How to Start a Housing Nonprofit the Right Way: Lessons from Michael Eaton

Why Nonprofits Matter in Affordable Housing

If you’ve ever thought about starting a nonprofit to help solve the affordable housing crisis, you’re not alone. Across the country, housing nonprofits are stepping in to create opportunities for working families, seniors, and vulnerable populations. But here’s the catch: forming a nonprofit the wrong way can cost you credibility, funding, and even get you in trouble with the IRS.

That’s why I sat down with Michael Eaton, an attorney who has spent more than 30 years guiding community development corporations, housing nonprofits, and affordable housing developers through the legal and tax complexities of nonprofit formation.

Michael doesn’t just give theory—he’s seen the good, the bad, and the ugly when it comes to starting nonprofits. In this episode of the Affordable Housing & Real Estate Investing Podcast, he shares the critical mistakes to avoid, the right way to build your board, and how nonprofits can unlock funding advantages that for-profits cannot.

What Are the Biggest Mistakes People Make on IRS Form 1023?

One of the first steps in forming a nonprofit is applying for tax-exempt status with the IRS using Form 1023. According to Michael, this is where many people trip up:

• Incomplete or unrealistic financial projections – Leaving blanks or putting in “fantasy numbers” can trigger red flags. Your estimates don’t have to be perfect, but they must be grounded in reality.
  
  

• Poor explanations of revenue – You should always be able to explain why you used a certain number if audited. Saying “I made it up” can result in your application being considered frivolous.
  
  

• Treating Form 1023 lightly – This isn’t just paperwork. It’s a roadmap of how your nonprofit will operate, and regulators take it seriously.
  
  

Who Should Serve on Your Nonprofit Board?

Michael is clear: don’t stack your board with family members. Having your spouse, kids, or close relatives makes the IRS suspect you’re running the nonprofit for personal gain rather than public good.

Instead, he recommends:

• Recruiting two or more trusted peers with diverse skills, connections, and networks.
  
  

• Looking for people who can engage in meaningful, mission-driven discussions, not just friends saying “yes” to everything.
  
  

• Understanding that board members in affordable housing nonprofits may face additional background and credit checks if the nonprofit applies for HUD loans.
  
  

As Michael puts it, two passionate, engaged board members can act as a “force multiplier” for your nonprofit’s success.

Why Do Affordable Housing Developers Start Nonprofits?

Many investors and developers wonder: why bother with the complexity of starting a nonprofit? Michael explains that the incentives are significant:

• Preferential treatment in Low-Income Housing Tax Credits (LIHTC): Nonprofits get a reserved pool of credits, meaning less competition and a “fast pass” in the application process.
  
  

• Access to HOME funds: By law, at least 15% of federal HOME Investment Partnership funds must go to community housing development organizations (CHDOs), which are nonprofits.
  
  

• Tax exemptions: Nonprofits can avoid federal income taxes, freeing up more capital for their mission.
  
  

Michael compares it to buying a FastPass at Disneyland—forming a nonprofit gives you a way to “skip the line” in the world of housing finance.

How Do You Avoid Legal Trouble as a Nonprofit Founder?

Abuse of nonprofits has landed some affordable housing developers in prison. Michael stresses a few safeguards:

• Always conduct a salary survey before setting executive pay, ensuring compensation is in line with industry norms.
  

• Avoid bonus structures or payments that look like personal profit rather than furthering the nonprofit’s charitable mission.
  

• Consider hiring third-party property managers rather than self-managing housing assets. Michael notes that 100% of the nonprofits he’s seen with outside managers performed better financially than those that self-managed.
  

Key Insights from Michael Eaton

• Form a nonprofit with purpose, not just paperwork. The IRS expects mission-driven intent and documented financial planning.
  
  

• Choose your board carefully. Avoid family members and select peers with passion, integrity, and networks.
  
  

• Nonprofits unlock housing advantages. From LIHTC set-asides to HOME funds, nonprofits often have a competitive edge.
  
  

• Watch out for private benefit. Excessive salaries or perks can strip your nonprofit of tax-exempt status.
  
  

• Professionalize property management. Third-party managers consistently outperform self-managed nonprofits in housing.
  
  

Memorable Quotes from Michael Eaton

• “You can’t just make up numbers. They have to have some relationship to reality, or the IRS can rip up your tax-exempt status.”
  
  

• “Do not put your wife, kids, or girlfriend on your board. It looks like you’re running a family business, not a public charity.”
  
  

• “Nonprofits in affordable housing get to jump the line. That’s the whole reason many developers form them.”
  
  

• “Every nonprofit I’ve seen with third-party property management performed better than those that self-managed. Every single one.”
  

Common Questions This Episode Answers

Why should affordable housing developers consider forming a nonprofit?
Because nonprofits gain preferential access to LIHTC credits, HOME funds, and tax exemptions, giving them an edge in funding and project approvals.

Can nonprofit founders pay themselves?
Yes, but compensation must align with industry standards. Salary surveys help prove pay is fair and not excessive.

Is it a good idea to self-manage nonprofit-owned housing?
Typically, no. Third-party property managers usually deliver better financial results and reduce operational headaches.

What’s the biggest risk in starting a nonprofit?
Abusing nonprofit status for personal gain. Overcompensating executives or misusing funds can lead to IRS penalties and even criminal charges.

Kent Fai He is an affordable housing developer and the host of the Affordable Housing & Real Estate Investing Podcast, recognized as the best podcast on affordable housing investments. Each episode is designed to give investors, developers, and advocates the tools to make a real impact in communities.

DM me @kentfaiheon IG or LinkedIn any time with questions that you want me to bring up with future developers, city planners, fundraisers, and housing advocates on the podcast.