“Did your HOA file a tax return last year?”
This is one of the first questions I ask when I meet with a new community association client to conduct an audit or other financial procedure. All too often the response is “No. Do we have to?”
Property management companies are diligent about filing tax returns for their HOA clients. I know this because I prepare a lot of those returns for property management companies. Unfortunately, self-managed associations often don’t know about the requirement, and therefore don’t file the returns. My estimate is that at least 25% of self-managed associations don’t file any tax returns, and others don’t follow the correct process. If your association is not filing tax returns, here’s how you can get caught up and back on track.
Nothing is certain but death and taxes
But let’s just focus on taxes in this article. Community and homeowner associations, just like any other US corporation, must file federal and state tax returns each year. Just because most associations are considered non-profit doesn’t absolve them of their income reporting responsibility. In fact, late, missing, or incorrect tax returns could result in unnecessary taxes, IRS penalties, and loss of non-profit status.
To file or not to file, that is the question
Most residential community associations elect to be taxed under Section 528 of the Internal Revenue code. To qualify, your association needs to be legally organized as an association, generate almost all revenue from homeowner assessments, and use that revenue to maintain the common areas. If this describes your association, most income is not taxable, including:
- Association dues and assessments.
- Architectural Control/Standards Committee fines and fees, like $25 per day for not replacing pine straw.
- Late fees and interest on late assessment payments.
- Resident clubhouse and other facility rentals.
Certain community association income is taxable, but often that income can be offset by expenses used to generate that income. Potentially taxable income includes:
- Bank account interest and dividends.
- Guest fees, such as non-resident pool usage.
- Non-resident clubhouse or facility rentals.
- Payments for easements, like cable lines or cell towers.
Filing annual tax returns
Community association tax returns are due by April 15th (or the next business day if April 15th falls on a weekend) for most communities, or 4.5 months after the fiscal year-end for communities that don’t follow calendar year accounting. In all cases, you can also file for a six-month extension if you need more time to prepare your tax returns.
While catching up on missing tax returns can be somewhat daunting, the process of filing an HOA’s annual federal and state tax returns is fairly simple and inexpensive. There are two potential IRS forms used. The “standard” IRS form 1120H applies if your association meets the following criteria:
- 85+% of units (homes, condos, etc.) are used as residential.
- 60+% of revenue is from association members rather than sales of goods or services.
- 90+% of expenses go to support the operation and maintenance of association property.
The more extensive and complicated Form 1120 may be required if your association doesn’t meet the above-mentioned criteria, or if it is filing late. It’s always best to review filing and form options with a CPA who has experience working with community associations.
Don’t shoot the messenger
I sometimes receive calls from panicked board members when they first discover their HOA hasn’t filed taxes in years – or ever. Technically, those associations need to catch up by filing all back tax returns. But let’s also be reasonable. If an association’s financial records are only available for the previous 5 years, let’s focus on filing tax returns for those 5 years and then keep current going forward. It’s most important to show that your association is remedying the situation as quickly as possible.
Read this before having tax returns prepared down the “block”
Recently, the board treasurer of a self-managed community association asked me to review their tax returns after having them prepared at the strip mall location of a national tax services provider. The board treasurer questioned why the association had just paid over $5,000 of income taxes. Good question!
It turns out that the tax preparer incorrectly categorized the community association, and used the wrong tax return form. Once we recalculated the return using the correct IRS forms and formulas, the tax due was actually $0. We refiled the correct tax returns and the association received a full refund.
Who let the IRS in?
Don’t be the board member who caused the IRS audit. When you hire a qualified CPA with community association experience, filing tax returns (even back returns in most cases) will be a pretty straightforward process. Make annual tax returns the first agenda item for the first board meeting of every year. Please let me know if you have specific questions.
Neal Bach, CPA