By Kim Hitchcock, McNurlin, Hitchcock & Associates, P.C.
Today’s homeowner is savvy and aware of the tax implications of homeownership. Deductions for mortgage interest and real estate taxes are common topics of conversation, however, taxes paid by the HOA are often left out of the discussion. It is easy to assume that HOAs are tax exempt, but the IRS disagrees. The HOA could be subject to tax on income from vending machines, laundry machines, clubhouse rentals, easement proceeds, roof rent, etc. This is true, even if the HOA is registered as a nonprofit corporation.
If, after reading this article, you are uncertain how these rules apply to you, or your HOA, be sure to enlist the support of a qualified CPA Firm.
Homeowner Associations can pay taxes?!
Homeowner associations (also called HOAs, CIRAs or Associations) have a distinctive taxing structure that is complicated by multiple taxing options. To start, we will first define the HOA.
What is a Homeowner Association?
According to the IRS, the HOA is an entity that provides a benefit to the community. It can be a condominium association designed to care for property in a specific condominium project, a residential real estate association designed to care for properties in an area or a timeshare association. The important factor is that the HOA is created as an entity designed to act on behalf of individual owners or members for the good of the overall community.
For that reason, the HOA is not often taxed on dues and assessments which are collected from members for the purpose of maintaining the property, even when the dues collected are greater than the current year expenses.
My HOA is a Colorado non-profit. Why do we pay taxes?
The State of Colorado recognizes the HOA as a nonprofit corporation. It is important to note that a nonprofit corporation in Colorado is not tax exempt under the Internal Revenue Code (IRC). To become tax exempt, the requesting organization must file complicated paperwork and report their mission to the IRS.
What tax form does the HOA file?
The HOA is a legal entity and a corporation. It is required to have a tax ID number (FEIN) and file annual tax returns with the IRS and possibly with the State as well. The good news is that the HOA can often elect to take advantage of the tax benefits provided by IRC §528 by filing the shorter Form 1120-H instead of the longer Form 1120 unless the HOA is primarily commercial, not residential, or if the HOA is primarily funded by non-exempt sources.
Form 1120-H; U.S. Income Tax Return for Homeowners Associations
HOAs that elect to file form 1120-H will start the process by designating each item of revenue as “exempt” or “nonexempt”. “Exempt” revenue would include member dues, assessments, and anything that is charged to members based on their ownership percentage. Everything else, such as investment income, rental income, resort fees, and vending income is “non-exempt”. This is an important designation because the “exempt” income is also the “tax free” income.
Non-exempt income, less all associated expenses and a $100 statutory deduction, is subject to the 1120-H tax at a federal rate of 30% (plus State).
Form 1120, U.S. Income Tax Return for Corporations
Associations that do not elect to file form 1120-H will file the full form 1120, but the HOA will still benefit from special rules for membership organizations. HOAs that file form 1120 will start the process by designating each item of revenue as received either by a member or by a nonmember. Income received from a member is “tax free” if it is used to pay for member/community expenses.
If the HOA collects member income, dues, or assessments that exceed community expenses, the HOA will have something called “excess membership income”. This excess must be applied to the following year budget or refunded to the members. Choosing which option, either budget adjustment or refund, is addressed through a resolution at the HOA annual meeting.
Income from nonmembers, less all associated expenses, is subject to federal tax on Form 1120 at a federal rate of 21% (plus State).
As you can see, the complexity of the tax return really depends on the activities of the HOA and the availability to file the shorter Form 1120-H vs the longer Form 1120. Talk to your tax professional if you are seeking more guidance on this subject.
Kim Hitchcock is a CPA in Lakewood Colorado and the managing partner of the public accounting firm, McNurlin, Hitchcock & Associates, P.C. Kim is also a member of her residential HOA and is involved with the HOA of her family’s vacation rental. She has more than 26 years of experience in public accounting in the tax, audit, and accounting fields working specifically with CIRAs and small businesses. To find out more about Kim and the team at McNurlin, Hitchcock & Associates, P.C. visit www.mcnurlincpa.com.