When it comes to filing tax returns for an HOA or condominium association, there are generally two options: Form 1120-H and Form 1120. The association will have to qualify in order to file Form 1120-H, but that should not be a problem for most associations.
But with options come questions. Which form has a higher audit risk? Which form will result in the lowest tax liability? Which return is more difficult to prepare? The questions may be more difficult to answer than first thought. We look to answer some of these questions here.
Both forms have their advantages and disadvantages. Normally the determining factor is which will yield the lowest tax liability. That is the first thing that any association manager will consider. But in reality, there are many factors that should be carefully examined before determining which form to file.
Tax Advantages of Form 1120:
Lower rate of 15% on the first $50,000 of income. This compares to a 30% rate (32% for timeshare associations) for Form 1120-H. Half the tax rate is certainly a big advantage.
Losses, if any, can be carried forward as a net operating loss to utilize in future periods. Losses cannot be carried forward on Form 1120-H. This is an important factor if the association finds itself with substantial losses in a given year.
The association does not have to qualify to file. In order to file Form 1120-H, the association must qualify under Section 528.
Potential to utilize Revenue Ruling 70-604 to defer member income to future periods. This gives the association flexibility and allows it to mitigate its tax situation.
Tax Advantages of Form 1120-H:
Rather straightforward and simple to prepare. Form 1120 is the same form completed by large corporations. It can be complex and has numerous questions and issues to address.
Exempt income, net of exempt expenses, is not taxable. In contrast, all income net of expenses is taxable under Form 1120.
They can be a much cheaper tax return to prepare. Most CPAs will charge a lower fee for tax preparation services.
Some states exempt condo associations who file Form 1120-H from state taxation. This can be a big advantage for states with complex HOA tax laws or high rates.
Large associations are not subject to the alternative minimum tax.
Substantially lower audit risk. Most HOA audits are based on Form 1120 and can result in not only additional income tax, but penalties and interest.
Deciding which tax return to prepare and file should only be done with careful consideration. Form 1120-H is a rather straightforward form, but it often does not result in the lowest tax liability. Form 1120 is more complex, but offers a lower tax rate.
Which form is best? It all depends on the facts and circumstance surrounding the association. Make sure you review the situation with your CPA and make the best decision for your association.