Not every board member knows there may be a tax exemption for HOA communities. After all, not everyone is aware of HOA-related laws and legal processes. However, homeowners associations should remember this as it may impact their community’s finances.
Tax Exemption for HOA Communities
Many homeowners only care about whether or not HOA fees are tax-deductible. Not everyone is concerned with the tax exemption of the HOA itself. This is a shame, as taxes may also impact the community’s finances and the residents’ obligations.
Are homeowners associations tax exempt? Most communities think that because they file tax returns, they owe taxes to the Internal Revenue Service (IRS), but this is not always the case. There are ways homeowners associations can avail of various HOA tax exemptions. There are three specific paths outlined in the Tax Code:
- 501(c)(4). Tax exemption for HOA communities that are considered social welfare organizations. These are organized not for profit but work solely to promote social welfare.
- 501(c)(7). Tax exemption for HOA communities that are considered social clubs meeting specific requirements.
- IRC 528. Tax exemption for HOA communities specifically. These exempt HOAs from taxing dues and assessments when they are used for the property’s maintenance and improvement.
The first method homeowners associations can try is qualifying for 501(c)(4). This method is the strictest of the three and can be quite difficult to achieve because the homeowners association must function for the benefit of the general public. As such, there are several revenue rulings an HOA must follow to qualify.
Many HOAs have tried this route for IRS homeowners association exemption. However, many have failed to qualify as the rules are quite strict. For instance, one nonprofit membership housing cooperative offered affordable housing to community members. The court did not exempt this cooperative because their contributions were not made for the general public and were not “of a public character.” This is because the cooperative mainly benefitted the HOA’s members instead of the public.
The requirements under 501(c)(4) aren’t so clear-cut. It’s difficult to gauge whether an applicant will qualify as they must limit the private benefit the HOA provides. Moreover, the IRS seems to examine the nature of the HOA’s benefits instead of the number of people who receive them. Here are some of the things the IRS may look into:
- Whether the association is a condominium association (COA); a COA’s general nature and structure does not qualify for exemption.
- Whether the association limits public access to streets, green spaces, and common sidewalks; HOAs that prohibit access do not qualify for exemption.
- Whether the association does the following:
- Serves a community with a relationship to a governmental area
- Offers common areas and facilities that are for the use and pleasure of the public at large
- Does not perform activities to maintain the exterior of private residential properties
How to Apply for Section 501(c)(4)
Homeowners associations that wish to apply for this section must electronically submit Form 8976, found in the IRS website’s Electronic Notice Registration System. The IRS requires a $50 fee to be submitted electronically along with the registration to finish the association’s notification. Organizations that do not pay the fee will receive a notice of non-payment in 5 days. The application will be denied if the association has not paid after 14 days.
Homeowners associations will only complete form 8976 once. Afterward, they may need to file annual information notices using Form 990, 990-EZ, or 990-N based on their gross receipts and total assets. In addition, HOAs can also choose to file Form 1024-A to be recognized as tax-exempt.
Homeowners associations that find Section 501(c)(4) challenging often turn to Section 501(c)(7). This section is much easier as it doesn’t have stringent requirements for the benefit of the general public. A homeowners association that mainly operates to own and maintain recreational facilities and areas can elect to be a tax-exempt social club. It’s more reasonable as HOAs can limit access to their facilities to members only.
However, Section 501(c)(7) also has certain disqualifications that may be deal-breakers for homeowners associations. For instance, the HOA cannot implement or enforce architectural guidelines to maintain the community’s external appearance. This, and a few other requirements, may make it difficult for many HOAs to apply and qualify.
Like Section 501(c)(4), there are also a few requirements under Section 501(c)(7). The IRS outlines the following requirements for qualification:
- The HOA must be organized for exempt purposes
- HOAs must offer opportunities for personal contact among its members, and membership should be limited
- The HOA must be supported by assessments, fees, and dues
- An HOA’s net revenue must not benefit a person who has a private interest in the HOA’s activities
- The HOA must be considerably organized for exempt purposes if it exceeds safe harbor guidelines for investment and nonmember revenue
- HOAs can obtain de minimis revenue from unconventional sources
- The HOA’s governing instrument cannot discriminate against members based on religion, race, or color
The IRS can also disqualify certain homeowners associations based on the following:
- The HOA cannot own or maintain residential properties that are not included in its social amenities
- HOAs cannot enforce covenants that maintain the housing development’s external appearance and architecture
- Communities must not offer police and fire protection
How to Apply for Section 501(c)(7)
Homeowners associations must not apply to achieve Section 501(c)(7) status. Instead, they only need to file an annual Form 990 to be recognized as a social club. The IRS does offer formal applications through Form 1024, but it is not required by law.
Homeowners associations are offered IRC 528 as an alternative to Section 501(c)(4). It’s also more achievable than Section 501(c)(7). IRC 528 exempts assessments and dues from income taxes where they are used for maintaining and enhancing the property. Every association described under IRC 528 may qualify, though the status is more of a quasi-exemption than a complete one. It is not a determination of tax exemption.
Like the previous two sections, IRC 528 has specific requirements for qualifying associations. Condominium associations and homeowners associations must meet the following:
- The association must be managed and operated to offer the upkeep, construction, management, and purchase of association property
- An HOA’s net earnings cannot inure private individuals or shareholders
- 60% of the HOA’s gross income must be solely comprised of membership fees, assessments, and dues (function income exempt)
- 90% of the HOA’s expenses for the taxable year are for the care, upkeep, management, construction, and purchase of association property
- Associations must elect to apply for the section for the taxable year
How to Apply for IRC 528
A homeowners association may elect to be under IRC 528 by filing Form 1120-H. It also serves as the annual return form that HOAs must file. HOAs must file this form before the 3rd month’s 15th day after the tax year’s end.
Tax Exemption for HOA Communities: A Complicated Affair
Applying for tax exemption for HOA communities can be a complicated affair. That’s because, while there are a few options, most come with strict requirements. Chances are, most homeowners associations won’t be able to qualify for Section 501(c)(4) or (7). Nonetheless, HOAs may have quasi-exemption under IRC 528 as it is more inclusive.
If your HOA is struggling with taxes and tax exemption, an HOA management company may be able to help. Clark Simson Miller is a world-class company offering management services to various homeowners associations. Call us now at 865.315.7505 or contact us online to learn more!