Yes, an HOA can be a nonprofit. This article will explain what it means for an HOA to be a nonprofit and the tax exemptions available.

Key Takeaways

• Homeowners associations (HOAs) are typically established as nonprofit organizations, focusing on community management and welfare rather than profit generation.
• HOAs can pursue various tax exemptions under the Tax Code, including Section 501(c)(4) for social welfare organizations, Section 501(c)(7) for social clubs, and IRC Section 528 for quasi-exemptions, each with unique eligibility requirements.
• Consulting professionals like tax experts and HOA attorneys is crucial in navigating the complex rules and maintaining compliance to get and keep tax-exempt status.

Defining a Nonprofit Organization

A nonprofit organization is distinguished by its primary mission to serve the general public good rather than to generate profit for owners or shareholders. These organizations do not intend to distribute profits to members, directors or officers, aligning their activities with community benefits. Homeowners associations (HOAs), by their very nature, often fit this mold. HOAs are usually formed as nonprofit corporations, focused on managing and improving community interests, not profit. A nonprofit membership housing cooperative can also embody these principles, serving the needs of its members while prioritizing community welfare.

The operational framework of an HOA further aligns it with the principles of a nonprofit organization. Governed by elected volunteer boards, HOAs oversee the governance and management of their communities. The board members, serving as volunteers, are responsible for the oversight and management of the nonprofit organization, ensuring that the community’s interests are prioritized. These boards ensure that the communities they serve benefit from maintenance, improvements, and community-building activities without any profit motives. This structure not only ensures transparency and accountability but also solidifies the HOA’s status as a nonprofit.

Types of Tax Exemptions Available for HOAs

 

When it comes to tax exemptions, homeowners associations have several paths they can explore. The primary tax exemption options available for HOAs are outlined in the Tax Code and include Section 501(c)(4) for social welfare organizations, Section 501(c)(7) for social clubs, and IRC Section 528 for quasi-exemptions. Each of these paths provides a unique set of benefits and requirements that can help HOAs manage their financial obligations more effectively. To qualify for certain tax exemptions, HOAs must typically manage residential property as their primary purpose.

Navigating the complexities of these exemptions requires professional guidance. Tax professionals and HOA attorneys can assist associations in understanding the intricate requirements and ensuring compliance with IRS regulations. This professional guidance is essential not only for maximizing potential tax benefits but also for avoiding costly mistakes that could jeopardize the HOA’s tax-exempt status.

Understanding these tax exemptions is key for any HOA to optimize its financial health. The following sections will dive deeper into each exemption type and provide more information on how HOAs can qualify and maintain these statuses.

Section 501(c)(4) Social Welfare Organizations

Section 501(c)(4) of the Tax Code provides a path for HOAs to qualify as social welfare organizations. To be eligible for this tax-exempt status, an HOA must:

• Be operated primarily for the common good and general welfare of the community.
• Ensure the association’s activities benefit the community as a whole not individual members.
• Provide benefits that flow to the public rather than to individuals, as established by legal precedents.

 

Additionally, HOAs must conduct activities directed toward benefiting the broader community, not just individual members, to maintain their nonprofit and tax-exempt status.

HOAs must also follow specific operational standards to maintain their nonprofit status. This means maintaining transparency and accountability in their financial dealings.

Application Process for Section 501(c)(4)

To apply for 501(c)(4) status, HOAs must:

• File Form 8976 to notify the IRS of their intention to operate as a social welfare organization.
• Pay a submission fee of $50 at the time of filing.
• After the initial application, commit to filing Form 990, 990-EZ, or 990-N annually to maintain their tax-exempt status.

 

Given the complexity of these requirements, consulting a knowledgeable qualified CPA is highly recommended. A CPA can assist with the initial application process and any audits, ensuring compliance with internal revenue service regulations and preserving tax-exempt status.

Section 501(c)(7) Social Clubs

Section 501(c)(7) offers tax exemption for HOAs primarily existing for recreational purposes. Key points include:

• This section allows HOAs to qualify as social clubs.
• It relaxes some of the public benefit requirements compared to Section 501(c)(4).
• An HOA must primarily exist for the pleasure, recreation, and other non-profitable purposes of its members to qualify under this section.

 

Membership in a Section 501(c)(7) social club is limited to individuals who share common areas of interest. The HOA must ensure its membership criteria align with this tax exemption status, focusing on fostering community and shared recreational activities.

