Owning a home in Delaware planned community or development puts you in a homeowner or condominium association where you jointly own properties like roads and parks. One perplexing aspect of HOAs and condo associations is to understand their tax reporting requirement. Many Delaware homeowner associations and condo associations even don’t understand the requirement to file tax returns and therefore do not file.

An estimated 35% of Delaware HOAs and condo associations don’t file, and if they file, they are using a wrong process. Most of these are the self-managed associations. Let’s therefore address this confusion and help your association avoid the frustration and penalties faced due to noncompliance.

Delaware HOA Tax Return Options

Delaware and IRS treat all associations as corporations and are required to file federal and state tax returns. HOA and condo association management confuse that being treated as an association or a nonprofit corporation with the Secretary of State exempts them from filing annual tax returns.

They are wrong, only those associations who have filed for a recognition and been accepted as a nonprofit by IRS do not file taxes. Obtaining this recognition is expensive and difficult as an association has to provide evidence that their areas benefit the public and that their funds are used to maintain these areas for the benefit of the general public and not only their members. This recognition is obtained by filing Form 1024 with the IRS under tax code section 501 (c)(4).

Corporations are traditionally required to file Form 1120, U.S. Corporation Income Tax Return. It is flexible with the expense allocation as associations do not have to maintain the 90% rule and have lower tax rates, 15% for the first $50,000 taxable income. However, Form 1120 does not favor HOAs and condo associations. First, it subjects all association’s income to taxation; any funds set aside or in excess of expenditure will be taxed. Second, it is complex for HOAs and condo associations to file.

Delaware HOAs and condo associations can, however, bypass Form 1120 by making a special election to file Form 1120 – H, which is a form specifically designed for homeowner associations. It is a one-page, much simpler form compared to Form 1120. Most HOAs and condo associations qualify for this election but have to fulfill section 528 requirements. An association has to ensure that over 85% of its units are used as a residence and 60% of its revenue to be “exempt-function income.”

Exempt function income is generated from members like dues and fees and not from the sale of goods and services. An association should also ensure that a bigger part of its expenditure (90%) goes to management, maintenance, acquisition and construction of association property.

Delaware Condo Association Tax Return Help

If a Delaware homeowner or condo association qualifies to file Form 1120 – H, then it will just be taxed on any non-exempt income it generates. The non-exempt income can be generated from a variety of sources, such as:

• banks interest;
• renting the clubhouse;
• vending income;
• laundry machine income; or
• golf-course fees.

Expenses used solely to generate the non-exempt income are then deducted; records to support these expenses should be available. Homeowners associations are allowed a $100 deduction on taxable income, and a flat rate of 30% (32% for timeshare associations) applied.

HOAs and COAs should elect to file Form 1120 – H annually. The form must be filed before its due date, including extensions. If HOA fails to file Form 1120 – H by the required due date, they will get an automatic 12 month extension to make any election. Once your association has filed Form 1120 – H, you cannot revoke it unless IRS consents to it. Your association will have to request IRS consent by filing a ruling request; a fee is applicable for every ruling request applied. We all know the importance of tax and financial planning.

Almost all members of a homeowner or condo association ask this question, even the board elected to manage the HOAs or COAs. This is because HOA and COA taxations have different forms to be filed, rules and regulations regarding not-for-profit associations and exempt functions which makes taxation questions a bit tricky to answer.

Homeowner or condo associations are treated as corporations for tax purposes, even if an association was incorporated under Arkansas State Secretary as a non-profit corporation. In fact, missing, late or incorrect tax return subjects the association to fines, IRS penalties and even loss of non-profit status. An association can, however, file for a recognition and acceptance as a nonprofit by IRS in some cases. But obtaining this status can be difficult and expensive.

All corporations are required to file Form 1120, U.S. Corporation Income Tax Return every year. This form is a little complex for homeowner and condo associations and it takes into account all income generated for tax purposes. The better side is that it has a lower tax rate of 15% for the first $50,000 taxable income. Not many associations generate that much income and the 90% expense rule does not apply.

Most of Arkansas homeowner and condo associations elect to file Form 1120-H. Form 1120 – H is designed specifically for homeowner and condo associations and is much easier and has no tax risk if the association meets IRC Section 528 requirements of;

1. Over 60% of gross revenue is from members and does not result from the sale of goods and services.
2. Over 90% of the expenditures is on maintenance, repairs and operations of the association.
3. At least 85% of the units should be residential.
4. Annual residual income must not be used to benefit association members.

If the above requirements are met, an association’s “non-exempt” function income is taxable. Non-exempt function income is generated from other activities the association undertakes other than to their members, for example, income from bank interest, rented facilities like clubhouses and non-member use of property like a vending machine. Taxable income is then allowed a $100 deduction and a flat tax rate of 30% is used.

Tax returns are due on the April 15th if the association follows a standard calendar year. If the association follows a fiscal year, tax returns are due on the 15th day of the third month subsequent to the year-end. However, if you are unable to timely file, an extension is available. Form 7004 is used to file for an extension, however, you will still need to pay fines for late returns from the date the returns were due to present.

You should ensure that your HOA or condo association files relevant federal tax forms with the IRS before its deadline, even if you have no tax to file, you do not want to start a friction with IRS. Form 1120-H is recommended but some associations sometimes choose to take advantage of the 15% tax rate offered by Form 1120. Always ensure to contact a CPA to help you with your HOA or condo association tax returns.

