Federal Form 1120-H, 990 or 1120?

Changing Your Condominium's Tax Filing Status Can Net Savings

By Laura V. Scheel

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For the uninitiated, tax filing for something as complicated as a community association can seem more than daunting. Fortunately, there are multiple options for homeowners associations, and with a little background knowledge, you can take the first steps toward making the right choice for your particular situation.

For starters, you should know that no matter how your condominium association is legally organized –whether as a trust, a corporation, or a Homeowners Association (HOA) – it doesn’t affect your filing status or the need to file tax forms annually to the federal government.

Even if your association has not generated any income and owes no money to the IRS, it’s required to file a federal tax form each year. And though a great many condominium associations are run as not-for-profit entities, from the viewpoint of the IRS, associations are considered corporations.

Under federal tax laws, condominium and homeowner associations have the advantage of choosing among several filing options – each with its own accompaniment of regulations and qualifications – and the ability to alter that status from year to year to their benefit. The two most common filing options to choose from are the ‘ExemptMethod’ of form 1120-H, or the ‘Corporate Method’ of form 1120.

A third and less commonly-used method is to file as a nonprofit corporation (form 990). This filing status can be of great advantage to an association, though it is much harder to obtain and difficult to change.

1120-H is Simplest Form

The simplest form to file (it is a mere one page), says CPA George Malloy of Wellfleet, Massachusetts, is 1120-H, under IRS Code Section 528, which was designed specifically for homeowners associations. Under this exempt method, there are several requirements that must be met in order to utilize this form.

First, according to IRS documents, at least 85% of the units within the association must be for residential use. Second, at least 60% of the association’s gross income for the tax year must consist of exempt function income. Exempt function income is defined as income consisting of membership dues, fees, or assessments from owners used to pay for the general maintenanceof association property, as well as real estate taxes, principal, and interest on that property.

Examples of nonexempt income might include rental income, interest (as from a reserve fund), dividends, or capital gains, special use charges such as laundry or vending machines, and revenue from non-member use of association property.

A third requirement states that at least 90% of the association’s expenses for the tax year must consist of expenses to “acquire, build, manage, maintain, or care for its property.” And finally, say IRS rules, “No private shareholder or individual can profit from the association’s net earnings except by acquiring, building, managing, or caring for association property or by a rebate of excess membership dues, fees, or assessments.” The flat tax rate is 30%for condominium associations and an automatic $100 deductible applies.

Generally speaking, explains CPA Gary Weinman of the Braver Group, based in Newton, Massachusetts, form 1120-H works well for associations that don’t generate much in the way of taxable income. Many associations base their assessments on expected expenses and maintenance, so there is little excess that could be counted as taxable income. This filing status also benefits associations that see minor change in both revenue and expenditurefrom year to year. Money set aside in reserve funds is not taxable, though the interest earned on the amount is subject to tax.

Under the form 1120-H, an imbalance of exempt income versus expenses is not necessarily a bad thing, adds Malloy. Suppose the association collected $100,000 in membership assessments but the yearly expenditures totaled only $45,000: Since dues are not taxable, the gain of income over expenses is not taxed, only the interest.

One of the main disadvantages of filing form 1120-H is the flat 30% tax rate, which can be significantly higher than the graduated corporation rates (beginning at 15%) available when filing form 1120, though this of course ultimately depends on the final calculation of taxable income after expense allocation. For some associations, after the $100 deduction is applied, the tax rate can prove to be very favorable. Condominium associations that generate a good deal of taxable income find it more difficult to apply expenses to meet the stringent 90% rule. For associations that have suffered a loss in a particular year, form 1120-Hdoes not allow for an operating loss deduction for the following year.

Corporate Filing Is More Flexible

The other filing option is the traditional corporate method, Form 1120, under IRS Code Section 277. While it allows for the advantage of being more flexible with the allocation of expenses (no 90% rule), and can save money with much lower tax rates (starting at 15% for the first $50,000 of taxable income) it also creates a much more complex calculating scenario. For the most part, as with form 1120-H, membership dues are considered tax-exempt income.

“This is where the dance is,” says Weinman of the careful figuring to adhere to the strict regulations when it comes to expenses and income. “There really is no definitive answer in allocating the various expenses; it’s all in the moving around of things to the association’s best advantage.” In addition to the web of restrictions and qualifications associated with the use of form 1120, there is a higher risk of an audit from the IRS. The multiple page form is oftenbest maneuvered by an experienced and knowledgeable tax professional.

