IRC 528: Tax Rules for Homeowners Associations Explained

Homeowners associations (HOAs) manage residential communities, maintain common areas, and enforce neighborhood rules. While they collect fees from homeowners to fund operations, their tax obligations can be complex. The IRS provides guidelines under Internal Revenue Code (IRC) Section 528, which grants certain HOAs favorable tax treatment if they meet specific criteria.

Qualifying Organizations

To qualify under IRC Section 528, an HOA must primarily manage and maintain residential property. This includes condominium management associations, residential real estate management associations, and timeshare associations.

The HOA must be structured as a corporation, trust, or unincorporated association—partnerships and sole proprietorships do not qualify. At least 60% of its gross income must come from membership dues, fees, or assessments paid by homeowners. Additionally, at least 90% of its expenditures must go toward acquiring, constructing, managing, maintaining, or caring for association property. Excessive spending on unrelated activities can jeopardize its eligibility.

Tax-Exempt and Nonexempt Functions

Qualifying under IRC Section 528 provides tax benefits, but not all HOA income is exempt. The IRS distinguishes between exempt function income and nonexempt function income.

Exempt function income includes dues and assessments collected for maintenance, repairs, and administrative costs. These funds, used for the upkeep of shared property, are not taxable. For example, if an HOA collects fees for landscaping and security, this revenue remains tax-exempt.

Nonexempt function income comes from activities unrelated to property management, such as renting clubhouse facilities to non-members, selling advertising space, or earning investment income. The IRS taxes this income at a flat 30% rate. If an HOA earns $10,000 from nonexempt sources, it would owe $3,000 in federal taxes.

Filing Requirements

HOAs qualifying under IRC Section 528 must file an annual tax return using Form 1120-H. This form ensures only nonexempt function income is taxed.

Accurate categorization of revenue and expenditures is essential. Misclassifying income can lead to IRS scrutiny, and financial records must align with reported figures to avoid audits or penalties. The IRS imposes a 30% tax rate on nonexempt income, making precise record-keeping crucial.

Form 1120-H is due by the 15th day of the fourth month after the end of the association’s tax year, typically April 15 for calendar-year HOAs. Late filings can result in penalties and interest charges. If more time is needed, an HOA can request a six-month extension by filing Form 7004 before the original deadline.

Activities That May Affect Status

Maintaining tax-exempt status requires careful financial and operational management. One risk is improper reserve fund handling. While HOAs set aside reserves for future repairs, excessive accumulation without a clear purpose may attract IRS scrutiny. If reserves generate significant investment income that is not reinvested into property maintenance, the HOA could lose its status and face taxation under IRC Section 277.

Another risk arises when an HOA delegates too much authority to a third-party management company, particularly in financial decision-making. If the board of directors loses control over operations, the HOA may no longer qualify as a self-governing entity established for homeowners’ benefit, potentially jeopardizing its IRS status.