Applying for Section 501(c)(7) Status

Applying for Section 501(c)(7) status is relatively easy. HOAs must file an annual Form 990 to maintain their tax-exempt status. Unlike other sections, there is no formal application process for Section 501(c)(7) status; HOAs must comply with necessary filing requirements to be recognized as a tax-exempt social club.

This status benefits homeowners associations organized for pleasure, recreation, and non-profitable purposes, allowing them to focus on enhancing members’ quality of life through recreational facilities and development without the burden of federal income tax exemption and the received benefits provided, including association property.

IRC Section 528 Quasi-Exemption

In our experience as CPAs, IRC Section 528 is by far the most common status for HOAs. It offers a quasi-exemption for HOAs, with the following key benefits:

• Exempts HOAs from income taxes on dues and assessments used for property maintenance and improvements.
• Focuses on funds collected from members being used primarily for maintaining shared community spaces and services.
• Is more achievable than other tax exemption options.
• Is an alternative to Section 501(c)(4).

 

While many HOAs may qualify for IRC Section 528, a condominium association or condominium management association may have different eligibility requirements or may not qualify, depending on their ownership structure and the private benefits provided to unit owners.

Qualifying for this quasi-exemption requires that the HOA’s income primarily comes from membership dues and assessments used for property-related expenses, including exempt function income. Careful financial management and documentation are required to meet IRS criteria and maintain quasi-exempt status.

Electing IRC Section 528

Homeowners associations must file Form 1120-H annually to elect IRC Section 528. Key points include:

• The form must be submitted by the 15th day of the third month following the end of the tax year.
• Filing Form 1120-H affirms the HOA’s qualification for the quasi-exemption.
• Qualification requires at least 60% of the association’s gross income to come from membership dues and assessments.

 

In addition, 85% of homes must be used for residential purposes.  And, 90% of HOA expenditures must go toward HOA operations.

HOAs must manage their income sources carefully to meet the 60% threshold. Consulting a tax professional can help HOAs navigate these requirements, ensuring compliance and maximizing the benefits of the quasi-exemption under IRC Section 528.

Revenue Rulings and Court Cases Impacting HOA Tax Status

 

Revenue rulings and court cases have played a pivotal role in defining how homeowners associations (HOAs) can achieve and maintain tax exemption under federal income tax law. The Internal Revenue Service (IRS) regularly issues revenue rulings to clarify the requirements for nonprofit organizations, including HOAs, seeking exemption under Section 501(c)(4) of the tax code.

One influential revenue ruling, Rev. Rul. 69-280, determined that a nonprofit organization focused solely on exterior maintenance of homes within a housing development did not qualify as a social welfare organization. The IRS concluded that the benefits provided were primarily for private residences and did not extend to the general public, highlighting the importance of avoiding private benefit when seeking tax-exempt status.

Court cases have further shaped the landscape. In Commissioner v. Lake Forest, Inc., the court looked at a nonprofit membership housing cooperative that provided low-cost housing. The court found that the organization was not eligible for exemption because it was not operated exclusively for social welfare and the benefits provided were directed mainly to its members, not the broader community. This case underscores the need for HOAs to demonstrate a reasonably recognizable relationship with the area they serve and to ensure their activities benefit the community at large, not just property owner members.

Conversely, the case of Rancho Santa Fe Association v. U.S. illustrated circumstances where an HOA could qualify for exemption. The court found that the association, which maintained common areas such as green spaces and sidewalks for the benefit of all residents and the general public, met the requirements for tax exemption under Section 501(c)(4). This decision emphasized the value of maintaining common areas and providing benefits that extend beyond the HOA’s membership, reinforcing the public character of the organization.

The IRS has also clarified its position in Rev. Rul. 74-99, stating that for an HOA to qualify as a tax-exempt social welfare organization, it must serve a community with a recognizable relationship to an area ordinarily identified as governmental. The organization’s activities should not be limited to exterior maintenance of private residences, as this could be seen as providing a private benefit rather than serving the public interest.

For Arizona HOAs, there is an additional opportunity to obtain state franchise tax exemption if the association is already recognized as tax exempt under federal income tax law, such as Section 501(c)(4) or 501(c)(7). To be eligible, the HOA must apply to the Comptroller’s office, demonstrate that it is a nonprofit corporation, and show that it maintains residential properties for the benefit of its members and the community.

