There is good news and bad news when it comes to HOAs and taxes. The bad news is, yes, you do have to file federal tax returns. The good news is that it is rare for HOAs to pay any money in federal taxes. For this article, we are only focusing on federal taxes because that impacts all HOAs. But some states also require filing for taxation, so make sure you check that as well.
The easiest way to handle HOA taxes is for a CPA to complete and submit your paperwork. But even if you go that route, it is helpful for you to understand why and how HOAs are taxed. There have been reports of associations not realizing they were required to submit returns and hadn’t done it for several years! That shouldn’t happen to you.
How Does the IRS View HOAs?
While an HOA generally doesn’t earn any profit, it is considered a regular corporation for federal tax purposes. It’s true whether they are an association or a nonprofit corporation. Some HOAs have applied for and received nonprofit status by the IRS, but it is rare and complicated to do. So we will stick to the way most HOAs deal with taxes.
As a corporation, HOAs have two options to file for federal taxes. They can use either Form 1120-H, or Form 1120. Form 1120 is the U.S. Corporation Income Tax Return, and what is usually used by corporations. But HOAs are a different type of corporation, which means using that form can be very complicated. So Form 1120-H was created just for HOAs. That doesn’t mean you are required to use 1120-H, you can choose between the two.
Most HOAs, about 70%, file with the IRS using Form 1120-H. It was designed to make HOA’s lives easier since their finances are so different from regular corporations.
HOAs are allowed, and some are required to file with Form 1120. There are a few disadvantages to using the same filing as a regular corporation if you have a choice. The first is that it is much more complicated to complete. Which could cost you more if you have a professional handle your taxes or make your treasurer pull their hair out if they are tasked with completing the forms?
Second, you could wind up paying more. Under this form, anything considered income is taxable. For an HOA, income is any money taken but not yet spent, even if it has been set aside for specific costs later, such as maintenance or repair. Finally, using Form 1120 will require paying estimated tax payments, which is more work for your accountant or your already-stressed treasurer.
Since HOAs aren’t truly corporations because they are not expected to profit, the IRS created 1120-H. Under 1120-H, only things like interest from bank accounts or investments, fees from guests using association facilities, or money earned from renting out the clubhouse are taxable. These are called “non-exempt” income and are taxed at an even 30%.
All other money coming in, such as funds earmarked for future use, expenses, and even assessments, will not be taxed. The idea for this system is that HOAs are only taking in money to pay for the costs needed to run the community and not profit. So the IRS wants to make sure organizations that use the 1120-H are indeed HOAs. Form 1120-H can only be used if:
- Most — 85% or more– of the units (homes, condos, etc.) are used as residential;
- More than half — 60% — of the association’s gross income has been earned from homeowners in their role as association members, instead of customers who paid for goods or services; and
- At least 90% of the association’s expenses are from operating and maintaining the community.
You might be thinking, ok, but what about the taxable income? How much is that going to cost us? The good news about being categorized as a corporation by the IRS – the expenses can offset taxable income from generating that income. For instance, let’s say you earned taxable income because you rented the clubhouse to one of the residents. Any expenses you have from the advertising rental of the clubhouse can be deducted. This makes it possible for most HOAs do not pay any federal taxes at all.
If you wind up with extra money left over, you can roll it over endlessly. Then later, if your association winds up in the red, that money can be considered income and offset with losses. An accountant can go over that with you in more detail, but it is something to keep.