Homeowners’ associations (HOAs) are organizations formed by a group of homeowners for the purpose of preserving and maintaining the appearance of an area and the ownership and maintenance of common property.  Because most HOAs operate for the benefit of a specific group, rather than the community at large, many have difficulty meeting the tax-exempt purposes required under IRC sections 501(c)(4) and 501(c)(7).  As a result, Congress enacted section 528 with the view that it’s not appropriate to tax revenues of an association of homeowners who act together if an individual homeowner wouldn’t be taxed on the same activity.

So what does this mean for your HOA?  If you’re the treasurer for a small, self-managed community, there is a good chance that your HOA does not utilize the services of a CPA on a regular basis.  As a result, you may be wondering… “hmmm… I don’t think we filed a tax return last year.  Do I really need to do this?”  The answer, according to the federal government, is “yes.”  However, you will be relieved to know that you do have options regarding which form you can file.

A qualified HOA has two choices:

  • File Form 1120 and pay tax as if it were a C corporation
  • Elect to file Form 1120-H, U.S. Income Tax Return for Homeowners Associations

Now just what is a qualified homeowners association?  Well, it is one in which the following apply:

  • At least 60% of the association’s gross income for the tax year consists solely of membership fees, dues or assessments from property owners
  • At least 90% of the association’s expenses for the tax year consists of expenses to acquire, build, manage, maintain, or care for association property, or in the case of a timeshare association, for activities provided to, or on behalf of, members of the timeshare association
  • No private shareholder or individual profits from the association’s net earnings except by acquiring, building, managing or caring for association property or by a rebate or excess membership dues, fees or assessments

Why elect to file Form 1120-H?

  • Net exempt function income is not subject to tax
  • You are not required to pay estimated taxes
  • A specific deduction of $100 is allowed
  • You are not subject to AMT
  • No balance sheet is required on the return
  • It is a simple one page form
  • The election to file Form 1120-H is available on a yearly basis.

Why file Form 1120?

  • You can tax advantage of graduated rates (15%, 25%, 34%, etc)
  • Form 1120-H is a flat 30% rate (32% for timeshare associations)
  • In certain situations, the tax may be lower filing Form 1120 versus Form 1120H
  • If there is a net operating loss (NOL), it can be used to offset another tax year.  A NOL is not allowed on Form 1120-H.

How does Exempt Function Income factor in?

Exempt function income consists of dues, fees, or assessments paid by property owner-members for maintenance or improvement of the property.  Conversely, interest, dividends, coin laundry income, vending machine income, rental of units owned by the association and rental of parking/storage/party room areas are all taxable.  Thus, if you are a large association and have significant income from these sources, you may want to file Form 1120 because it may yield in your income being taxed at a lower rate.

What about state returns?

Each state varies, but if you have to file a Federal return, you may need to file a state return as well.  In Illinois, a state return is required if you have income that is taxed at the Federal level.

For more information regarding HOAs, feel free to visit this IRS site.