These revenue rulings and court cases make it clear that HOAs seeking tax-exempt status must focus on providing community-wide benefits, maintaining common areas, and ensuring their activities are not primarily directed toward private residences. The distinction between public benefit and private benefit is central to qualifying for exemption under Section 501(c)(4). Because the legal and tax landscape is complex and subject to change, it is essential for HOAs to seek professional advice to ensure compliance with both federal and state tax laws.

By understanding the guidance provided by the IRS and the outcomes of key court cases, homeowners associations can better position themselves to qualify for and maintain tax-exempt status, ultimately supporting the long-term health and vibrancy of their communities.

What if an HOA Earns Interest on its Bank Deposits?

 

Homeowners associations often maintain reserve funds and operating accounts in financial institutions, which may earn interest over time. While this interest income might seem like a minor aspect of an HOA’s finances, it can have implications for the association’s tax-exempt status and reporting requirements.

It is important for HOAs to accurately report all interest income on their annual tax filings, such as Form 990 or Form 1120-H, depending on the exemption type. Failure to report interest income properly could lead to penalties or jeopardize the association’s tax-exempt status.

Additionally, HOAs should consider the impact of interest income on their overall revenue thresholds, as excessive unrelated business income may trigger additional tax liabilities. Keeping clear financial records and consulting with tax professionals can help ensure that interest income is handled appropriately in compliance with IRS regulations.

What if an HOA Rents its Club House or Other Spaces to the Public for Events?

When an HOA rents out its clubhouse or other community spaces for public events, it introduces additional considerations regarding its tax-exempt status. While generating rental income can provide valuable funds for the maintenance and improvement of community property, the Internal Revenue Service (IRS) closely examines such activities to determine whether they align with the HOA’s nonprofit purposes.

If the rental income is related to the HOA’s exempt functions—such as maintaining and operating community facilities for the benefit of its members and the community—the income is generally considered exempt function income. This means it typically does not jeopardize the HOA’s tax-exempt status under Section 501(c)(4), 501(c)(7), or IRC Section 528.

However, if the rental activities extend beyond the HOA’s exempt purposes or involve commercial use that primarily benefits private individuals or entities, the IRS may classify the income as unrelated business income. This type of income is subject to taxation and could potentially threaten the HOA’s tax-exempt status if it becomes a substantial part of the association’s activities.

To maintain compliance, HOAs should:

• Ensure rental activities support the community’s general welfare and align with the HOA’s mission.
• Keep detailed records of rental income and expenses, clearly distinguishing exempt function income from unrelated business income.
• Limit the extent and frequency of rentals to avoid the appearance of operating a commercial enterprise.
• Consult with tax professionals to evaluate the impact of rental activities on tax-exempt status and to properly report income on required IRS forms.

 

By managing rental operations and aligning them with their exempt purposes, HOAs can benefit financially while preserving their nonprofit status and continuing to serve their communities effectively.

Examples of Taxable and Non-Taxable Rental Income for an HOA

Understanding the distinction between taxable and non-taxable rental income is crucial for homeowners associations to maintain their tax-exempt status. Rental income can come from various sources, such as leasing out clubhouses, recreational facilities, or other community spaces. However, not all rental income is treated equally under IRS guidelines.

Non-Taxable Rental Income

Rental income is generally considered non-taxable, or exempt function income, when it directly supports the HOA’s exempt purpose. Examples include:

• Renting community facilities to members for social events open to all HOA residents.
• Leasing space for community activities that benefit the association’s members or the broader community.
• Charging fees for the use of recreational facilities that are maintained for the enjoyment of members.

 

This type of income typically aligns with the HOA’s mission and is not subject to federal income tax, as it is part of the association’s exempt function income.

Taxable Rental Income

Conversely, rental income may be taxable if it arises from activities unrelated to the HOA’s exempt purposes or benefits private individuals disproportionately. Examples include:

• Renting clubhouse or other facilities to non-members for commercial events without a clear connection to the HOA’s community welfare goals.
• Renting community facilities for private events where other residents are not included.
• Leasing property for commercial use where the benefits primarily accrue to private parties rather than the community.
• Engaging in rental activities that resemble a business enterprise rather than supporting the HOA’s nonprofit functions.

