Prior to changes in the federal tax code quite some time ago, homeowner associations were set up as a 501(c)(4) (or sometimes as a 501(c)(7)) organization. Now, they primarily fall under Section 528, which was created specifically for HOAs. Even though they are nonprofit corporations, homeowner associations must file tax returns and pay taxes. HOAs can choose to file taxes under either Section 528 (using Form 1120H) or Section 277 (using Form 1120) of the federal tax code (IRC), with potentially very different ramifications.
Section 528 was set up specifically for HOAs. Form 1120H is a simple one page form and all income is taxed at a flat 30%. The HOA must meet the 60% exempt function revenue test, the 90% exempt function expense test, and 85% of the sq footage of all the units must be for residential use. Taxable income is calculated from “nonexempt function income.” All “exempt function income” is non-taxable. Under Section 528, HOAs are not entitled to net operating loss deductions and there is a possibility of more income being taxed compared to electing 1120.
Under Section 277, the HOA is taxed like a regular corporation and Form 1120 is more complex, although the tax rate is now a flat 21% (as opposed to the tiered rate prior to 2018. Additionally, compliance risks are much higher. Risks include reserves being taxed, excess member income being taxed, and prepaids are income in the year paid and therefore contribute to the excess member income. Taxable income is calculated from nonmember income, all member income is considered non-taxable.
Most HOAs will file Form
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Statutes and Cases:
(For reference: 57-8 is the Condo Act, 57-8a is the Community Association Act, 16-6a is the Nonprofit Act)