Many people think that non-profit means no taxes. Unfortunately, this is not the case.
Non-profit does not mean tax-exempt. Often, board members, and sometimes even managers, think that condominiums, co-operatives, and homeowner associations (collectively referred to as CIRAs by the IRS, common interest real estate associations) are tax exempt. They are not. However, they generally have little taxable income, and can escape taxes most years.
When are they not taxable? To file a simplified form 1120-H, rather than the full corporate 1120 return, a CIRA must meet the following requirements:
- At least 60% of the association’s total income must be exempt function income.
- At least 90% of the association's expenses for the tax year must consist of expenses to acquire, build, manage, maintain, or care for its property
- No private shareholder or individual can profit from the association's net earnings except by acquiring, building, managing, or caring for association property or by a rebate of excess membership dues, fees, or assessments.
In the case of our Florida condominiums, exempt function income consists of membership fees or assessments from owners of condominium units. This income must come from the members as owners, not as customers, of the association's services.
What is taxable income? All other income that does not qualify as exempt function income. So, basically that’s everything other than Maintenance Fees on your monthly income statement: rental income, laundry income, screening fees, late fees, interest earned, etc. When completing your tax return, you allocate expenses directly connected to the production of the non-exempt income as deductions against that income to reduce your bottom line taxable income, which is taxed at 30%, if filed on form 1120-H. The big item here that often pushes CIRAs into a taxable state, is rental income.
Rental income is absolutely a great bonus. This is money the association actually gets to collect, usually after foreclosing on a prior owner who didn’t pay. Now, the unit is in the Association’s name, and bringing in income. The Board is thrilled. However, this income often pushes the CIRA over the line into taxable, and can also cause you to fail test 2 above, forcing the association to file a full form 1120, and therefore, a Florida tax return as well, resulting in higher fees from your CPA.
What can you do about this? First, make sure you are allocating all expenses related to the rental of that unit as deductions against the rental income. The best way to do this is to have separate line items for the expenses related to the rental unit. These may income things like water, electric, a/c repairs, painting the interior walls to ready the unit for rental, etc. After that, ensure that you set aside and not spend 30% of the rental income to pay for any taxes that may be due at year end. Yes, nothing in life is free!
Please note, however, that form 1120 carries a different tax structure. Sometimes, filing an 1120 (and therefore the state F-1120 must also be filed) can result in a lower overall tax bill. If you meet the 1120-H test, consult your CPA on which form is best to file. This election can be made each year, independently of every other year.
-Karen Danzinger, CPA, LCAM
Orchid Management Solutions
