Cohousing-L Mailing List: Re: HOA taxes

[Jerome Garciano (jlgebox-04]

While I haven't focused much on HOAs in my practice, I thought a summary of
the federal tax statutes and regs pertaining to the categorization of HOA
income and expenditures might be helpful. I've also found a nice article
summarizing the issues and explaining the difference between filing 1120 and
1120-H.  If you want a copy please email me at jgarciano [at] eapdlaw.com, and I
will email you a PDF of it.
Jerome Garciano
**************
Section 528 of the IRS Code is the federal statute related to the income tax
on homeowners associations.  The categorization of HOA income and
expenditures can be important in three areas: (1) the definition of
"homeowners association" for federal tax purposes; (2) the 90% expenditure
test; and (3) the 60% exempt function income test.

The statue defines "homeowners association" in part as an organization that
is organized and operated primarily for the "acquisition, construction,
management, maintenance, and care of association property."  "Association
property" includes property held by the organization, property commonly held
by the members of the organization, and property within the organization
privately held by the members of the organization.  It includes real and
personal property owned by the organization or owned as tenants in common by
the members of the organization.  Such property must be available for the
common benefit of all members of the organization and must be of a nature
that tends to enhance the beneficial enjoyment of the private residences by
their owners.  On the other hand, facilities or areas set aside for the use
of nonmembers, or in fact used primarily by nonmembers, are not association
property.

Similarly, the 90% expenditure test requires 90 percent or more of the
expenditures of the organization for the taxable year be for the
"acquisition, construction, management, maintenance, and care of association
property." Qualifying expenditures may include expenditures for (1)  salaries
of an association manager and secretary; (2)  paving of streets; (3)  street
signs; (4)  security personnel; (5)  legal fees; (6)  upkeep of tennis
courts; (7)  swimming pools; (8)  recreation rooms and halls; (9)  replacement
of common buildings, facilities, air conditioning, etc; (10)  insurance
premiums on association property; (11)  accountant's fees; (12)  improvement
of private property to the extent it is association property; and (13)  real
estate and personal property taxes imposed on association property by a
State or local government.  Investments or transfers of funds to be held to
meet future costs shall not be taken into account as expenditures.
The 60% exempt function income test requires that 60 percent or more of the
organization's gross income for such taxable year be "exempt function
income."  "Exempt function income" consists solely of income which is
attributable to membership dues, fees, or assessments of owners of
residential units or residential lots.  If an assessment is more in the
nature of a "fee for the provision of services" in the course of a trade or
business rather than a "fee for a common activity" undertaken by a
collective group of owners for the purpose of enhancing or maintaining the
value of their residences, the assessment will not be considered exempt
function income to the organization.  Income attributable to dues, fees, or
assessments will not be considered exempt function income unless each
member's liability for payment arises solely from membership in the
association. The regulations give examples of "fee for common activity": (1)
assessments made for the purpose of paying the principal and interest on
debts incurred for the acquisition of association property, (2) paying real
estate taxes on association property, (3) maintaining association property,
(4) removing snow from public areas, and (4) removing trash.  Dues, fees, or
assessments that are based on the extent to which a member avails him or
herself of a facility are not exempt function income.  The regulations give
examples of receipts which are not exempt function income, including: (1)
amounts received from members for special use of the organization's
facilities, the use of which is not available to all members as a result of
having paid the dues, fees or assessments required to be paid by all
members; (2) interest earned on amounts set aside in a sinking fund, (3)
amounts received for work done on privately owned property which is not
association property, and (4) amounts received from members in return for
their transportation to or from shopping areas, work location, etc.