Condominium associations that generate substantial income from non-exempt sources such as rental units or clubhouse rental fees for non-members, for example, would most likely do better with the 1120 form. A significant advantage for form 1120 filers allows more flexibility for fluctuations in income. If your association has three rental units and all are filled in one year, that income is taxable. If the next year they fail to rent at all, that loss can be carried over. In another example, if there is an abundance of assessment fees after all expenses have been deducted, the association can elect to either return the excess as a rebate to the homeowners or capitalize and defer the assessments to the following year, thereby protecting that gain from being taxed (IRS Revenue Ruling 70-604).

Non-Profit Filing Can Be Difficult

Filing as a non-profit entity (501 (c)(4), form 990) is the least common method for associations. Malloy has obtained this status for several of his clients on Cape Cod and it’s not easy. “There is an incredible amount of paperwork and research involved,” he says. “Close attention must be paid to the wording in your association’s bylaws as this can affect your status in the eyes of the IRS.” Having your accountant wade through the morass of forms and filing of documents can be a more costly proposition, but under the right circumstances, it can prove to be the best option.

In order to qualify for 501(c)(4) status, the IRS requires evidence “that areas such as roadways and park land that it owns and maintains are open to the general public and not just its own members.”

In one example, a fierce autumn storm provided the impetus to seek non-profit status for one of Malloy’s association clients. The power of the storm stripped the beach of much of its sand and created a very vulnerable situation for both the homeowners and the future of the beach itself.

Non-profit status allowed association members to use their dues to pay for beach renourishment, as well as securityand road maintenance, all for shared public access to the waterfront. This status even qualified the association to receive state funds to help pay for the beach renewal.

Once non-profit status has been approved, it cannot be changed without permission from the state AttorneyGeneral’s office. In addition to being freed from tax payments, non-profit status offers more protection to the individual homeowner in the face of liability. “It's an umbrella over the entity,” says Malloy. “In the case of a costly lawsuit, the non-profit entity gets sued, not the individual.”

Certain circumstances can make one form worth filing over the other, year by year. Much of what determines which form to file come tax time depends on whether the association has made or lost money in a given year, says Malloy. It is in an association’s best interest to completely fill out both forms and determine which form results in a lower tax payment before deciding which status to file.

It pays – in many ways – to have a reliable CPA on your side when considering your association’s tax options. Their familiarity with tax laws, restrictions, and audit red flags can prove invaluable. Even if you prepare your association’s tax forms yourself, it’s a good idea to seek advice if you know that circumstances are going to change, advises Weinman. The addition of rental units or the opening of a clubhouse that will be open to thepublic, for example, will not only add taxable income to your association, but a new level of complexity.

Weinman offers some important advice: “Keep records. It seems obvious, but many people don’t, and this can create some real headaches at tax time. Association managers have to know what’s what; and that includes every check that’s written for expenses and alldeposits coming in. Someone has got to be watching the store, so to speak.”

Using specialized software like QuickBooks can make things a lot easier, Weinman says, even if you are paying a professional to prepare your association taxes. “Generally, the better the records, the cheaper the accounting fee. Sometimes we’ll get a shoebox full of paperwork to deal with, and while we’ll work through it, it’s a much more costly proposition.” That sort of disorganization doesn’t help anyone and can cause troubles in the long run.

Those in charge of “watching the store” also need to know when federal taxes should be filed. Association bylaws should determine when the calendar year ends; returns and any payments are always due 75 days after the end of the fiscal year. If necessary, associationscan file for an extension of up to six months; though any estimated taxes must be paid by the original filing deadline in order to avoid penalty and interest.

Tax time for your association can be made a lot easier with a little planning, a little help, and a bit of knowledge on tax filing status.

Laura V. Scheel is a freelance writer from East Orleans, Massachusetts

Comments

an unknown user

What state tax form do you file in Mass when you file a 1120-h.

Sal

A helpfull overview. Thank you

Rick

It seems impossible to find good instructions for filling out 1120-H. Can Financial Management Account Fees be deducted to offset dividend earnings??

Millie

We are a FL. condo association whose board changed our IRS status to homeowners. These are vacation units and 4 owners use them during winter. Approx half are rented to winter residents and summer vacationers. Association does not receive any rental income. Would we be considered residential.l

an unknown user

I am the controller for a mangement company and need to prepare the tax returns for the associations we manage. Is there online training available for these form?

