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.