The Board of a community association wants to know if the Association should become a 501(c)(3) tax-exempt non-profit corporation. What Happens Now?

To qualify for tax-exempt status under Internal Revenue Code (“IRC” or “Code”) 501(c)(3), a homeowners’ association must show that it serves the following functions: religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. Since homeowners’ associations typically do not serve any of these functions, they do not qualify for charitable tax-exempt status. They do, however, fall within requirements of other sections of the Code such as IRC 501(c)(4) and 528.

IRC 501(c)(4) provides a strict standard for a homeowners’ association to qualify for tax-exemption status. Under IRC 501(c)(4) a homeowners’ association must operate for the benefit of the general public, i.e., it must provide a community benefit at large, and not merely serve to benefit only the owners and occupants who live in the Association.

In order to qualify for exemption under IRC 501(c)(4), homeowners’ associations must overcome the presumption that they are essentially and primarily formed and operated for the benefit of their members. This can be done by showing that the Association is primarily formed and operated for the benefit of the community at large. A homeowners’ association may impose reasonable restrictions on the use and enjoyment of a small portion of its overall common area or facilities and still qualify for exemption under IRC 501(c)(4). As alternatives to exemption under IRC 501(c)(4), a homeowners’ association may elect to seek exemption under IRC 528.

IRC 528. IRC 528 may be a more attractive alternative because it exempts from income tax any dues or assessments received by “qualified” homeowners’ associations from its members, where these dues and assessments are used for the maintenance and improvement of Association property. Since most Associations do not receive income or support from any source other than its members, this may be a good option. To be considered a “qualified” homeowners’ association under IRC 528, the Association must 1. be organized to operate, manage and maintain Association property; 2. none of its income may benefit a private shareholder or individual; 3., 60% or more of Association income comes from assessments collected from its owners; and, 4. 90% or more of its expenses are used for the management, maintenance and care of Association property.

If the Association meets these requirements (which most do) IRC 528 may be a good option to explore for a reduced tax status. IRC 528(b) has recently been amended to provide for a 30% tax on homeowners’ associations exempt under IRC 528, thus lowering their tax rate. This makes exemption under this section more attractive. Associations interested in this should contact their attorney or CPA.