By: John S. Morlu II, CPA
Many Homeowners Associations (HOAs) are structured as nonprofit corporations under state law. However, being a nonprofit does not automatically exempt HOAs from taxation. Federal law recognizes HOAs as entities that earn income—primarily through membership dues and assessments—and therefore subjects them to specific tax obligations. To navigate these rules effectively, HOA boards must understand the key distinctions and IRS provisions applicable to their organization.
HOAs and Their Nonprofit Status
While HOAs are often considered nonprofit entities because they do not operate for profit, the IRS treats them as businesses for tax purposes. HOAs generate income in the form of dues, assessments, and other fees from members, making them subject to federal taxation unless they meet strict exemption criteria.
Historical Perspective: IRS Code and HOAs
Initially, HOAs fell under IRS Code 501(c), a section of the tax code encompassing various nonprofit organizations, such as:
- 501(c)(3): Religious, educational, or charitable organizations.
- 501(c)(4): Civic leagues and social welfare organizations.
- 501(c)(7): Social and recreational clubs.
Most HOAs historically qualified as 501(c)(7) organizations, paying taxes on income generated from nonmember activities (such as rental income or investment earnings). Some HOAs also sought exemptions under 501(c)(4) as social welfare organizations. However, qualifying for these categories proved challenging due to strict eligibility requirements.
In response, the Tax Reform Act of 1976 introduced IRS Section 528, which created a new tax category specifically for HOAs. This provision simplified tax compliance while offering distinct advantages tailored to HOA operations.
What Is IRS Section 528?
IRS Section 528 was designed to give HOAs an alternative to qualifying under 501(c). Under this section, HOAs that meet specific criteria can exclude certain types of income from taxation and benefit from simplified reporting requirements.
Key Features of IRS Section 528
- HOAs are taxed only on their non-exempt income, such as rental income or interest from investments.
- The tax rate is 30% of taxable income for residential HOAs and 32% for timeshare associations.
- HOAs must file Form 1120-H annually to elect coverage under this section.
What Qualifies as an HOA Under IRS Section 528?
To qualify as an HOA under Section 528, an association must meet the following criteria:
- Purpose: The organization must exist to acquire, construct, manage, and maintain association property.
- Income: At least 60% of the gross income must come from dues, fees, or assessments paid by homeowners.
- Expenses: At least 90% of annual expenses must be related to maintaining or managing association property.
- Nonprofit Operations: None of the HOA’s net earnings can benefit private individuals or shareholders.
- Election: The association must elect to operate under Section 528 by filing Form 1120-H annually.
Key Tax Terms for HOAs Under Section 528
1. Taxable Income
Taxable income is the difference between an HOA’s gross income (excluding exempt-function income) and allowable deductions.
2. Exempt-Function Income
This refers to revenue derived from membership dues, fees, or assessments. Such income is excluded from taxable income under Section 528.
3. Deductions and Modifications
- A $100 specific deduction is allowed.
- No net operating loss deductions are permitted.
- Other deductions must directly relate to producing taxable income.
IRS Section 528 vs. Section 501(c)(4)
While Section 501(c)(4) provides tax exemptions for civic organizations, the standards are far stricter than those under Section 528. To qualify as a 501(c)(4), an HOA must:
- Operate exclusively for the public’s benefit (not solely for its members).
- Ensure none of its earnings benefit private individuals or shareholders.
- Promote social welfare as its primary purpose.
Because most HOAs exist to serve their members rather than the general public, qualifying under 501(c)(4) is rare. As a result, most associations elect to file under Section 528 using Form 1120-H.
Filing Requirements for HOAs
Form 1120-H
This form is specifically for HOAs electing to operate under Section 528. It simplifies tax reporting and offers benefits like excluding exempt-function income.
Form 1120
HOAs can alternatively file Form 1120, the corporate income tax return. While this form offers more deductions, it requires detailed reporting and carries a higher risk of IRS scrutiny.
Pro Tip: HOAs can switch between Form 1120 and Form 1120-H each year, but they must file the selected form by the due date, including any extensions.
Deadlines
- For HOAs using the calendar year: April 15.
- For HOAs with a fiscal year ending June 30: September 15.
Filing an extension (Form 7004) provides additional time to submit tax returns but does not extend the deadline to pay taxes owed.
Why HOAs Must Still Pay Taxes
Although HOAs operate as nonprofit organizations, federal law requires them to file taxes because they earn income, primarily through dues and assessments. Thankfully, Section 528 significantly simplifies the process by excluding exempt-function income, which comprises the bulk of most HOAs’ revenue.
Industry Fact: According to IRS guidelines, exempt-function income typically accounts for 85–90% of an HOA’s gross income, significantly reducing taxable liabilities.
Navigating Tax Complexity
HOA taxes can be challenging to navigate, particularly with the nuances of IRS rules and state-specific requirements. Boards must also manage financial planning, reserve funds, and audits alongside tax compliance. Consulting with an experienced CPA or partnering with an HOA management company can alleviate the burden and help ensure compliance.
Conclusion: Simplifying HOA Taxes
Understanding IRS provisions like Section 528 is crucial for HOA boards to manage their tax obligations efficiently. By filing the correct forms, meeting deadlines, and leveraging exemptions, HOAs can minimize their tax liabilities and focus on maintaining their communities.
When in doubt, seek advice from a CPA specializing in HOA taxation to avoid costly errors and penalties. Taxes are inevitable, but with the right approach, they do not have to be overwhelming.
Author: John S. Morlu II, CPA
John S. Morlu II, CPA, is the CEO and Chief Strategist of JS Morlu, a globally acclaimed public accounting and management consulting powerhouse. With his visionary leadership, JS Morlu has redefined industries, pioneering cutting-edge technologies across B2B, B2C, P2P, and B2G landscapes.
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