What You Need to Know About Form 1120-h
The IRS treats homeowners associations (HOAs) and condominium associations (COAs) as corporations, regardless of whether they are residential or commercial. This means they are required to file a federal income tax return. In some states, these associations are also expected to submit a state tax return. Note that the requirement to file returns doesn’t necessarily mean that the associations owe taxes. If you are running an association, you need to know how to treat different incomes and expenses in regards to tax. This is a comprehensive guide on all you need to know about 1120-h, a special income tax return form for homeowners and condominium associations.
Form 1120-h vs. form 1120
HOAs and COAs can file their income tax returns through forms 1120-h or 1120. 1120-h is specifically meant to record HOA tax returns. Form 1120 is a general form used to report corporate income tax returns. Filing 1120-h has several advantages. Firstly, it reduces the logistical work involved; it’s a one-page long form specifically designed for use by HOAs and COAs. Further, if you file 1120-h, exempt function income will not be taxable. Filing 1120-h also reduces the probability of your association being audited for tax irregularities
Which associations are eligible to use 1120-h
With the numerous benefits gained by from filing 1120-h, you would wonder why an association would prefer to submit form 1120. Not all associations are eligible to file 1120-h; this form is for qualifying associations only. To be eligible to file 1120-h, your association should meet the following requirements
- At least 85 percent of the housing units should be residential.
- Membership dues should contribute at least 60 percent of the association’s gross income. The income from membership dues is also referred to as exempt function income.
- At least 90 percent of the annual expenses should be for the association’s business. This applies to both reserve and operating expenses.
- No shareholder should benefit from the association’s earnings
If your association doesn’t meet the above conditions, it will be taxed at the regular corporate rate, and it will be required to file form 1120.
Exempt function income
HOAs and COAs often have the challenge of distinguishing between exempt and non-exempt income when filing 1120-h. Exempt function income is deducted from the gross income when calculating the taxable income. Exempt function income is income received from members in their capacity as members. This includes membership fees, membership dues, and assessments of owners of residential units. Any income earned from members in their capacity as customers is taxable.
Non-exempt function income
Income received from members in their capacity as customers is taxable. Also, income earned from non-members is placed under non-exempt function income. Establishing whether someone is acting a member or a customer isn’t straightforward. One way of doing this is by checking whether all members enjoy the benefits for which the member is paying. If the benefits are not accessible to all members, income earned from them is taxable. For example, if your association charges all members an annual fee for using a particular recreational facility, the revenue generated is exempt function income. However, if the same facility is charged per use, the revenue generated is non-exempt function income. Other examples of non-exempt function income are parking fees, laundry income, dividends, and capital gains.
Deductible expenses and tax rates
Like other corporations, HOAs and COAs can offset taxable income with costs incurred when generating non-exempt function income. Examples of these expenses include production costs and advertising fees. Besides deductible income and expenses, the associations are entitled to a $100 standard deduction. The IRS applies a flat rate of 30 percent on the taxable income of residential HOAs and COAs. For timeshare associations, the tax rate is 32 percent.
Form 1120-h is not currently processed on the Mef system. Therefore, it can only be filed on paper. The deadline for submitting the form is the 15th day of 4th month after the end of the association’s tax year. However, if the fiscal year of your association ends in June, the deadline for filing the form is 15th September.
Filing 1120-h is not one day’s work; it requires preparation and planning. You need to gather all the materials you will need during the filing process. For example, you’ll need to collect receipts and invoices for exempt function income and expenses. If you fail to beat the deadline, you can fill form 7004 to request an extension. This will grant you an extension of six months.
Late returns, missing returns, and inaccurate tax returns attract hefty fines from the IRS. Further, your association could lose the special tax status, which will increase the tax bill significantly. It will be a pain to explain the sudden changes in income to other members. If you are in charge of filing your association’s 1120-h returns, it means you have a heavy responsibility on your shoulders.
Filing HOA and COA tax returns requires specialized knowledge in tax accounting. Hiring a tax expert could reduce your taxable income significantly without flouting the rules; from education and experience, these experts can easily tell which revenues and expenses are tax deductible. Further, it helps your association avoid the penalties that come with inaccurate tax returns.
All you need is Condo Manager
The good news is that you can cast all the strains associated with filing tax returns on Condo Manager. Condo Manager is a one-stop shop for all your association’s needs. We have brought together a team with many years of experience in association management and accounting. We also develop custom solutions to meet the unique needs of condos and homeowner associations. Contact us today for a free demo.