Jim

Our budget for 2009 was $37,260.00, we had 28 expenditure transactions, we have 35 homes in our HOA. What should we expect to pay a Professional to complete our 1120-H? The teasuer uses Quicken to issue quarterly reports to the HOA Board members, thus documentation is well organized.

Fran

I am the treasurer for a HOA and need to prepare the tax returns for the associations we manage. Is there online training available for these form?

Barry

Here is a location for the 2009 Instructions www.irs.gov/pub/irs-pdf/i1120h.pdf

Jane

If all our HOA income is exempt and all expenses is maintenance, how do I show this on line B and C? Total income 15,000 and total expenditures 10,000.

Jim

What happens to excess asscessments since they are not taxable, Are they returned to the members.

Lisa Fernandez

If I have a homeowner association that has both residential and commercial units and I collect only assessments and pay out only normal property expenses, how do I file with the IRS if the ratio of the commercial and residential units are 50/50 and not 85% residential? I appreciate your assistance.

cts

I did not see a respons to Janes question. My question is, are accounting fees/professional fees considered a qualifying expenditure deductible on line B of Form 1120-H?

paul johnson

i am about to file income tax for my association. where can I get a sample of filled in copy?

WJY

we are a POA that is incorporated as a not for profit corporation and we are a POA assoc. if we sell property(2 recreation lots) to use the profit to build a community clubhouse, are we taxed on the net sales gain of the property? and if so, how can we best minimize the amt. of taxes apid?. thanks-

Elena

How can a concerned unit-owner gain any information she requests dealing with the above issues; when she is unable to get copies or answers dealing with how the association handles it's tax returns ?

Stan Buckland

I am the Finance Chair of an HOA that now files a Form 1120, and has Net Operating Loss Carry Forwards. We operate three restaurants and a theatre primarily for the benefit of the 4,500 residents who pay an annual maintenance fee for upkeep of all of the facilities, including a subsidy for these operations. The restaurants and theatre are treated as a business amenity and operate at a 10-12% loss, subsidized by the resident fees. Are revenues from these amenities considered exempt income for purposes of calculating the 60% gross income criteria for filing an 1120H? We also contribute 22% of our annual dues toward our Reserve, or sinking fund. Are these reserve constributions (except the interest earned) considered tax-exempt for either the 1120 filing or a potential 1120H fililng?

Steve Knight

Interesting and informative article. I'd like to see an article that addresses a point similar to the one raised in Stan Buckland's post -- involving the tax implications of payments into a capital reserve fund for an OFFICE condominium. My understanding is that condo fees used for operations/maintenance are tax deductible as business expenses, while payments to the reserve fund are not deductible up front but may be deducted in the future as capital expenses are incurred (either directly or on a depreciation schedule). Am I wrong about this? I'm dealing with an office condo board that has collected several years worth of operating/maintenance fees from the owners -- who have presumably all been deducting 100% of these fees on their own tax returns. Just recently, the board announced that $X of the operating/maintenance account (dating back 5-7 years) is now being considered a "capital reserve fund" -- though no such separate fund exists and all of these monies are in a commingled account. Do I now need to file 5-7 years of amended tax returns for my office unit? Do these people even know what they're doing?

Don Moore, CPA

If the condo assoc. is for business office property; what form must be filed? Are the dues exempt function income?

an unknown user

Has the Form 1120-H been replaced by Form Section 280H (for a Personal Service Corporation? What should a non-profit small HOA use to file for 2010?

an unknown user

what irs form do we use for not for profit homeowners association - townhomes

an unknown user

I'm getting discouraged and frustrated, to think that when I write for a form 1120-H, all I get is a letter back to me to go to the same website and print it off. The error message says"THE FILE IS DAMAGED AND COULD NOT BE REPAIRED". I presume the form doesn't need to be mailed anymore!?

SMIOA Treasurer

I finally located the 2010 form on the IRS website. Apparently it was being revised. It's at www.irs.gov/pub/irs-pdf/f1120h.pdf and the instructions at www.irs.gov/pub/irs-pdf/f1120h.pdf

Mass Man

I live in MA....We do not collect any monies or fees...Whateve comes up, we put together and pay...It's deeded as a condominium however, it's only 2 units...duplex. Question is, we/I received some damage to my side and put an insurance claim. The check was issued to the condo so I had to set up an account to deposit the money. Then wrote out the checks to pay for the repairs. All the money that came in for the claim was documented and paid out for the repairs. No profit, no balances, etc...But I believe the IRS says I must file a 1120??? Also, I have owned my half since 2003. The building was built in 1988 or so and I don't beleive anyone has ever filed. (prior owners) (both sides have always been privately owned.)

emily condo. assoc. inc.

