Income Tax regarding Right of Way/Non member income

Hoping someone on here has experience with a situation like ours. I am finding it difficult to get an exact answer from a CPA as many don't have experience with HOA's.

I am a bookkeeper by trade and have been filing an 1120H for years with no issue.

There is a right of way on our association property for the abutting lot owner to access his land via our private roads. While not legally enforceable, he has agreed to pay us a portion of dues to help pay for road maintenance and plowing.

My question is whether the dues he pays are considered exempt function or not. The instructions on form 1120H say "Income that is not exempt function income includes:.. ....payments from nonmembers..." I understand in situations where HOA's generate revenue from renting out their clubhouse, etc and why that would be subject to taxes. But while the abutting lot owner is not a member of the HOA, the funds we receive from him are specifically used for shared road repair, maintenance, and plowing expenses as he has equal use of the roads due to the right of way. He isn't a member to have access to all use of HOA property. This isn't a revenue stream for us so I don't see why it shouldn't be considered exempt function income.

Do we need to pay tax on his portion of dues?

First, I understand your point. However the IRC and CFRs seem clear that this non-member income is non-exempt function income. See for example https://www.law.cornell.edu/cfr/text/26/1.528-9.

On the other hand, I also think that a portion of the costs to maintain these private roads may be taken as a non-exempt function expense. Consider this from https://overnightaccountant.com/blog/article/how-to-determine-your-hoas-1120-h-exempt-function-expense-percentage:

This section of the code has been interpreted to mean that associations must allocate a reasonable amount of expenses related to the production of nonexempt income to nonexempt expenditures. The benefit of this allocation requirement is that it allows associations to reduce their tax burden by offsetting taxable, nonexempt function income with expenses related to generating that income. The downside, however, is that the allocation will impact the 90% exempt function expense calculation.

As a simple example, assume an HOA brings in $40,000 in member dues and assessments. The HOA also has a clubhouse that is open to members at no additional charge but also generates $10,000 in rental fees. The clubhouse is rented 20% of the time it is open during the year. Repair and maintenance of the clubhouse costs $5,000 for the year. A reasonable allocation of these shared costs would be 20% of $5,000 or $1,000. Assume further that this HOA pays a firm $2,500 during the tax year to market and manage rental of the clubhouse. Since all of these costs are related to generating rental income, 100% of the $2,500 would be nonexempt expenditures. In this example, the $1,000 of the maintenance cost and all $2,500 of the marketing fees would be nonexempt function expenses, totaling $3,500.

This means the non-exempt expense might cancel out the non-exempt income. The end result might be no tax.

Do you mean "excludable," as in not counted as part of the gross income reported on Form 1120-H, lines 1-7, pursuant to 26 USC 118? I do not know.

Ah-ha...light bulb!

If it is excludable on line 7, then I don't need to deduct on line 15.

So instead of:
7 - Other Income - $800
10 - Repairs Deduction - $600 (Plowing)
15 - Other Deduction - $200 (Reserve Fund allocation for road paving in a couple years)

It would be:
7 - Other Income - $600
10 - Repairs Deduction - $600 (Plowing)

I will track the reserve fund and when the expense actually occurs for repaving and reserve funds are used, I will include the income to gross income at that point and deduct accordingly.

You have helped me tremendously! Thank you so much!