Do HOAs Have To File Tax Returns?
A home owners association is considered a corporation by the Internal Revenue Service. Even if the association is organized as a non-profit, the IRS will treat it as a corporation. That means HOAs must file tax returns, including a state return in some states, but that does not necessarily mean an HOA may owe taxes. Know the rules before you get your HOA into any tax troubles. HOA tax returns require some special handling of different types of income and expenses.
Although your association is a corporation in the eyes of the IRS, a special part of the tax code, section 528, was created specifically for associations. If you file under section 528, some of the association’s income will be exempt from taxes. This exempt status only applies to certain types of revenues, so it is important to understand your tax status when setting up your record-keeping.
For example, your association won’t have to pay tax on membership dues. You can also exclude revenues from assessments. Both of these types of income are collected to be spent on association projects and property upkeep, so they are not considered profit. Any late fees your charge on these types of revenues are also excluded from taxes.
If you rent out your facilities, such as the clubhouse or pool, you don’t pay taxes on the rental fees you collect. However, this exemption only applies to rentals to residents, so keep accurate records of who rented the facilities. Doing this can help you defend the tax-free rental income if you have to.
Your association must pay taxes on facility rentals to non-residents. It is important to set aside some of your non-resident facility income to cover the taxes your association will owe. If the association receives money from cable companies for access or cell tower leases, it must pay taxes on that revenue as well. In fact, any income from leasing out part of the property for any purpose is taxable. Income from laundry facilities and vending machines is taxable.
One way associations make ends meet is by investing in CDs, bonds and other investment vehicles. Any interest earned from such investments is taxable. Taxable income would include capital gains from stocks, as well as dividends and interest income.
Despite some tax liability, your association can deduct expenses. For example, maintenance of common areas and facilities can be deducted. So can the cost of investment advice and legal fees associated with contracts the association enters into. Track all expenses your association pays, so that you can ask your CPA if they qualify as deductions.
Gather all records for income and expenses early, because the filing deadline for associations to file tax returns is March 15th or the 15th day of the third month after the end of your fiscal year. You can file an extension if you can’t meet the deadline. You would file form 7004, which gives you an additional six months to file. By the way, your expenses to have your returns prepared are also tax deductible.
Homeowner associations can usually use form 1120-H, a form specially designed for HOA tax returns. However, there are minimum requirements you must meet in order to use this form. First, 85% of the units in your association must be residential. No more than 40% of your association’s revenues can be from sources that are not membership dues. In addition, 90% of your expenses must be for association business. Failure to meet these qualifications can result in your association being taxed at the regular corporate rate.
Another way to lose your association’s special status with the IRS is to fail to file returns. It is a best practice to file any missing or late returns as soon as possible to avoid losing your income exemptions. Your association may have to pay fines and penalties for late returns, so make the membership aware of the potential liability long before any surprises arise.
An additional best practice is to use a CPA that is familiar with filing tax returns for homeowner’s associations. Filing incorrectly, using the wrong form, or overlooking exemptions can cause your association to overpay by many thousands of dollars. If you do discover you have overpaid, you can file an amended return to get all or part of your money back.
The bottom line is that HOA tax returns require special knowledge and skills. Whoever is charged with overseeing association finances should not take a do-it-yourself approach when it comes to filing returns. Nothing is as disturbing as having a group of angry property owners protesting the handling of association taxes that results in penalties and fees.
No article should be taken as specific tax or legal advice. There are many issues and special circumstances that can arise in filing association returns. Use the information to help you understand questions you should ask your CPA, and to prepare your books so that you can readily identify types of income and expenses.