If you own a home in a planned community or development, there is a good chance you are a member of a homeowners’ association (HOA). One perplexing aspect of HOA management is following the tax reporting requirements of the IRS. Some common questions our office receives are “Must our HOA file a tax return?” “What return must it file?” and “What happens if we haven’t filed for a number of years?” In today’s article, I will address some of these fundamental questions. My goal is to clarify some of the confusion associated with HOA tax reporting and help your HOA avoid the frustration and additional expense that often accompany noncompliance.
For federal tax purposes, homeowners associations are treated as corporations. Even if an HOA was created as an association or a nonprofit corporation with its respective state, it is still considered a regular corporation for federal tax purposes. The only exception is the rare instance in which the HOA has filed for recognition and been approved as a nonprofit by the IRS. Obtaining this approval can be expensive, complicated, and is most often requested by filing form 1024 with the IRS utilizing tax code section 501(c)(4) or 501(c)(7).
Corporations are required to file Form 1120, U.S. Corporation Income Tax Return, annually. Filing form 1120 has several distinct disadvantages for an HOA. First, Form 1120 is relatively complex and requires a level of bookkeeping sophistication many HOAs lack. A second disadvantage of filing Form 1120 is that all of the HOA’s “income” is taxable – making any funds collected and not spent (for example, funds set aside for road maintenance or replacement) during the year subject to corporate income tax. A third disadvantage of Form 1120 for an HOA is that it may subject the HOA to making estimated tax payments, another burden for the often overburdened volunteer treasurer. Still another disadvantage of filing Form 1120 is the annual cost of hiring a professional to prepare the return.
The tax code gives many HOAs the ability to avoid Form 1120 by making a special election. Section 528 allows Homeowner Associations that meet specific requirements to bypass Form 1120 by filing Form 1120-H, an income tax form designed explicitly for Homeowner Associations. Form 1120-H is a one-page form that is much easier to complete than the many-page, multiple schedule Form 1120. Although most HOA’s qualify, each must meet several criteria to utilize this election. To file Form 1120-H, at least 60% of the HOA annual revenue must be “exempt-function income.” Exempt-function income includes membership dues, assessments, fees and interest on those fees. Also, 90% of the HOA’s expenditures must be “exempt-function expenses,” used exclusively for the management, maintenance, acquisition, and construction of association property.
If the HOA qualifies to file Form 1120-H, only its “non-exempt” income is taxable. Non-exempt income includes interest and dividends, rental income from property owned by the association, and laundry/vending machine income. The HOA is allowed to deduct expenses directly related to the generation of non-exempt income but must have written records to prove the deductions. Form 1120-H allows for a $100 deduction from non-exempt income to arrive at taxable income. The HOA’s taxable income is then subject to a flat tax rate of 30% (32% for timeshare associations).
Filing Form 1120-H is an election qualifying HOAs must make each year. HOAs make this election by filing Form 1120-H by its due date (the 15th day of the third month after the end of the HOA’s tax year - a six-month extension to file can be obtained by filing Form 7004). Once made, the election cannot be revoked without IRS consent.
If an HOA does not file Form 1120-H within twelve months of its due date (including extensions), the HOA may lose the opportunity to use form 1120-H for that tax year. Losing the ability to utilize form 1120-H will force the HOA to file the more complex Form 1120. The HOA may also be required to pay penalties for late filing and late payment of any tax due.
Hopefully, this article has helped to clarify some of the confusion surrounding a Homeowners Association’s income tax filing requirements. We have not, however, had time to discuss more complex HOA tax issues that may impact your association’s particular circumstances.
Need to know more? All HOAs must file a tax return each and every year. If your HOA is among the vast majority of HOAs that has no non-exempt function expenses we invite you to learn how to prepare your own Form 1120-H. Our Form 1120-H Basics course can be used year after year to help you prepare your HOA’s 1120-H—- saving thousands of dollars in preparer fees!
All courses and articles are for informational purposes only and do not constitute tax advice. Taxes are complicated - do not act on course information without consulting a professional. Always refer to treasury regulation before making any tax decision. Read the full disclaimer.
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