Living in a residential development that is planned according to community standards and provide social amenities like parks, clubhouses for everyone residing within the community means you are part of a homeowner or a condo association. Residents contribute funds towards maintaining these common areas through dues and assessments.

In recent years, issues have arisen over the management of HOAs and condo associations. One issue that many associations grapple with is filing federal and state tax returns. Many HOAs (especially those that are self-managed) do not know about the filing requirements. Often they just don’t file at all. Your association will most likely have two filing options – Form 1120 or Form 1120–H.

South Carolina HOAs have Filing Options

First, it is mandatory to file tax returns. South Carolina HOA and condo associations will have a corporate charter at the state level. Associations are generally not “for-profit” entities. They exist to serve the association members. But they are not technically charitable organizations either.

Option 1: Form 1120. This is the traditional corporate method which was the only available form before the Tax Reform Act of 1976. This form is a little more complex for HOAs to file. They will subject all association income (net of expenses) to taxation.

Option 2: Form 1120-H. This form is filed under IRC Section 528 and it specifically is designated for HOAs. It is a simple and straight forward return. However, condo associations and HOAs must meet the following criteria to qualify for Form 1120–H:

• At least 60% of association revenue is from members and is not related to the selling of services;
• At least 90% of expenditures relate to normal operations, management property maintenance;
• At least 85% of units are used as residential residences;
• Income is not accrued to the benefit association members or related parties.

Exempt-Function Income: Section 528 provides that dues and fees from association assessments under it’s normal course of operations is treated as exempt-function income. Accordingly, this income is not subject to taxation.

Non-Exempt-Function Income: But there is some association income that is subject to taxation. This is income that is ancillary to the association’s daily activities. This could include bank interest and dividends, golf course green fees, clubhouse rentals, etc.

Taxation: Since the IRS will not subject an association to taxation on net exempt income, only non-exempt income will result in a tax liability. A $100 standard deduction is then applied to taxable income. This includes section 105.

Electing to File Form 1120-H

South Carolina HOAs and condo associations must make an annual election to file Form 1120–H. They would make it by filing a timely tax return (including extensions). If an association fails to make the timely election, they may forfeit their opportunity to file under form 1120-H, which would require them to file Form 1120.

Most Kentucky homeowner associations and condo associations are classified as non-profit corporations pursuant to the Non-profit Corporations Act. Non-profit corporations are considered as corporations for federal and state tax purposes and must file tax returns just like any other corporation across the states.

The returns are due by 15^th of April each year if an association follows calendar year accounting method, of which most do. An automatic extension can be applied for by filing IRS Form 7004 called the Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns.

An association gets a six-month extension to file the appropriate tax return but will have to incur interest on any tax not paid by the regular due date of the return.

Kentucky HOA & Condo Tax Return Filing Options

There are three forms to be utilized when filing income taxes:

• Federal Form 1120–H
• Federal Form 1120
• Federal Form 990

Section 528 of the IRC allows associations to file Form 1120 – H, which is the standard form for homeowner and condo associations. They, however, have to accomplish the following criteria:

1. 60% of HOA’s annual revenue must fall under exempt-function income, meaning that they are generated from owners who are members and not as customers.
2. HOAs should also ensure that 90% of its expenditure is on capital expenditure, maintenance, and management expenses.
3. The units within the community should mostly be used as residences, more than 85%.
4. Annual residual income must not be used to benefit association members.

The greatest source of revenue to an association on an annual basis typically comes from membership dues, fees or assessments.  So long as the payments come from the owners as owners and not as customers, membership dues, fees or assessments are exempt from income.

Taxable income can be generated from interest from banks and dividends, guest fees, such as golf-course usage, renting facilities like clubhouse, and payment for easements, like cell towers. A flat rate of 30% is applied on net taxable income for associations and 32% for timeshare associations.

Federal Form 1120 is More Flexible but Complex

Under Section 277 of the IRC, some associations prefer to file Form 1120, which is a traditional corporate method. While it boasts an advantage of being flexible with the expense allocation, (they do not have to maintain the 90% rule), and lower tax rates, (15% tax rate for the first $50,000 of their taxable income), they do not favor HOAs.

First, all HOA’s income becomes taxable; any funds set aside or in excess of expenditure will be taxed. Second, they have proven to be complex, requiring some level of accounting and bookkeeping that most HOAs do not keep and third, HOAs are also required to make an estimate of their payable tax, and as pointed out that they lack a level of bookkeeping, will be a hard task to accomplish.

Federal Form 990 has no Tax but Difficult to Obtain

Non- Profit associations under Section 501(c) (4) file Form 990. However, it requires a lot of investing in research, paperwork, and time. You must produce evidence showing that areas owned by a homeowner association like park lands and roadways are actually used by the general public and not limited to their members only.

If by any chance IRS accepts your application, you will be privileged to use your funds to improve your community, and general maintenance, for the good of the general public of course. Homeowner association could even receive state funds to help maintain these areas.

Summary

Members and management of an association should check to ensure that their association does not go on the wrong side of the IRS by filing relevant tax returns on time. An association should seek the help of a knowledgeable CPA or tax professional to review and decide on the best federal form an association should file.