What Are 1120-H Deductible Expenses?
For HOAs using Form 1120-H, properly classifying income is essential for identifying allowable deductions and correctly calculating your tax liability.
Form 1120-H, the U.S. Income Tax Return for Homeowners Associations, is a specific IRS form for qualifying HOAs, condominium associations, and timeshare associations. Its purpose is to allow these organizations to separate their income and expenses into two categories, which determines what portion of their income is subject to federal income tax.
Understanding Exempt Function Income and Expenses
The structure of Form 1120-H is built around “exempt function” activities. Exempt function income is the money an HOA collects for its core purpose of managing, maintaining, and caring for association property. This category includes membership dues, fees, and assessments from homeowners, which the IRS does not tax when an HOA files Form 1120-H.
Consequently, expenses paid for using this exempt function income are referred to as exempt function expenses. These cover costs like landscaping, security services, swimming pool upkeep, and general repairs to shared facilities. These expenditures are netted against the non-taxable income and have no impact on the final tax calculation.
To qualify to file Form 1120-H, an association must meet specific criteria. At least 60% of its gross income must be exempt function income, and 90% of its expenditures must be for the acquisition, construction, management, and care of its property. Additionally, at least 85% of the units must be used for residential purposes.
Identifying Deductible Expenses Against Non-Exempt Income
Deductions on Form 1120-H apply to expenses incurred to generate non-exempt function income. This is income from sources other than member dues, such as interest earned on bank accounts or revenue from renting a clubhouse to outside parties. This income is taxable, but the association can deduct expenses directly associated with generating it.
Direct expenses are a straightforward type of deduction. If an HOA pays a bank service fee on an interest-bearing account, that fee is deductible. Similarly, if the association pays for advertising to rent its facilities to non-members, those advertising costs are deductible against the rental income.
Associations can also deduct a portion of indirect expenses, which are costs that benefit the entire association but can be partially allocated to non-exempt activities. Examples include a percentage of management company fees, insurance premiums, utility costs for rented common areas, and professional fees for accountants or attorneys.
The allocation method must be reasonable and consistently applied. An association might base the allocation on the percentage of revenue, square footage, or time spent on the non-exempt activity. Maintaining clear records that justify the allocation is important in case of an IRS inquiry.
The Specific $100 Deduction and Tax Calculation
Filing Form 1120-H allows for a special $100 deduction. This flat amount is claimed in addition to other deductions for expenses related to generating non-exempt income, regardless of actual expenses.
To calculate the final tax liability, an association first totals its non-exempt function income. From this total, it subtracts all allowable deductions, including direct and allocated indirect expenses. After subtracting these operational expenses, the association then subtracts the specific $100 deduction to arrive at its final taxable income.
Once taxable income is determined, a flat tax rate is applied. For homeowners and condominium associations, this rate is 30%, while for timeshare associations, it is 32%. This rate applies to all taxable income, including ordinary income and net capital gains. For example, if an HOA has $2,000 in non-exempt income and $500 in related deductions, its taxable income is $1,400 ($2,000 – $500 – $100), resulting in a tax liability of $420 ($1,400 x 30%).
Reporting Expenses on Form 1120-H
Form 1120-H is structured for clear reporting. Lines 1 through 5 are used to report non-exempt function income, such as interest, dividends, and gross rents. The sum of these amounts is entered as total gross income on line 6.
Following the income section, the form provides lines for deductions. Lines 7 through 15 are for itemizing expenses incurred to produce non-exempt income, such as salaries, repairs, rents, and depreciation. The total of these itemized deductions is entered on line 16.
The final tax computation takes place on lines 17 through 21. The filer subtracts total deductions (line 16) from total income (line 6). The specific $100 deduction is then subtracted on line 18 to arrive at the taxable income on line 19, with the final tax entered on line 20.