This site provides information regarding tax exempt homeowners associations. We hope that you will find the information on this site helpful in understanding the differences between the various Internal Revenue Code (IRC) Sections under which an association may qualify for tax exemption. This site is not a discussion of associations that are exempt under IRC Section 528 simply by virtue of filing Form 1120-H, but deals with associations that are exempt under IRC Sections 501(c)(4) and 501(c)(7).
Homeowners associatons that qualify as exempt organizations under IRC Section 501(c)(4) are completely exempt from income taxes, except for any unrelated business activities. Associations that qualify under IRC Section 501(c)(7) are exempt on member activities, but pay taxes on net income from nonmember activities and investment earnings.
This site is maintained by Gary Porter, CPA, who has more than twenty years of experience with homeowners association taxation, and has provided tax exemption services for more than 60 homeowners associations.
Background information on tax exempt Homeowners Associations
IRC Section 501 was established by congress to provide a taxing scheme for non profit organizations. Two specific subsections of IRC Section 501 that can potentially apply to homeowners associations are Sections 501(c)(4) and 501(c)(7).
IRC Section 501(c)(4) deals with “Social Welfare” organizations that serve a public benefit. Few homeowners associations will qualify under this section, but for those that do, the tax savings can be substantial. While the benefits of this section are generous, the qualification criteria are very stringent. The tax savings for most associations comes from the fact that interest income earned by an association exempt under this section is not taxable income. In addition, in some states, tax exempt associations become exempt from state sales tax. For those associations, the sales tax savings can be even larger than the income tax savings. Associations exempt under this section file Form 990 and are relieved of the tax risks associated with filing Form 1120.
IRC Section 501(c)(7) deals with “Recreational” organizations. The primary type of organization that qualifies for exemption under this section is a country club. Again, very few homeowners associations will qualify for exemption under this section because of the stringent qualification requirements. Contrasted to IRC Section 501(c)(4), associations exempt under IRC Section 501(c)(7) are not completely tax exempt. They will pay taxes on their interest income, and on most net non member income. Associations exempt under this section file Form 990 and are relieved of the tax risks associated with filing Form 1120.
Applicable tax law
In addition to the basic Code section, there are numerous other citations that MUST be considered by any association that is contemplating applying for tax exemption. The most important of these citations are listed on the attached sheet (Tax Citations).
In addition, there are dozens of other citations that apply; Revenue Rulings, Court cases, Private Letter Rulings, General Counsel Memoranda, Revenue Procedures, and Technical Advice Memoranda. The preparer of the exemption application must possess a working knowledge of these rulings in order to safely prepare the application.
The most important of the above rulings is Treasury Regulation 1.337(d)-4. This regulation is unknown to many tax practitioners that attempt to prepare exemption applications, because the subject matter is corporate reorganizations. However, changing a corporation from taxable to tax exempt is considered a corporate reorganization, so the Regulation applies. The impact of this Regulation can be devastating to an association, because the Regulation essentially applies a transfer tax on taxable corporations that become tax exempt. The tax is based on the excess of the fair market value of the assets transferred (say, a golf course), over their tax basis. Since most association common area assets will have no tax basis, the fair market value equals the taxable gain. In the case of a $10,000,000 golf course, the full amount would be taxable, and at the maximum corporate tax rates.
Our experience, and a private letter ruling to the IRS (withdrawn once we got the answer we wanted, so it is not published) has allowed us to determine a SAFE way to avoid the potential negative impact of Treasury Regulation 1.337(d)-4.
If the tax preparer who is preparing your exemption application is unaware of Treasury Regulation 1.337(d)-4, or does not know how to safely navigate around its negative provisions, you are taking an enormous risk by filing your tax exemption application.
Our firm has been hired in several instances to “fix” defective applications prepared by others. We have also successfully gained tax exemption where other CPAs and even tax lawyers have tried and failed. That simply makes the process more expensive for the association. We have also been successful in regaining tax exempt status after it has been revoked by the IRS as a result of an audit. Having the right professional representation when you’re undergoing an IRS audit is very important.
Articles about tax exempt homeowners associations
1) Tax Exempt Homeowners Associations – the Complete Guide
2) Regulation 1.337(d)-4 – Closing the Door on Tax Exempt Homeowners Associations
3) CAI Victory in Amending Proposed regulation 1.337(d)-4
4) IRC Section 501(c)(4) and Gated Associations
Ask the Expert
If you think your association may qualify for tax exemption, but you’re not really sure, please call Gary Porter at 805-433-6022 for 30 minute free, no obligation, consultation. Gary Porter has successfully completed more than 100 exemption applications for homeowners associations, including more than 20 gated associations. Once we have reviewed your data and said “it’s a go,” we have a 100% success rate (so far) in gaining tax exemption for the associations for which we have filed applications. Cumulative tax savings for our association clients exceeds $22,000,000 to date.
Please contact Gary Porter for your association tax exemption services. We serve associations nationwide.
Background information on Gary Porter, CPA
Gary Porter, CPA is licensed by the California Board of Accountancy and the Nevada Board of Accountancy. His CPA practice is limited to Common Interest Realty Associations, including homeowners associations, condominium associations, timeshare associations, fractional ownership associations, and condo hotel associations. Mr. Porter is the co-author of the PPC (Practitioners Publishing Company) Guide to Homeowners Associations and Other Common Interest Realty Associations, and Homeowners Association Tax Library. He is also the author of more than 300 published articles on financial matters related to homeowners associations. He has been working with homeowners associations since 1976.