There is a lot of confusion surrounding the taxation of condo associations. Many believe that they are tax-exempt as a “non-profit” and are not required to file a tax return. Even though I have heard this argument over my career, unfortunately, it is simply not correct.
Condominium associations are classified as common interest realty associations. They are required to file federal tax returns. Most states (that have an income tax) follow the federal guidelines. However, filing requirements and tax rates will vary state by state.
But even though a tax return is required, this does not mean that the HOA or condo association will owe any tax. Most activities of the association will be classified as exempt income (more about this later). But many condo associations will have other income, such as interest income and laundry income, which could subject the entity to a tax liability.
Within the IRS law, section 528 is specifically designed for qualifying condo associations. It defines certain criteria that establishes whether the association is allowed to file Form 1120-H.
For example, gross income from exempt activities must be at least 60% of overall income. Furthermore, at least 90% of all expenses must go towards the construction, management, administration and maintenance of exempt property or facilities.
Under Section 528, membership dues and assessments are generally called exempt income and, accordingly, are not taxable. As long as the income is not received from the members as “payment for services” it should be exempt. Payment for services is typically when as association rents out a clubhouse, pool area or a golf course. Interest and dividend income is also not exempt income.
But this income can be netted against expenses made for the acquisition, construction, maintenance and management of association property. Make sure that you properly track income and expense by “exempt” and “non-exempt” so that they are easy to classify come tax time.
There are a couple other requirements. But needless to say, most HOAs and condo associations will meet these requirements. A qualified CPA will help you navigate the tax law. If an association does not meet the requirements, they are required to file Form 1120.
The good news is that there is some flexibility in which forms can be filed. Completing a condo association tax return may sound easy. But there are many mitigating factors that need to be considered. A DIY approach is not recommended. Make sure that you are well versed on the tax code and hire a qualified CPA if the process becomes too complex.
Board members must make sure that a tax return is filed annually. If they fail to do so, there can be severe penalties to the HOA. As stated previously, there might not be any tax due, but it’s always better to file and find out rather than not file at all!