Federal Form 1120-H: Instructions and Requirements
Clarifies the annual election to file Form 1120-H, detailing how it isolates and taxes an HOA's non-membership income at a specific flat rate.
Form 1120-H, U.S. Income Tax Return for Homeowners Associations, is a specialized tax form available to certain organizations, including condominium management, residential real estate, and timeshare associations. Filing this form is an annual election that allows an association to separate its exempt-function income, such as member dues, from its non-exempt income, like interest earned on bank accounts. This can result in a more favorable tax outcome compared to filing the standard corporate income tax form.
Qualification Requirements for Filing
To be eligible to file Form 1120-H, a homeowners association must satisfy a series of specific tests outlined by the Internal Revenue Service (IRS). The first is an organizational and operational test, which requires the association to be organized and run for the purpose of acquiring, building, managing, and maintaining its property.
The 60% source of income test mandates that a minimum of 60% of the association’s gross income for the tax year must come from exempt-function income. This category primarily includes membership dues, fees, and assessments collected from the property owners who are members of the association.
Complementing the income test is the 90% expenditure test. This requirement stipulates that at least 90% of the association’s spending for the year must be for qualifying expenditures. These are expenses related to the acquisition, construction, management, maintenance, and care of the association’s property. Examples include costs for landscaping, security services, and repairs to common areas.
Finally, the association must meet a residential test. This test requires that substantially all of the units within the association are used as residences.
Calculating Taxable Income and Tax
When an association elects to file Form 1120-H, it is taxed only on its nonexempt function income. Common examples include interest earned on checking or savings accounts, dividends from investments, fees paid by the general public for use of association facilities, and revenue from on-site amenities such as vending machines.
From this nonexempt function income, the association can subtract expenses directly connected with generating that income. For instance, if the association rents out its clubhouse, the costs for cleaning and utilities for that event could be deducted. After subtracting these direct expenses, the IRS allows for a specific $100 deduction. General operating expenses, such as landscaping or routine maintenance funded by member dues, are not deductible against this income.
The resulting figure, known as homeowners association taxable income, is then subject to a flat tax rate of 30%. This flat tax is applied regardless of the total amount of taxable income, simplifying the calculation compared to the tiered rates often found in other types of tax returns.
To illustrate, consider an association that earned $2,500 in interest and received $500 from renting its community hall to non-members, with associated cleaning costs of $150. The total nonexempt income is $3,000. After subtracting the $150 in direct expenses and the specific $100 deduction, the taxable income is $2,750. The tax liability is calculated as $2,750 multiplied by 30%, resulting in a total tax of $825.
Information and Documentation for Form 1120-H
Before filling out Form 1120-H, an association must gather its Employer Identification Number (EIN). Complete and accurate financial statements for the tax year, including a balance sheet and an income and expense statement, are also necessary.
A detailed breakdown of all income sources is needed to properly separate exempt-function income from nonexempt function income. Similarly, a detailed list of all expenditures must be compiled to verify that the association meets the 90% expenditure test.
The current version of Form 1120-H and its accompanying instructions can be downloaded from the IRS website. Once the financial data has been organized, it can be transferred to the appropriate lines on the form.
Filing the Form 1120-H
For associations operating on a calendar year, the due date is the 15th day of the 4th month following the end of the tax year, which is typically April 15th. Associations using a different fiscal year must file by the 15th day of the 4th month after their year-end.
If an association needs more time to file, it can request an automatic six-month extension by filing Form 7004 on or before the original due date. An extension to file is not an extension to pay. Any tax estimated to be due must still be paid by the original deadline to avoid penalties and interest.
The completed Form 1120-H must be mailed to the IRS service center designated in the form’s instructions; the specific address can depend on the association’s location and total assets. Many associations may also have the option to file Form 1120-H electronically. After filing, the association should keep a copy of the return for its records.