TAX EXEMPTION FOR HOMEOWNERS ASSOCIATIONS
- Consider the Money From Becoming Tax-Exempt-
The Internal Revenue Code sub-section that applies is: 501(c)(4). It refers to “Social Welfare Organizations". Generally, the IRS sees “Social Welfare Organizations" as similar to charities under sub-section 501(c)(3) with the difference that private support is allowed. The IRS says to get tax-exempt status a homeowners association should show that it is operated for the benefit of all the residents of the community. Numerous homeowners associations in the Houston area have shown they are qualified. Tax-exempt status means getting tax savings. For an association spending $100,000 on services subject to state sales tax, the annual savings will be at least $8,000. For more savings, look at the federal tax return the association files. Business Reasons to be Tax-exempt In addition to the future tax savings, reasons homeowners associations become tax exempt under sub-section 501(c)(4) include: 1.) the right to claim refunds of state taxes paid within the relevant period of limitations, and 2.) permanent negligence tort liability relief under state law when an organization is recognized as tax-exempt under sub-section 501(c)(4). For relief from damage claims for negligence the relevant statute is Texas Civil Practice & Remedies Code § 84.007. When the requirements are met, then liability is limited to the amount of insurance the association already has. The basic requirement is that the policy limits be at least $500,000 for each person and $1,000,000 for each single occurrence of personal injury and $100,000 for occurrence of property damage. In the alternative, a $1,000,000 single limit policy will be sufficient. IRS Requirements to Qualify The IRS says to get tax-exempt status a homeowners association should show that it is operated for the benefit of all the residents of the community. Also, IRS will inquire about the organization and operation for the common good and general welfare of the people of the community as a unit ordinarily identified as a governmental subdivision. The IRS has made it clear that private benefit is permitted. The IRS has made it clear by examples in the Revenue Rulings and acquiescences in Tax Court cases that associations carrying on the same activities as the usual ordinary community association are not conducting themselves for private enrichment and receive the recognition of sub-section 501(c)(4) status. The association should be prepared for the IRS to ask questions about the recreational facilities. Access to recreational facilities is part of what the IRS considers when deciding about qualification for tax exemption under Code sub-section 501(c)(4). The IRS has a history of concern about communities that limit access to only members and guests of members. The IRS will usually ask for information about how members of the general public can access your recreational facilities. The general public is probably already using your facilities because you are allowing that access, so you only need to have a written policy for that. There are several ways to assure there is worthwhile access for your community association. For example, the IRS has approved charging a fee imposed on non-members if they want to use recreational facilities. Restrictions and separate closed areas are permitted. For example there is an IRS Private Letter Ruling that stated: “The general public is permitted to utilize X’s common areas and facilities except for some restrictions to its community centers, swimming pools and tennis courts. Based on the circumstances in this case we feel that X meets the requirements of Rev. Rul. 74-99 and 80-63. Limited non-public access should not be fatal to section 501(c)(4) exemption when considered in relation to the overall activities and services provided by X vis-a-vis the public-at-large and the community which it serves." In Revenue Rulings the IRS states it is appropriate to recognize tax-exempt status for an association performing functions local government is traditionally concerned with, including recreational facilities. When the community association does undertake to do such a function it overcomes the presumption that it is organized and operated primarily for the benefit of members and it will qualify for exemption under sub-section 501(c)(4) of the Internal Revenue Code. Another approach is that a recreational facility can be spun-off into a separate organization. As a separate club, a recreational facility may be qualified for exemption under sub-section 501(c)(7).
Process and Procedure Even though an association considers itself within the rules for tax-exempt status, it can file with the IRS an Application for Recognition of Exemption (IRS Form 1024) to get a formal written determination. The IRS charges a filing fee for this. The Texas State Comptroller’s office will respond to a separate request. A community association is entitled to be represented by an attorney or CPA in the application process. An experienced representative helps the associations decide if its activities may qualify for tax-exempt status. Easy changes in documents and policies may be done before application. The IRS estimate of average time required to prepare the application is 58 hours. Usually, there are follow-up questions from the IRS to be answered. If the IRS rejects the application, an appeal can be done and if still not resolved can lead to a decision by a federal judge. Expect the IRS to take at least six months to process the application. It can take two years. Disclosure Pursuant to Treasury Regulations in Circular 230: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matter(s) addressed herein.