 

Income from these activities is considered unrelated business income and may be subject to taxation. Excessive unrelated business income can also jeopardize the HOA’s tax-exempt status.

Best Practices for HOAs

To manage rental income effectively and maintain tax-exempt status, HOAs should:

• Clearly document the purpose of rental activities and how the income supports community welfare.
• Be sure that the annual financial statement of the HOA clearly identify taxable rental income.
• Limit rental activities to those that align closely with the HOA’s exempt purposes.
• Keep detailed records distinguishing exempt function income from unrelated business income.
• Consult tax professionals to evaluate rental agreements and income reporting.

 

By adhering to these practices, HOAs can maximize the benefits of rental income while minimizing tax liabilities and compliance risks.

Common Misconceptions About HOA Tax Exemptions

Several common misconceptions about HOA tax exemptions need to be addressed:

• Many homeowners mistakenly believe they can deduct their HOA fees; however, this is typically not possible for primary residences.
• HOA fees can only be deducted if the property is used for rental purposes.
• The fees must relate to maintenance and property management costs to be deductible.

 

Another misconception is that HOAs are automatically exempt from property taxes. Whether an HOA must pay property taxes depends on specific state or local tax laws, and they may still be subject to assessment. HOA fees typically do not include property taxes and are separate from other financial obligations owed by homeowners.

HOAs face challenges in qualifying for tax exemptions, which can limit their operational capabilities. For example, the quasi-exemption under IRC 528 is contingent on meeting specific operational criteria and is not a full tax exemption. The IRS may end up denying exemption if it determines that the HOA has primarily benefitted private individuals rather than the broader community. Understanding these nuances is crucial for HOAs to qualify for exemption and manage their finances effectively.

Get Professional Advice

Navigating tax exemptions and nonprofit status complexities can be overwhelming for any homeowners association. To ensure compliance and maximize benefits, HOAs must get professional advice. Tax professionals and HOA attorneys can help associations understand the intricate requirements of maintaining tax-exempt status and avoid costly mistakes.

Engaging experts with specific expertise in HOA tax matters can significantly reduce risks associated with applying for tax exemptions. These professionals provide valuable guidance throughout the application process and during any subsequent audits, ensuring HOA compliance with IRS regulations. Consulting an HOA attorney is particularly important for HOAs aiming to achieve 501(c)(4) status.

Annual Tax Returns for HOAs

HOAs are required to file a tax return with the IRS every year.  These should be filed on time to stay out of IRS tax trouble.  You are welcome to reach out to the friendly and responsive Tax Department at Massey and Company CPA to have your HOA tax returns professionally prepared.

Conclusion

In summary, homeowners associations have several options to explore when it comes to achieving tax-exempt status. By understanding the criteria and application processes for Section 501(c)(4) social welfare organizations, Section 501(c)(7) social clubs, and IRC Section 528 quasi-exemptions, HOAs can make informed decisions that benefit their communities. Additionally, pursuing state-specific franchise tax exemptions and obtaining nonprofit corporation status can further enhance an HOA’s financial health and operational efficiency. Some exemptions require demonstrating that the association benefits citizens eligible in the broader community, rather than just its members, and applications for state franchise tax exemption may need to be submitted to the comptroller’s office.

The journey to securing these exemptions is complex but beneficial. By seeking professional advice and carefully managing their finances, HOAs can navigate the legal and financial landscape. By taking advantage of these opportunities, HOAs can channel more resources into community projects, foster a stronger sense of community and create a more vibrant and well-maintained neighborhood.

Frequently Asked Questions

Can an HOA qualify as a nonprofit organization?

HOAs can indeed qualify as nonprofit organizations, as they manage community interests without profit motives and serve the benefit of their community. This classification helps in their operations and governance.

What are the main tax exemption options available for HOAs?

The main tax exemption options available for Homeowners Associations (HOAs) include Section 501(c)(4) for social welfare organizations, Section 501(c)(7) for social clubs, and IRC Section 528 for quasi-exemptions. Understanding these options can significantly impact the financial management of an HOA.

Are HOA fees deductible for homeowners?

HOA fees are generally not deductible for primary residences, but they may be deductible for rental properties if they pertain to maintenance and property management costs.

Why is it important for an HOA to seek professional advice?

It is essential for an HOA to seek professional advice to effectively manage tax-exempt status and prevent expensive errors. Expert guidance can ensure compliance and facilitate smoother operations.

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