HOA Taxes & Audit

Warren,

I can't talk about State taxes.
Regarding federal taxes, the Association (regardless of tax exempt status) must file taxes every year.
If you haven't filed a tax return, the audit will disclose that (as they will ask for copies).

For federal taxes, you will likely file form 1120-H. This will exempt all assessment income and you will typically only need to pay taxes on interest earned on your savings account.

First I would like to thank any and all of you folks that reply to this post. Your knowledge and real life experience is very valuable to me.

My best answer to why our Association is self-declaring that it is tax-exempt under IRC 501(c)(4) is that a CPA that the Association contracted with has convinced the Board that the Association qualifies as a Social Welfare Organization. The Board has paid him $9000.00 to submit necessary paperwork to accomplish this. If he is successful he claims the Association will not have to pay approximately $200,000. in 2017 income taxes. The Association sold two manager units and realized a significant gain.

The CPA has obtained an extension of time to file IRS Form 990. That filing is now due on 11/15/2018.

California does not allow this since the Association has no Letter of Determination from the IRS. Consequently the Association paid approximately $48,000. in taxes to the Franchise Tax Board.

I totally disagree with what the Board is doing, however, the Board has taken the position that this CPA is a leading HOA tax expert and they will do whatever he advises them to do.

Did you notify IRS in advance of this? it is required by law to have advance notice. Also do you own common property or a pool that restricts access to members? If so, it clearly states that you would not qualify.

OK. The Association realized a large amount of taxable income from the sale of two condominium units.
Rather then paying 30% on that income and excluding everything else (utilizing IRS 1120-H), the Board hired a CPA to creatively save taxes and file various paperwork and tax forms.

That's great that the IRS hasn't checked into any of those forms (at least per the CPA).

Of course, when they do, the IRS won't go after the CPA. The IRS will go after the Association.

I'm all for saving money. However, I'm not sure this was the right way to do it.

I have forgotten to mention one thing. The Association agreed to have a cell tower placed on the common area many years age. For that the association receives $6,500. per month from three of the primary cell phone companies. That income has always been included in our non-exempt income. And this recently hired CPA claims that is Social Welfare.

Did that truck make a stop here in Southern California?

FOR SURE IT DID. I would also look into your insurance policy on the directors to see if this is going to be covered. Check for Turnip Truck section.

HERE'S WHAT THE IRS SAYS ABOUT 501(C)(4) SOCIAL WELFARE STATUS:

"A membership organization formed by a real estate developer to own and maintain common green areas, streets, and sidewalks and to enforce covenants to preserve the appearance of the development may be exempt as a social welfare organization if it is operated for the benefit of all the residents of the community.

The term community generally refers to a geographical unit recognizable as a governmental subdivision, unit, or district thereof. There is no precise definition of a community. Rather, whether an area is a community depends on the facts and circumstances of the particular situation. Even if an area represented by an association is not a community, the association can still qualify for exemption if its activities benefit a community.

The association should include with its exemption application 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. It also must show that it does not engage in exterior maintenance of private homes.

A homeowners’ association that is not exempt under section 501(c)(4) and that is a condominium management association, a residential real estate management association, or a timeshare association generally may elect under the provisions of Code section 528 to receive certain tax benefits that, in effect, permit it to exclude its exempt function income from its gross income."

BEFORE YOU GIVE THIS CPA ONE CENT, I WOULD HAVE HIM PROVIDE YOU A WRITTEN PROPOSAL ABOUT HOW HE PLANS TO PLEAD FOR THIS KIND OF STATUS FOR YOUR HOA AND THE RATIONALE FOR THE PLEA.

YOU SEEM TO HAVE A LOT OF UNRELATED INCOME COMING IN. TAXES MUST BE PAID ON THAT. THERE MUST BE ANOTHER CONDO NEAR YOU THAT IS SIMILAR TO YOUR FINANCIAL PICTURE. APPROACH THEM FOR A REFERRAL FOR SOMEONE WHO IS VERY EXPERIENCED IN HOA ISSUES.

Why not make the cpa responsible if you are audited by the irs? Think that can be done. Seen it on some tax documents those who represent is held responsible for the results. That way somewhatprotected or they quit.

Good questions and advice Ben. The finance committee, of which I am a member, did get advice from another CPA. She advised against self-declaring tax exemption under IRC 501(c)(4).
The Association's long time employed previous CPA did not approve of the effort and would not participate. He maintains that we must file either IRS Form 1120-H or 1120. I personally contacted the IRS Exempt Organization. Based on the information I provided, they were of the definite opinion that our Association did not qualify as a IRC 501(c)(4) organization. However, they are only able to take action after a Form 990 or Form 1024 is filed. Our CPA has obtained a 6 month extension to due so, now due 11/15/2018.

