Many Americans live within a homeowners association (“HOA”). In fact, there are over 300,000 HOAs in the United States. But little is known about the tax filing requirements of HOAs, including how to file tax form 1120-H.
In this post, we will walk through an HOA tax return. It is a relatively straightforward form, but there are several unique tax concepts that should clearly be understood before attempting to complete the return.
We will start at the top of the return and go through section by section. In each section, we will discuss some of the critical definitions and give you some real world examples that are applicable to HOAs.
Form 1120-H Example: Top Section
The image above is the top section of the form. It details some of the basic information of the homeowners association. This includes: name, address, EIN (the tax id#), and date of formation.
You also must select which type of HOA the entity is and a couple other compliance questions like whether or not this is a final or amended return and if there was a name or address change. This info should be straightforward.
But sometimes HOAs are challenged with finding their EIN, especially if this is a first year return or if they have a back or unfiled HOA tax return.
The next section of the form is where we start to dive into the financial information. Specifically, we look at functional income and expenses.
Form 1120-H Example: Function Income & Expense
Total Exempt Function Income:
Exempt function income generally consists of income received in the specific function of the HOA. This would typically include membership fees and/or the assessment of monthly or annual dues. This would cover: the owners of the real property served by the management association, the condominium owners or the timeshare owners.
The key point is that the income must come from the members that are served by the association. It cannot come from customers of the association. Fees and assessments that relate to a specific common activity would qualify. However, any charges for providing services would not.
Income that is not exempt function income would typically include:
- Amounts that are specifically excluded under IRS code section 528.
- Payments from members that are designated for specified use of the association’s facilities. This would be apart from facilities and areas that are open to all members.
- Payments received from non association members.
- Member payments for transportation services.
- Interest on amounts earned in savings accounts or reserves.
- Payments for any work completed on non-association property.
Expenditures for Exempt Income:
To qualify as an HOA, a minimum of 90% of the association’s expenses for a given year shall consist of expenses to manage, maintain and care for the association property.
This line will group all these expenses into a total amount. These expenses would typically include, property taxes, insurance, repairs, maintenance, management fees and legal and professional fees. Remember that the important part is that they are not allowed to be more than 90% of the income.
The previous line includes all expenses directly incurred for the production of exempt income. However, on this line you would include all expenses that relate to non-exempt income. Administrative expenses can be allocated on this line, but they cannot exceed 10% of all expenses in order to meet the 90% test.
Tax Exempt Income:
This includes any income not subject to federal taxation. Typical amounts include municipal bond interest. This would include amounts that were received during the year as well as any amounts accrued on such investments.
HOA Tax Return – Gross Income Section:
Now that we have examined exempt function income and expenses we can take a closer look at other income received by the HOA that does not relate to the exempt function. These income items are not that common in an HOA tax return, but can and do exist.
- Dividends and Interest. Many HOAs have established reserves for future expenses. These reserves are established for capital improvements to be made on the property in the future. The future expenditures often relate to roads, street maintenance and sewer repairs. Accordingly, a portion of dues and fees are set aside to cover these future expenditures. These reserves are often placed in money market accounts or certificates of deposit that will generate taxable interest income. In addition, the HOA may invest in publicly traded stocks that will generate taxable dividend income.
- Rents and Royalties. The HOA may receive income from the rental of property. This may include storage facilities, land or other structures. In addition, royalty income could be received resulting from certain intangible assets of the HOA.
- Gains and Losses. These can relate to the sale of stocks or bonds or the disposition of property or equipment owned by the HOA.
The combination of these items are grouped into line 8 on form 1120-H. They are segregated together because they are non-exempt activities. The next part of the HOA tax return takes a closer look at some of the deductions.
HOA Tax Return – Deductions Section:
Next we will examine certain deductions that relate to gross income, excluding exempt function income. This section is only applicable to the extent that there is gross income in the previous section.
For example, the HOA may sublease property that is used to rent out. The HOA may also pay salaries, interest, or other costs relating to non-exempt income. It is very important that these costs are not included in exempt function costs…remember the 90% test.
Lastly, the HOA is given a standard deduction of $100 before actual taxable income is determined.
Tax Liability & Payment Section:
Now that we have determined taxable income, we will need to calculate any tax due and then consider payments that were made.
HOAs that file form 1120-H are taxed at a flat rate of 30%. This rate applies to condo associations and residential real estate associations. The tax rate for timeshare associations is a flat 32%. These rates are applicable to ordinary income as well as capital gains.
It is important to note that form 1120-H does not allow net operating loss deduction like form 1120. This is an important planning consideration.
There is often confusion surrounding the signature section of an HOA tax return. The return should be signed by the president or another officer that is authorized to sign on behalf of the HOA. Such officers may include the treasurer (or assistant), controller, or chief accounting officer.
But often an HOA tax return is signed by someone else. If the return is signed on behalf of the association an assignee, or trustee, the fiduciary must sign the return instead of the association officer.
If an officer of the association completes Form 1120-H, the paid preparer space should be blank. If the return was prepared by someone who doesn’t charge the association they should also not complete that section.
However, a CPA or other paid preparer must sign the return and complete the “Paid Preparer Use Only” section.
Filing an HOA tax return may not be as easy as you think. We may not have covered all the detail, but at least we have covered the main issues in this example.