On Sun, Feb 7, 2010 at 9:34 AM, Diana E Carroll <dianaecarroll [at] 
gmail.com>wrote:

>
> My read on the 1120-H tax requirements are that you can include those as
> function-related if they benefit the whole community, and not specific
> individuals.  So we include common house internet service, childcare for
> general meetings, landscaping & gardening supplies, etc.
>
> What you CAN'T include are things specific to individuals.  So for
> instance our community maintains storage space, and people can "rent"
> storage for their exclusive use.  That income doesn't meet the tax
> exclusion requirements, so we pay taxes on it (offset by any expenses
> that we can tie specifically to maintaining the storage space.)
>
> The example the IRS gave was that if people pay on a per-use basis to
> use laundry machines, that is taxable and in the strict limits you
> mention.  If the HOA maintains the laundry machines for everyone's use
> and includes usage in the monthly assessments, that amount meets the
> non-taxable requirements.  (Our community recently decided to move from
> a per-use approach to an usage-include-in-condo-fees approach, which
> reduces our taxable income.)
>
> If you have a different read on the taxes I'd like to hear what it is.
> We haven't yet filed taxes yet since we are in our first year!  I've
> been pouring over the IRS materials on this to try to understand it.
>
> - Diana
>
> On 2/7/2010 9:14 AM, Rosemary McNaughton wrote:
> > I'd like to know the same.  Our community has been perplexed by how to
> > handle functions that aren't related to the condominium association
> > function (property maintenance).  Meals, childcare, affordability
> > fund, community life, the garden, car-sharing, raising chickens...  If
> > you are filing the 1120-H tax form, there are strict limits on how
> > much of your income and expenditures can be non-function-related.  We
> > had to spin off meals from the condo association when we realized
> > that, and it's just run with a personal bank account right now.  I'd
> > done a search on the archives here and found that one community at
> > least had formed a sub-corporation for the common meals.
> >
> > If you're filing the plain 1120, as we do, I'm not as clear on what
> > the restrictions are, but I've been wondering if it would be more
> > appropriate to set up a separate entity to encompass the
> > non-property-maintenance activities of our community.  We may end up
> > seeking legal and tax advice on this, but I'd love to hear what other
> > communities have done.  I believe in our state LLCs must pay a
> > $500/year filing fee, which would overwhelm the pretty small budgets
> > we're talking about here.
> >
> > Another issue that concerns me is insurance restrictions and health
> > codes - if we set up something formal for meals, do we have to be
> > inspected by the city?  Do our childcare providers need to be
> > licensed?  If we charge for people to stay in our CH guest room do we
> > need a lodging license?  Seems like a lot of big questions to worry
> > about for very small operations, but I admit it's been paralyzing -
> > the amount of money we're talking about is so small that it doesn't
> > seem to make sense to pay to get everything done perfectly and
> > legally, but we also don't want to mess around with something that
> > would put our condo operations at risk.
> >
> > -Rosemary McNaughton
> > Rocky Hill Cohousing
> > Florence, MA
> >
> > On Tue, Jan 26, 2010 at 12:38 PM, Diana E Carroll
> > <dianaecarroll [at] gmail.com>  wrote:
> >> Speaking from a banking perspective...what is the legal entity that owns
> >> the bank account?  did you set up an LLC or does an individual own it or
> >> what?  Thanks.
> >>
> >> We've had a few things we'd like to handle as financially separate
> >> systems but couldn't figure out how to do it without registering the
> >> "club" as an LLC.
> >>
> >> - Diana
> >>
> >> On 1/26/2010 12:30 PM, Lynn Nadeau / Maraiah wrote:
> >>> Someone just asked for insights about "splitting off" aspects of the
> >>> meal system from the whole community operation. We do that with the
> >>> accounting part: Separate books, and separate bank accounts, are kept
> >>> for the weekly cooked meals. The account holds both the kitty for
> >>> pantry supplies and the escrow money people have pre-paid for future
> >>> meals. Dinner fees are paid into it; cooks are reimbursed from it;
> >>> checks are written from it for pantry supplies.
> >>>
> >>> Ways it's not split: Our Common House Operations team supervises the
> >>> systems for meals, does most of the pantry shopping, and maintains the
> >>> accounting. Also, community annual assessments have included a couple
> >>> of vegetable-garden "shares" so that any Monday-night cook can use our
> >>> garden produce.
> >>>
> >>> Maraiah Lynn Nadeau, RoseWind Cohousing, Port Townsend WA
> >>> www.rosewind.org
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> >>>
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