensate for conversion costs and lost rental income. If the payments to the benefit recipients are taxable, C will have to file information returns for them.

GWE 

Under Sec. 61(a), gross income means all income from whatever source derived, except as otherwise provided. Under the general welfare exclusion (GWE), gross income does not include payments to individuals by governmental units under legislatively provided social benefit programs for the promotion of the general welfare; see, e.g., Rev. Ruls. 74-205, 1974-1 CB 20, and 98-19, 1998-1 CB 840.

To qualify under the GWE, payments must (1) be made from a governmental fund, (2) be for the promotion of the general welfare (i.e., generally based on individual or family needs) and (3) not represent compensation for services; see Rev. Ruls. 75-246, 1975-1 CB 24, and 82-106, 1982-1 CB 16. Payments to businesses generally do not qualify for the GWE, because they are not based on individual or family needs; see Bailey, 88 TC 1293 (1987), acq., 1989-2 CB 1.

In Rev. Rul. 76-395, 1976-2 CB 16, the Service ruled that payments made to low-income individuals primarily to subsidize home improvements necessary to correct building code violations and provide safe and decent housing were excluded from the recipients' income under the GWE. In Rev. Rul. 2005-46, IRB 2005-30, 120, it concluded that the GWE did not exclude payments made by a state to reimburse businesses for uncompensated losses from a natural disaster.

Here, P differs materially from the home rehabilitation program described in Rev. Rul. 76-395. There are no income restrictions for eligibility, and the improvements subsidized by P are not intended to address primarily building code violations necessary to make housing safe and decent. Further, because the properties involved contain multiple dwelling units, most of them, if not all, represent at least in part rental property. Thus, P provides benefits to an investment or business activity, rather than addressing individual or family needs; see Rev. Rul. 2005-46.

Conclusion

Payments under P represent gross income to the recipients and C is subject to the Sec. 6041 information-reporting requirements, unless the recipient is a corporation or other specified entity for which payment is exempt under Regs. Sec. 1.6041-3(p).

IRS LETTER RULING 200625006 (6/23/06)

David O'Driscoll, J.D., LL.M.