What IRS Tax Forms Do Condominium and Homeowner Associations File?
Glenn Tyndall, CPA
The primary purpose of an audit is to assure users of the financial statements that these statements are reliable.
You may have heard that Homeowner Associations have several IRS returns that they may choose to file that may net them some tax savings. Regardless of what form your association files, the IRS has two strict requirements:
- A homeowner association must always file a tax form, regardless of whether it’s legally organized as a trust or corporation; and
- Even if your association has not generated any income and owes no money to the IRS, it’s required to file a federal tax form each year.
The two most common filing options to choose from are the ‘Exempt Method’ of form 1120-H and the ‘Corporate Method’ of form 1120. The least common filing is to file as a non-profit corporation (Form 990).
Associations may file Form 1120–H under IRS Code Section 528, which was designed specifically for homeowners associations. Under this exempt method, there are several requirements that must be met in order to utilize this form.
First, according to IRS documents, at least 85% of the units within the association must be for residential use.
Second, at least 60% of the association’s gross income for the tax year must consist of exempt function income. Exempt function income is defined as income consisting of membership dues, fees, or assessments from owners used to pay for the general maintenance of association property, as well as real estate taxes, principal, and interest on that property.
Examples of nonexempt income might include rental income, interest (as from a reserve fund), dividends, or capital gains, special use charges such as laundry or vending machines, and revenue from non-member use of association property.
Third, at least 90% of the association’s expenses for the tax year must consist of expenses to “acquire, build, manage, maintain, or care for its property” and “No private shareholder or individual can profit from the association’s net earnings except by acquiring, building, managing, or caring for association property or by a rebate of excess membership dues, fees, or assessments.”
The flat tax rate is 30% for homeowner’s associations and an automatic $100 deductible applies. The primary disadvantage of filing form 1120-H is the flat 30% tax rate, which can be significantly higher than the graduated corporation rates (beginning at 15%) available when filing form 1120. Most homeowner associations choose to file Form 1120-H because of the substantial amount of guidance available for homeowner associations. The filing of Form 1120 may achieve tax savings, but it comes at the increased risk of IRS audit and the assessment of interest and penalties since there’s no guidance for how the form should be completed for homeowner associations.
The other filing option is the traditional corporate method, Form 1120, under IRS Code Section 277. While it allows for the advantage of being more flexible with the allocation of expenses (no 90% rule), and can save money with much lower tax rates (starting at 15% for the first $50,000 of taxable income) it also creates a much more complex calculating scenario. For the most part, as with form 1120-H, membership dues are considered tax-exempt income.
There is no guidance on the regulations when it comes to allocation income and expenses for homeowner associations filing Form 1120. This is because homeowner’s associations were not considered when the rules and regulations were created for Form 1120, as they were in Form 1120-H. There’s a higher risk of an audit from the IRS, with increased exposure to interest and penalties.
Homeowner associations that generate substantial income from non-exempt sources such as rental units or clubhouse rental fees for non-members, for example, would most likely do better with the 1120 form. A significant advantage for form 1120 filers allows more flexibility for fluctuations in income. If your association has three rental units and all are filled in one year, that income is taxable. If the next year they fail to rent at all, that loss can be carried over. In another example, if there is an abundance of assessment fees after all expenses have been deducted, the association can elect to either return the excess as a rebate to the homeowners or capitalize and defer the assessments to the following year, thereby protecting that gain from being taxed (IRS Revenue Ruling 70-604).
Your association would have to qualify for 501(c)(4) status to file Form 990. The IRS requires evidence that areas such as roadways and park land that it owns and maintains are open to the general public and not just for its own members use under IRS regulation 501(c)(4). The homeowner association would enjoy non-profit status under this IRS regulation, assuming they would qualify. However, few associations qualify to file this form.