Our current CPA claims that the IRS is often incorrect and that I am not qualified to interpret the complexity of the situation. He may be correct. I am hoping that someone using this blog might have direct experience with an issue like this. Is there any one out there whose HOA is tax-exempt under IRC 501(c)(4)?

1.
The linchpin of the CPA's argument is that the cell phone tower on the condominium's common area qualifies the condominium as a "social welfare organization." In consequence, the CPA claims the condominium falls under 501(c)(4). The following from Page I-9 of https://www.irs.gov/pub/irs-tege/eotopici03.pdf appears to be relevant:

"... [A]n antenna service that provides signals to any television receiver in the community is exempt under IRC 501(c)(4) since it benefits the community as a whole rather than just the members. Rev. Rul. 62-167, 1962-2 C.B. 142."

But Revenue Ruling 62-167 (https://www.irs.gov/pub/irs-tege/rr62-167.pdf) is clear that the organization's purpose must be solely to provide television reception. To qualify as a 501(c)(4) social welfare organization, the organization must /primarily/ serve the public. From page I-3:

"Organizations that promote social welfare should primarily promote the common good and general welfare of the people of the community as a whole. An organization that primarily benefits a private group of citizens cannot qualify for IRC 501(c)(4) exempt status."

I think this CPA is wrong to disregard the main purpose of the condominium. The main purpose is to serve only the condo's members.

2.
Else here are just a few citations for why a condominium will not qualify as a 501(c)(4) organization:

-- IRS Revenue Ruling 74-17 is cited time and again as the reason why condominiums do not qualify as 501(c)(4) organizations. See https://www.irs.gov/pub/irs-tege/rr74-017.pdf

-- Also from https://www.irs.gov/pub/irs-tege/eotopici03.pdf (starting on page I-12): [To qualify as an IRC 501(c)(4) organization], "a homeowners' association must primarily serve the community rather than the private interests of its members. Therefore, the principal obstacle to exemption is the degree of private benefit involved in the operation of the homeowners' association." To "serve the community," it appears to me that the HOA's amenities (such as common areas, pool, parking et cetera) must be open regularly to the general public. Where the amenities provide a private benefit to owners, the HOA or condominium will not qualify as exempt under 501(c)(4).

-- From https://www.irs.gov/irm/part7/irm_07-025-004 :
A condominium owner’s association that maintains areas owned by the unit holders does not qualify for exemption under IRC 501(c)(4) since such an organization primarily serves private interests. See Rev. Rul. 74–17, 1974–1 C.B. 130.

3.
Five of the seven directors on WarrenT's board want to do as this CPA advises. The Board majority, on behalf of the HOA, has already gone forward, to the tune of several thousand dollars, to implement the CPA's plan. WarrenT does not have the numbers to stop this legal disaster. But he should get on record. If I were Warren, I would prepare a handout with the citations above, and then make the following motions: (a) to instruct the CPA to cease seeking 501(c)(4) status; and (b) to seek a refund from the CPA via a strongly worded letter from the HOA attorney. Read the handout aloud and ask that it be attached to the Minutes.

I believe WarrenT will be voted down. Once he is voted down, he must get comfortable with the fallout from this board's actions. I would try to calmly make it clear to members what a mistake this is and quietly lobby for the election of more savvy board members. At some point, ponder reporting this CPA to the oversight agency in California for CPAs, http://www.dca.ca.gov/cba/consumers/complain-cpa.shtml . I am not sure such a report is a good idea, but I know I would be studying the professional rules for CPAs. If the board ever agrees, submit the latter to the HOA attorney as well. It might be something to use in a letter from the HOA attorney to the CPA.

4.
Another alternative is for a member of the HOA, as an individual, to write the CPA; bring the above to his attention; and hear out the CPA's response. If the response is garbage, consider sending a demand letter to the CPA along with reporting the CPA to the California Board of Accountancy. The Board and CPA may very well pillory this member at meetings. But when the truth is on one's side, and when one stays calm and rational and ready to accept that one does not have the numbers, it is easier to withstand such an attack.

It appears the CPA is indicating that there is nothing wrong with asking for 501(c)(4) status, since the worst that will happen is that a $5000 fine will be imposed. Also Bill above indicates that a conversation with an IRS staffer is likely to happen before 501(c)(4) status is granted. The latter is reassuring. The Risk vs. Benefit analysis appears to be:

Risk = at most, lose $5000.

