Community associations have unique tax situations. Form 1120-H is specifically designed for HOAs, condo associations and timeshare associations. Even though the vast majority of HOAs will file the form, there are a few misconceptions when it comes to homeowners association tax filing requirements.
The definition of an HOA is not that complex. The important part to note is that it encompasses three separate operating entities: (1) residential management association; (2) condominium associations; and (3) timeshare association. Make sure your entity qualifies as an HOA before you commit to filing a tax return.
The United States has over 325,000 HOAs. But very little is actually understood when it comes to HOA tax filing requirements. Professional association managers oversee the vast majority of these communities. Typically, these companies understand the basics of tax filings. But all too often, they don’t understand all the complexities.
Before you consider what tax form you have to file, let’s take a closer look at the definition of a homeowners association. Asking what is an HOA may not be the easiest question.
When it comes to defining what an HOA is, there is not a “one size fits all” definition. There are actually three different types of homeowners associations. It encompasses condominium management associations, residential management and timeshares. Let’s try to understand them:
- Residential Real Estate Management Association. This type of HOA is operated to build, manage, and maintain a residential real property development or subdivision in which virtually all of the lots or properties are homes for individuals.
- Condominium Management Association. This type of HOA is similar to a residential real estate management association. It is operated to build, manage, and maintain a real property in a condominium community in which the units are substantially homes for individuals.
- Timeshare Association. This type of HOA is operated to build, manage and maintain for a property that has members (like owners) who hold a timeshare right of usage or a timeshare ownership interest in the real property of the timeshare association. A timeshare association cannot be a condominium management association. They are different entities.
- No less than 60% of the association’s gross income for the related year shall consist of exempt function income.
- At least 90% of the association’s expenses for the related year shall consist of expenses to build, acquire, maintain or manage. For a timeshare association, these activities shall be on behalf of and for the benefit of the members of the timeshare association.
- No private shareholders or individuals are allowed to profit from the association’s net earnings or profits except by acquiring, building, or managing association property or by a rebate of excess membership dues, assessments, or fees.
- Form 1120-H must be filed annually. This is an election made to be treated as a homeowners association.
Homeowners association tax filing requirements
Assuming your association qualifies to file form 1120-H, let’s look at a few tips and tricks to make tax season a bit easier on you. If you don’t meet certain conditions, Form 1120 might just be your only option.
At 30%, Form 1120-H has a high tax rate. So make sure that you minimize the tax impact. But before we dive into the specifics of the form, an HOA should review it’s activities to determine which form is best.
HOA tax filing – analyze exempt function income
Since exempt income is not taxable, the association needs to make sure that they properly segregate it. It normally consists of member assessments and fees, but there are numerous misconceptions. The most significant of which is the assumption that all fees charged to members are tax exempt.
In reality, exempt income typically covers only the amount collected from the homeowners’ dues, assessments, and late fees. It does not cover fees charged to members in their capacity as customers. More about that next.
Examine non-exempt function income
Assessments and fees can make it difficult to understand exempt function income. Why? Because the members of the HOA are essentially acting as customers of the HOA service. In addition to this, any income from non-members is also taxable because it has little relation to the HOA function itself.
Any investment income or fees collected from outside parties is also non-exempt income. For example, this could be income from a cell tower lease, laundry facilities, parking, capital gains, vending machines, pool facilities, golf course fees, bank interest, or clubhouse rental. There are a variety of sources of non-exempt income.
In some situations it gets a little subjective. It is not taxable if members are charged a flat $100 per year to use the recreation facility. Yet, an entry fee to a certain section of the facility, such as the pool, would not be exempt.
Breakout of expenses
Exempt and non-exempt expenses should be segregated. Any expenses for non-exempt activities can be used to offset non-exempt income. For example, maintenance, cleaning, or advertising can be listed even if it was for something that went towards the non-exempt income section of the form.
With other expenses, there are a whole range of additions you can make such as tax return fees, legal fees, management fees, repairs, cleaning, insurance, and utilities. As we mentioned earlier, a significant portion of your expenses must go towards the upkeep and maintained of the HOA otherwise you may not qualify for Form 1120-H.
Summary of homeowners association tax filing requirements
Examining the income components is critical and a large reason why most condo associations utilize a CPA to complete any HOA tax filing. Again, professional CPAs who spend their lives around Form 1120-H could be your best solution.
The biggest tip we can provide is to keep an eye on your finances all-year round. Not only will the instant filing make it easier for you and your CPA, you can assess how close or far away you are from hitting the Form 1120-H requirements. Now, you can make changes in the last couple of months of the tax year before it’s too late!
One thing is for sure – there are many misconceptions surrounding homeowners association tax filing requirements. Make sure that you do your own due diligence to ensure an accurate and timely tax return.