Are HOA tax exempt? This is a common question for board members and community managers. Taxes are part of running any organization, including homeowner associations. Understanding the rules can help boards make informed financial decisions.
Are HOA Tax Exempt?
Many ask, “Are homeowner associations tax exempt?” The answer is usually no. Most HOAs must file tax returns with the IRS. Although they are not considered traditional businesses, they still generate taxable income.
Income sources can include interest from reserve accounts, rental income from common facilities, or fees for certain services. Even if these funds are used for community expenses, they can be subject to federal taxes.
The Internal Revenue Code treats HOAs as corporations for tax purposes unless they qualify for specific exceptions. Associations may file taxes using either Form 1120 (U.S. Corporation Income Tax Return) or Form 1120-H (U.S. Income Tax Return for Homeowners Associations). Each form has different rules and tax rates.
A majority of associations prefer to use Form 1120-H because it allows them to exclude most assessment income from taxable income, provided they meet certain requirements. These include using at least 60 percent of income for exempt purposes and having at least 90 percent of expenses go toward maintaining property.
Are Condo Associations Tax Exempt?
Condo associations face similar tax rules as HOAs. A condo association is not automatically tax exempt simply because it is organized as a non-profit corporation.
The IRS looks at the type of income the association earns. Assessments from owners used for operating expenses and reserves are often excluded from taxable income if the association files under Form 1120-H. Still, any other income, such as clubhouse rentals to non-residents or interest earnings, is typically subject to tax.
State tax rules may also apply. Some states have separate tax obligations for condo associations, while others follow federal rules. Boards should check local regulations to ensure compliance.
Are Homeowners Associations Non-Profit?
Many boards assume that because their HOA is registered as a non-profit corporation with the state, it is exempt from taxes. This is not always the case. Non-profit status at the state level mainly affects liability and governance.
It does not automatically make the HOA tax exempt at the federal level. The IRS defines a tax-exempt non-profit under Section 501(c) for organizations that serve charitable, religious, or educational purposes. Most HOAs do not meet these criteria because their primary role is to manage and maintain properties for their members.
So, are HOA tax exempt if they are non-profits? No, not by default. They must still meet IRS requirements for tax exemption or file annual returns. Failure to file returns and pay taxes can lead to penalties.
Can HOAs Achieve Non-Taxable Status?
Yes, HOAs can achieve non-taxable status, but it is very rare. To qualify for full exemption, an HOA must meet the IRS requirements under Section 501(c)(4) for social welfare organizations or Section 501(c)(7) for social clubs. These require the HOA to serve the community as a whole, rather than just its members.
In practice, most HOAs do not meet these standards because their activities primarily benefit the homeowners, not the general public. For example, an HOA with gated access or amenities limited to members may not qualify.
HOA Tax Exemptions: How to Reduce Tax Liability
Boards are often seeking ways to reduce expenses, and this can extend to tax savings as well. While most are not fully exempt, there are strategies that an association can employ to reduce its tax liability. Let’s discuss them below.
1. File Under the Right IRS Form
Choosing the correct form is critical. Form 1120-H can exclude most owner assessments from taxable income if the association meets eligibility rules. This can significantly lower taxable income compared to Form 1120.
Additionally, Form 1120-H is easier to understand and complete. Form 1120, in comparison, is rather complex and requires more information. That said, it is always best to ask an accountant or HOA management company for assistance with filing tax returns.
2. Limit Non-Exempt Income
Income from non-member sources is taxable. This includes renting facilities to outsiders, advertising income, and certain investment earnings. When an association limits these activities, it can reduce its tax obligations. Another option is to ensure these activities stay within the allowable thresholds.
3. Use Funds for Exempt Purposes
The IRS allows income exclusions if the association uses the funds for maintaining, repairing, or improving common areas. To ensure a smooth tax process, boards should carefully track expenses and ensure that the majority of the association’s spending falls under these categories.
4. Keep Detailed Records
Many boards struggle to maintain accurate records, which can significantly hinder tax filing and liability management. Accurate records can help prove that the income qualifies for exclusion.
It is a good idea for HOA boards to maintain separate accounts for exempt and non-exempt income. Board members should also maintain organized records of receipts, contracts, and bank statements. This will make it easier to trace funds and file tax returns.
5. Work With a Tax Professional
Board members, especially those with limited experience, may struggle to keep up with HOA tax laws. These laws can be quite complex, making it hard to discern which ones apply and which ones don’t.
Hiring a CPA with experience in HOA filings will help ensure proper filing and maximize tax benefits. An HOA management company also typically offers tax assistance, which can be a significant benefit. These professionals can help reduce mistakes in tax reporting, which can lead to penalties.
6. Review Federal and State Tax Rules
Some states have exemptions or credits for HOAs that meet specific criteria. Meanwhile, others may require additional filings. It is essential to understand these rules to prevent double taxation and minimize tax liabilities.
7. Plan for Reserve Fund Taxes
Interest earned on reserve accounts is usually subject to tax as well. To reduce tax liability for reserves, boards can look at low-interest accounts with tax advantages. It is also best to plan for the taxes as part of the budget.
Are HOA Tax Exempt? Answered!
The short answer is that most HOAs are not fully tax-exempt. They may qualify for partial exemptions under IRS rules, especially when filing Form 1120-H. Still, the bottom line is that HOAs are not considered non-profits in the tax sense, so they must pay taxes and file returns at both the federal and state level.
Hillcrest offers HOA financial management services to communities in Chicago. Call us today at 630-627-3303 or contact us online to request a proposal!
RELATED ARTICLES:
- HOA Accounting For Board Members
- HOA Foreclosure Explained: Can The HOA Really Take Homes?
- What Triggers A Lien In Homeowners Association? Common Causes Explained
