Homeowners associations, condominiums and cooperatives, whether or not they are incorporated, must all file annual federal and sometimes state income tax returns. When these returns are due and what type of return must be filed depends on whether you are a homeowners association, condominium or cooperative. Homeowners associations and condominiums can generally file either federal tax form 1120-H or form 1120. Which form is right for your association depends on number of factors. Cooperatives must generally file federal form 1120-C.
If the association is a calendar-year association, the tax return is due by April 15. If you operate on a fiscal tax year, returns are due the 15th day of the fourth month after the end of your fiscal year.
A home owners association or condominium generally has two tax filing options available: Form 1120 or Form 1120-H.
This form is the regular corporation tax form and is required for commercial (non-residential) condominium associations. Although the tax rate is 21 percent on all of the taxable income, it is more difficult to prepare. Filing this return may also subject the association to increased risk of tax audit.
This form was designed for condominium and homeowners associations. It applies to associations electing to be taxed under this method. This form requires the allocation of income and expenses between “exempt-function income” and “non-exempt-function income.”
Exempt-function income is the amount collected by the homeowners association or condominium from the dues paid by every homeowner. This income is not taxable.
Non-exempt-function income is income that comes from other sources (usually nonmembers), but it can also include income from members that is paid for the use of specific amenities. Some examples of non-exempt-function income are interest received on bank deposits, guest fees for the pool, laundry income, clubhouse-rental income, commendation awards and income received from the rental of association property.
Interest income and other non-exempt-function income is taxed at a rate of 30 percent. Basically, associations elect tax-exempt status for that portion of the association’s income that comes from assessments. Likewise, association income that does not fit the definition of exempt-function income is not tax-exempt.
Non-exempt-function income may be reduced by expenses directly connected to that income (such as state income taxes). In addition, other expenses may be allocated, such as management fees, tax-return preparation, insurance, bank fees, utilities, repairs and maintenance, and security and cleaning. Net non-exempt-function income is taxable, subject to a $100 deduction.
Under the IRS rules, the association must satisfy all of the following requirements to use Form 1120-H.
- The homeowners association or condominium must be organized and operated to provide for the acquisition, construction, management, maintenance, and care of association property;
- Substantially all (85 percent or more) of the units or property are used by individuals for residential and auxiliary residential purposes;
- At least 60 percent of its gross income is derived from the membership dues, fees, or assessments of owners in the association;
- At least 90 percent of its expenditures for the tax year are used for the acquisition, construction, management, maintenance and care of association property. This includes current expenses and reserve expenses;
- No part of its net earnings may benefit any shareholder, owner or individual.
If the above tests do not qualify your association to file Form 1120-H, which is a very safe filing method and is the easiest to prepare, the association will be required to file the more complicated (and risky) Form 1120. We recommend that the majority of associations file Form 1120-H in order to avoid the tax audit risks of Form 1120.
Cooperatives must file the most complex of all association returns, an 1120-C. This form requires allocations of patronage and non-patronage income and deductions.
In summary, the majority of association returns are filed using Form 1120-H despite the higher tax rate. Form 1120-H is less complex to prepare (that is, less expensive), virtually risk-free, and most associations do not have taxable income, making the difference in tax rates a nonissue. The association’s goal should be to minimize taxes and reduce risk.
For additional tax information call the tax experts at RMS Accounting. RMS Accounting is a division of Royale Management and has been providing tax consulting, preparation and representation services since 1984.