IRS allowed association expenditures

First, the IRS does NOT specify what an HOA can and can't spend. The IRS simply does not regulate HOAs at all. Now what is the case is that an HOA may (or may not) have two options for filing their taxes.

In some cases they may file a special form for income taxes which is very advantageous. While it requires a straight 30% tax rate HOAs can often shelter most if not all of their income from being taxed. They may also file as a corporation and pay a variable rate depending on the amount of their income.

Now it may be that some of your expenses could cause you to lose the advantages of filing as an HOA. But the IRS does not state where the organization may spend its money.

Justine,

When an HOA chooses to file the HOA specific tax form 1120H, the IRS places some stipulations on reported income and expenses. "At least 60% of the assn's gross income for the tax year must consist of exempt function income. At least 90% of the assn's expenses for the tax year must consist of expenses to acquire, build, manage, maintain or care for its property," So, if the expenses incurred to maintain the wellness center, fitness classes and cafe exceed 10% of the assn's total operating expenses then your assn has met these IRS guidelines. Only timeshare assn's can include expenses for these type services and still meet the guidelines. If the guidelines cannot be met then the assn may be required to file the corp form, 1120. Do you know which form your assn is using to file federal taxes?

I don't know who the attorney is who is making these claims; however, I would certainly be asking the assn's CPA a few questions. Among them, would it be beneficial to your assn to apply for tax-exempt status and are these services causing the assn to pay more in federal taxes. Are these services available to the general public or only to members of the assn? This may have a bearing on whether or not you may be able to qualify for tax-exempt status.

We have been filing the 1120H tax return. Regarding the 10%, does that mean the net loss of the Cafe or the entire amount spent to operate it. If I can use the net loss number, we are o.k., but if I have to use the gross loss, we are definitely over. So, if I understand correctly, we would just change our tax return to the 1120 and the 10% rule goes away?

Justine,

Net profit or loss doesn't enter into it. What you have to look at is the actual expenses incurred to run the cafe,wellness center and fitness classes. If the amount is greater than 10% of the total expenses (all expense accounts including those 3)then I don't believe the assn qualifies to use the 1120H tax form. And, yes, the 10% rule only applies to the 1120H.

When using the 1120H, 60% of the assn's gross income must consist of exempt function income which are the assessments collected during the tax year. Some examples of non-function income are: interest earned on reserve accounts and payments from nonmembers for use of assn facilities. The monies in the reserve fund are not taxed.

Only the earned interest.