HOA Taxes: What to Know, When to File
Taxpayers across the country are preparing to file their personal income tax returns by April 15. Most community association board members and managers also need to circle that date on their calendars for HOA taxes.
Even though many homeowners associations, condominiums, and housing cooperatives are nonprofit organizations, they must file federal and possibly state and local income tax returns. Under the federal tax code, all organizations are taxed on their revenue unless specifically exempted.
Income that can trigger tax
Most associations will have at least some income from interest earned on investments. Some will have miscellaneous income from laundry facilities, late charges, special fees, repair charges, pool use, vending machines, or newsletter advertising. In addition, some associations may be subject to sales, payroll, or property taxes.
Two common federal filing options for HOAs and condominiums
Homeowners associations and condominiums typically have two methods of filing income tax returns.
Option 1: Section 528 (referred to as the exempt method). The association files IRS Form 1120-H. If an association meets certain tests regarding revenues and expenses, then all nonexempt income is taxed at the rate of 30%.
Examples of nonexempt revenue are interest and rental income. If an association uses this method, it suffers no tax consequences related to reserves or excess operating funds.
Option 2: Section 277 (referred to as the corporate method). The association files IRS Form 1120. Under the corporate method, operating and nonoperating income must be treated separately. All net income is taxed at 21%.
How to choose the right method (and why it matters)
Each filing method has unique features that make it an appropriate choice in particular circumstances. The association should evaluate its current financial position, budget, and future projections. Then, based on its overall analysis, it should determine which method is best.
The following circumstances might make one method preferable over another:
- If the association has little or no interest income, it may want to opt for Section 528 because the method is simple.
- Associations also should file using Section 528 if they’ve generated nonmember income greater than related expenses that results in a tax rate greater than 30 percent.
- Section 277 is the most appropriate selection in all other circumstances since it results in the lower tax.
When to involve a tax professional
If your community association has significant nonowner revenue, it is to the association’s advantage to consult with a tax professional to explore ways to reduce its potential income tax.
Deciding each year which tax filing method is appropriate should not be done in haste. Consult with the association’s tax advisor. Filing incorrectly can result in overpaying or opening the association up to tax liability.
Special rule for housing cooperatives: Subchapter T
Housing cooperatives should file under this section (Form 1120-C), which allocates income and expenses between patronage and nonpatronage sources. Like Section 277, income is taxed at 21%
Other taxes to budget for
Other taxes may apply to some associations. They should be accounted for in the budget. These taxes include:
- Personal property taxes. If an incorporated association has related personal property, it might be subject to personal property tax.
- Real estate taxes. If an association has acquired a unit or other real property, it must pay real estate taxes. Homeowners associations that are deeded recreational facilities and common elements may be required to pay some real estate taxes on these items. Real estate taxes on recreational facilities and common elements should be nominal, if they are charged at all.
- Payroll taxes. If the association has employees, it must pay federal and state unemployment taxes and employer’s Social Security and Medicare.
When to file
Generally, associations must file by the 15th day of the fourth month after the end of its tax year. For example, those that align fiscal year with calendar year would file April 15. However, an association with a fiscal year ending June 30 must file by the 15th day of the third month after the end of its tax year (Sept. 15).
At the state level, many states also require a state corporate income or franchise tax return, and the form often follows (but doesn’t always match) the federal choice.
The bottom line
Plan for taxes as part of annual budgeting and governance — not as a last-minute scramble. Make sure your association files on time, understands which income is taxable, and reviews each year whether Form 1120-H, Form 1120, or Form 1120-C (for co-ops) is the best fit. A quick check-in with a qualified tax advisor can help you avoid overpaying, reduce the risk of penalties, and keep more funds focused on maintaining the community.
>>Find community association accountants in CAI’s Professional Services Directory.
>>Read more about a community association’s financial responsibilities and HOA taxes in CAI’s Board Treasurer guide.
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Daniel Brannigan is CAI's senior director of publishing.