Benefit = save about $200,000 in HOA income taxes.

It sounds sleazy, and let's face it, it is sleazy. But I believe the IRS is backed up. Reports are that federal government budget cuts have resulted in the elimination of many IRS enforcement positions.For example, see https://www.usatoday.com/story/money/2017/11/06/irs-chief-more-budget-cuts-could-catastrophic-disrupting-tax-processing-refunds/837325001/

Should the plan I proposed above be undertaken? Or should this CPA be allowed to go forward, unobstructed? I think the CPA is "technically" wrong on the law. But what is a good CPA for but to find loopholes? The loophole here being the IRS may not have the staff to fight the CPA and condominium on this.

Oh dear. What to do. There is an argument that a volunteer director follow the best advice of professionals. There is another argument that a volunteer director seek to maximize the income to a HOA using legal means. Assuming the above about the fine is true, and given this dog-eat-dog world, I think I would quietly support the CPA's effort, and adopt a wait-and-see approach. Maybe ask for all documentation of the conversations (by phone, email or snail mail) the CPA has with the IRS.

Your board sounds more like a board of "investors" with that kind of mindset. They don't seem to get the concept of what a HOA is. I get this because of the HOA purchasing and selling of homes. (Now trying to get out of the taxes of it). Plus allowing to be paid to put a cell tower in. These are things a HOA should never do as they have to pay the piper.

Somehow your going to have to change the mindset here of "investing" and/or "Home values" mentality. The HOA typically is set up as a "non-profit" corporation. It's to collect as much money as it needs to spend. Anything above that is "Profit" and subject to taxations. Gathering more money doesn't equate to better home values. Just more money in the bank to help cover expenses or emergencies the HOA may have.

It doesn't sound like your board gets this concept by their profit making adventures or hiring of this CPA. This all should have stopped at the purchasing of the homes or allowing of the cell tower. Time to get together and vote the board off. In time, you all have more to worry about than an audit. Their profit making mentality going to do more damage than good.

Now keep in mind I am not totally saying a HOA/COA shouldn't rent or sell a property if they own it. I would avoid it at all cost in the first place but there are those situations that it can make sense. Those properties that no money is owed to bank/taxes and in good shape. Plus the HOA can afford to pay the HOA dues, insurance, mortgage payments, taxes, maintenance, repairs, and other home owning expenses. Yes the HOA should be paying it's HOA dues on property it owns. The HOA acts as a good landlord with a lease that has the caveat the renters obey the HOA rules. The rental income is enough to cover it's expenses of ownership. Basically making the home a non-profit situation till it is able to be sold. Which if the HOA does straight out sell a property, then they should pay the Realtor fees, taxes, and put the profit into the HOA budget. (Maybe reserves or pay for a big project).

The situation here is that the HOA is NOT wanting to be responsible and pay up. They are hiring a scrupulous CPA in order to avoid paying the proper sales associated cost like taxes on the profit. Now that is wrong and is of the wrong mindset. It tells me the HOA doesn't get their place or how to run a HOA. They are wanting to use it as investing gains. Which is never the purpose of a HOA. It's a "sales tool" for the developer and once turned over a "Club" of homeowners. The purpose of the club is to keep itself funded properly to meet it's needs.

As for the Cell Tower agreement... That is NOT the way to attract potential buyers. The complete opposite of what a HOA is to do. I would NOT want my house sitting that close to a Cell tower. They are pretty ugly and who knows what health dangers we will find out later. We have a neighborhood down the road with some nice houses. The problem? It's entirely built under High Voltage lines! Those giant towers run right down the street! No one wants to buy them and their property has a hard time selling.

So does the "profit" of the cell tower outweigh the attractiveness of bringing in new owners? Or waiting longer to sell? How do Realtors explain that big ugly metal tower as a new metal tree art sculpture that may or may not cause cancer?

And that is the bottom line.

Have not read the article on preparing for an HOA audit, but will soon. Thanks all for your input. We held a members meeting yesterday evening. The possibility of avoiding approximately $200,000. in taxes was judged by the majority of those who attended to be worth the approximately $20,000. it is costing the Association. Knowing what I think I know, these are very poor odds.

I have spend considerable time and a small amount of money, approximately $150.00, in an attempt to convince the Board and members of the community that self-declaring IRC 501(c)(4) tax-exemption is a bad idea. I failed to do so. The best thing that could happen is that I was wrong. The problem is that it will take at least two years before the IRS rules on this issue. There will be new Board members by then and little or no corporate memory of what transpired. The positive take away is that there are folks like you who offer the benefit of their knowledge and experience.