Under U.S. tax law, homeowners associations are considered corporations. As such, they have to file a federal tax return every year, regardless of whether they make a profit or owe any tax. The typical HOA can file Internal Revenue Service Form 1120, which is the standard corporate income tax return, or a simplified version designed specifically for homeowners associations, Form 1120-H.
Filing using the one-page Form 1120-H is easier than filing with Form 1120, which runs five pages and demands considerably more detail. However, HOAs that file the 1120-H must pay a tax rate of 30 percent on any profit they show for the year. Those that file Form 1120 pay a rate based on their income, according to Gary Porter, an accountant who specializes in HOA tax issues, most HOAs would pay only 15 percent tax on any profit.
A major consideration for an HOA to consider when deciding which tax return to file is how much of its revenue is "exempt." Since an HOA is made up of all the property owners within a community, the dues and assessments that the HOA collects from those owners is not really "income." It's simply money that the property owners are setting aside for HOA purposes. Therefore, it's exempt from income taxes. But income from outside the HOA is not exempt. This includes such things as interest on money held in an HOA account, fees paid by non-members to use HOA property or proceeds from renting out HOA-owned units in the community. Optional fees charged to members for specific services or events, such as an admission fee to a community party or a charge for using laundry machines, are not exempt, either.
An HOA figures its taxable income by taking its non-exempt revenue and subtracting its expenses. However, just as money received from HOA members is not considered income for tax purposes, money spent to benefit those residents isn't a deductible expense, either. This includes money spent to buy land, build units, manage the community and maintain common areas. That covers the bulk of what a typical HOA spends its money on. Deductible expenses might include such things as fees for managing money the HOA has invested or maintenance on the laundry machines that produce non-exempt income.
To file the 1120-H, an HOA must meet criteria set by the IRS. At least 60 percent of its revenue must be exempt. At least 90 percent of its expenses must go toward acquiring, building, managing or maintaining HOA property. And no individual member can profit from the HOA's earnings beyond receiving money for doing HOA work: acquiring, building, managing or maintaining property.
Making the Choice
If an HOA meets the IRS criteria and has no taxable income or very little, then filing the 1120-H is probably the best way to go, says Gary Weinman, an accountant quoted in "New England Condominium" magazine. The 1120-H also gives each association an automatic $100 deduction, so that may be enough to eliminate what little tax burden there is. On the other hand, if the HOA pulls in a lot of money from outside sources, the tax savings of filing the 1120 may justify the extra hassle. And, of course, if the HOA doesn't meet the IRS criteria, it has no choice but to file the 1120.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.