08/04/2022

Tax Status: Condo Association and HOAs

Homeowners Associations are generally taxed as corporations unless they have been approved by the taxing authorities as a tax exempt organization under Internal Revenue Service Code (IRC) Section 501(c). These Associations are typically very large Associations who offer and maintain amenities that also regularly derive significant income from the general public as well as members such as: golf courses, tennis clubs, equestrian facilities, marinas and other recreational facilities.

The few Homeowner Associations who have applied and been approved as tax exempt organizations will file Federal Form 990 or possibly Form 990EZ. The Form 990 or 990EZ are much more complex to prepare and are more expensive. In addition, the tax form is open to public inspection.

Obtaining IRC exempt status for your homeowners association will involve determining that your association is open or is willing to be open to the general public and paying a tax attorney or Certified Public Accountant (CPA) to prepare the application to send to the Internal Revenue Service (IRS).

You will then wait for the approval letter from the IRS. Once received, if you are approved, then your association will be tax exempt for purposed of Federal tax filings. Keep in mind "tax exempt" status, does not mean your association does not file a tax return. You will still have an annual filing requirement. And you may still have taxable income, if you have Unrelated Business Income activity, the net income from such activity may generate a tax liability. Such activity will be reported on 990-T, in addition to your Form 990 or 990-EZ filings.

I do not often suggest obtaining tax exempt status, because it is rare that a homeowners association is open to the general public. Think about it, do you want to open up your pool area to everyone?

The tax forms that most Homeowners Associations are required to file are:

o    Federal Form 1120-H - U. S. Income Tax Return for Homeowners Associations, or

o    Federal Form 1120 - U.S. Corporation Income Tax return

Filing using Form 1120-H - U. S. Income Tax Return for Homeowners Associations return

This tax form is the form often referred to as the "short form" or simply "1120-H". IRC Section 528 requires the allocation of income and expenses between exempt function activities and its activities for the production of gross income (nonexempt function activities). It is not taxed on its exempt function activities but is federally taxed at 30% on its net nonexempt function income. Timeshare associations that elect IRC section 528 are taxed at 32%. A CIRA filing under IRC Section 528, makes the election by filing Form 1120-H, the homeowners association tax form. The election to file Form 1120-H is continuous until the association applies for and is granted a revocation by the Internal Revenue Service. No carryover of net operating losses in allowed when Form 1120-H is used.

A CIRA must meet these tests to qualify for IRC Section 528 treatment, and use Form 1120-H:

1.  Residential test – substantially (85%) all the units must be for residential use

2.  Income test – 60% of the gross income must be of exempt nature

3.  Expenditure test – 90% of the expenses must of exempt nature, qualifying expenditures

4.  No benefit test – the residual income may not be used for members' benefit.

Filing using Form 1120 - U.S. Corporation Income Tax return

This tax form is the form referred to as the "regular Corporate Form". IRC Section 277 requires the allocation of income and expenses between membership and non-membership activities. Only its net non-membership income (typically interest income) is taxed at regular corporate rates. The Corporate tax rate is currently 21% on taxable net income. Net operating losses from membership expenses in excess of membership income can be carried forward only. 

• Under IRC Section 277, membership income is taxable, and qualified expenses are deductible except for capital expenditures.
• Similarly to non-exempt income under IRC Section 528, expenses directly related to income reduce the income from that source (e.g. maintenance income for laundry services reduces income from such services). Other expenses such as accounting and tax preparation fees, office expenses and management fees, fidelity bonds and state income tax may be used to off-set interest income. 
• Excess membership income may be capitalized and deferred if such treatment is elected. Generally, such treatment (Revenue Ruling 70-604) is for excess membership income undistributed by year-end. An annual meeting is required for such deferral to be elected. Alternatively, such excess may be elected to be treated as "replacement fund" for future contingencies or specific capital expenditures. 
• Each association must have a membership (not just a board) vote to elect to file under Code Section 277 to use Form 1120, the regular corporation tax form. This is referred to as an IRS Revenue Ruling 70-604 election. This election must be made annually by a membership vote. 
• In allocating income and expense line items to membership or non-membership activities consideration must be given to each line item about whether it is related to members or does it relate to nonmembers. 

No matter which Federal Tax Form is used, the Board of Directors should be involved in determining allocation of member and non-member activity in the case of Form 1120, and exempt and non-exempt activity is the case of Form 1120-H. The Board of Directors should review the allocations each year to ascertain they are reasonable and consistent, because activities can change from year to year.