Looking for answer for Fedreal taxes on commercial condo association which receives only maintainace every month to maintain the property.if all funds are not used in end of calander year does condo association have to pay fed tax on remaining maintanace funds Plz. advice yes/no & why?

Mass citizen

Interested to hear an answer to Mass Man above. In a similar situation, 2-unit privately owned, no fees.... we pay as things come up. What's the scoop?

H.W.

Form 1120-H on page 1, lines (either) C or D requires an expense number, one being Total expenditures for the 90% test and the other being Total expenditures. In an 1120 filing the filer is required to DETAIL all expenses on its Page 1, as well as detailing the "Other Expenses", as well as, to a smaller extent possibly, detailing its Cost of Goods Sold on Page 2. Is it your feeling that, on a 1120-H, neither lines C or D need a further schedule detailing what the Associations expenses are for the year?

lou

can a HOA be in the form of a partnership, if so can that partnership file form 1120-h instead of form 1065

Alabama Granpa

The HOA Board of Directors didn't pay State or Federal taxes for 3 years. They got caught. The HOA is responsible for the taxes, but who is responsible to pay the interest and penalty ?

Terri Cohen

If a non profit condo association takes title to a unit due to maintenance not being paid, is any profit on the sale due its taxes if the unit is sold to an existing member? What if it is sold to an outsider?

Colin

IRS Revenue Ruling 70-604 appears to me to only apply to condominiums. Does it mean that that it doesn't apply to cooperatives housing organizations? Also, does anyone know--and can provided references to that knowledge--what regulations for Reserve Studies apply to a cooperative that is incorporated in one State but is located in another one?

Colin

I'll answer my own question as I've paid for legal advice. I've been informed by a 'legal expert' that regulations that apply to reReserve Studies are those of the State in which the cooperative is located.

Mass Woman

I have the exact same circumstances as Mass Man, 2 unit (duplex) condominium, condominized in 1989. No funds collected, whatever needs to be done to the property is collected and paid my me and the other Unit Owner. Had some damage which an insurance claim was put in on and paid to the trust. Repairs made. Applied for EIn to open a bank account and found out about the 1120H. Does the IRS require us to to complete an 1120-H under these circumstances? What will happen if we do not file one to the IRS? And if we do need to file the 1120-H what year would I do it for? Woudl it be the year the bank acocunt is opened (we have not opened yet) or the year when the EIN was obtained (2011)? Thank you.

Don

out assoc is resp for maintenance of special driveway leading to 4 residents and an assoc park area. When we pay $100 for snowplowing, and in accord with bylaws, 75% is assessed the 4 owners, and the 25% remains as assoc expense. since all residents have access to the park area. (A) On our expense statement, should we show the net amount 25% (amt the assoc is resp for, as the total expenses -which is the basis for annual dues assessments to all owners) or, (B) show the 75% as an assessment in income section and 100% as expense on the finl statement.? Ya, I know, "big deal." thanks, Don

PAT WOODARD

I am attempting to do the taxes for my HOA on form 1120H. I feel there are deductions that can be taken and possibly a refund to the association. However, I can't find a tax preparation software that allows me to enter information for free, allowing me to see what we may have, or not, and then pay if this is the route for us to take. Is there a software that will allow me to enter information for free and pay if I file for this form?

RPB

Don - I'd go with showing the 75% as an assessment and the whole cost as an association expense. Sure does seem a strange way to cover plowing, which I assume is being done to common areas.

LKM

What if the Condo Association is 100% commercial (medical offices)? Can you obtain tax exempt status from the IRS, or do you need to file an 1120?

KWD

What if a HOA has no commonly owned property, but the covenants allow a access right of way for a road entry that should be maintained by the developer or an association? Do those expenses qualify 90% of the association’s expenses for the tax year must consist of expenses to “acquire, build, manage, maintain, or care for its property", since the HOA truly does not have any of its own property? And, if a surplus is built up over the course of many years and not used for the maintenance of that access road right of way, at what point does that excess money from each year either have to be used, refunded, or counted as income?

RFW

If homeowner association held property is purchased by the government for common use area, do proceeds qualify as exempt income?

RFG

Can an HOA take a tax deduction for condo fees which it pays itself for rental property it owns within the condo complex?

JB

Condo assoc incorp 30 yrs ago & has never filed a tax return - not a form 1120-H or form 1120. What should we do?


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