Tax time for HOAs?

As the year draws to a close, many of us are engaging in year-end tax planning for ourselves and our businesses. Since homeowners associations are almost always non-profits, HOA board members and managers may think that tax planning for HOAs is not necessary. While most HOAs won’t owe taxes, there are still tax-related issues to be aware of this time of year.

HOA Tax Returns

HOAs file Form 1120-H, the U.S. Income Tax Return for Homeowners Associations, which is a fairly simple, one-page return designed to determine if the HOA has earned non-exempt income and related expenses during the tax year. Here’s a link to the form and here’sa link to the instructions. It is important that Form 1120-H be filed each year in order to claim the special tax-exempt status accorded by the Internal Revenue Code to HOAs. The return is due by March 15 of each year but can be extended, although of course taxes are calculated on a calendar year basis in most cases – so you must act before December 31 if you anticipate any tax issues.

Exempt vs. Non-Exempt Income

While most HOAs don’t have any taxes due because all their income is considered “exempt”, any non-exempt income is taxed at a rate of 30%, which is very high. Worse, significant non-exempt income in a particular year, especially if repeated over multiple years, can jeopardize the HOA’s non-profit status, so HOAs must be very careful about earning income which could be considered non-exempt.

• Exempt function income is income generated from membership dues, fees and assessments, including interest charged to members and late fees. This type of income is generally tax exempt.
• Non-exempt function income includes income generated from investment interest and dividends, vending machines, and any income received from non-members, including rents received from non-members for use of HOA facilities.  This type of income is generally taxable.

Generally, 60% of an HOA’s income and 90% of its expenses must be from or for exempt purposes, or it can lose its non-profit status with the IRS. If this is a concern for your HOA in a particular year, consider filing a regular Form 1120, the U.S. Corporation Income Tax Return, instead of an 1120-H. This form takes into account all of the HOA’s sources of income and expenses, but may result in less tax, because the tax brackets start at 15% for the first $50,000 of income rather than a flat rate of 30%.

“Involuntary Conversion” Proceeds

The issue of non-exempt income can arise when an HOA receives insurance or condemnation (also known as eminent domain) proceeds – referred to generally as “involuntary conversions” in IRS parlance. Involuntary conversion proceeds are typically considered non-exempt income, and it is usually important that they be spent on specific HOA expenses related to the repair, replacement or acquisition of common areas or improvements in order to ensure that the 90% rule mentioned above is met.

If your HOA is due to receive involuntary conversion proceeds, it is very important to consult with your tax and legal advisors BEFORE receiving the money regarding the timeline for spending the money to avoid taxes. The usual replacement period is two years beginning the first day of the first tax year after the year when the proceeds are received.  In order to qualify for this deferral, the HOA must file an election with its tax return the year the proceeds are received. It is often wise to postpone receipt of the proceeds until after January 1 if the proceeds are due to be received toward the end of the year to allow more time to spend them. Be careful if your replacement period ends in the current year.

Involuntary conversion proceeds should never be refunded to the homeowners individually. The Internal Revenue Code and most state laws, including North Carolina’s, prohibit the income of a non-profit from being received by any member, officer or director of the non-profit. If the proceeds are not able to be spent on repairs or improvements, use them to reduce the assessments for coming years rather than issuing refunds to the members.

1099’s

HOAs are required to issue 1099s to their vendors. These are required to be sent out by January 31^st of each year and are required to be mailed to the IRS by February 28^th each year. The most common vendors for HOAs are repairs and maintenance services, attorneys and management companies. We recommend HOAs get a W-9 from vendors with the required information so that 1099s can be prepared and mailed out on time.

Who’s Preparing the Taxes?

Be sure your HOA understands who is responsible for preparing and filing your taxes. For simple HOAs with management companies, the management company may handle this and may not even ask the board of directors to review it before filing. More complex HOAs should be more directly involved with the tax preparation process. In any event, although not absolutely necessary, it is wise for the board of directors to review and approve the Form 1120-H and any state tax forms before they are filed, just to avoid errors and be sure the management company is being given proper oversight. If there has been significant non-exempt income, discussions with your tax professional should have occurred long before the end of the year. All HOAs should have a good accounting firm as a part of their team. We use Gordon, Keeter & Co. in Concord, North Carolina.

Property Taxes

Let’s not forget property taxes. In most states, common areas are not subject to property taxes, or are taxed at a de minimus value. In North Carolina, a filing must be made with the local tax assessor to obtain this exemption. (It only needs to be filed once and is good forever thereafter.) Most tax assessors will accept this filing up to June 30, which is the end of the fiscal year for local governments in North Carolina, but typically will not apply the exemption retroactively. So if there is common area to be turned over to your HOA, be aware that taxes may be due on it for the entire year in which it is turned over, and that your HOA must file with your local assessor to be sure the new common area is deemed exempt for future years. Check with you local tax office well ahead of time if you are in this boat.

Tax assessors are growing more aggressive in assessing HOAs for back property taxes on common areas or foreclosed homes owned by the HOA. In the past, many tax assessors might have foreclosed their tax liens on such property, but they did not typically seek payment directly from the HOA. Tax laws in North Carolina state that any future owner of property is personally liable for back taxes on that property. Tax assessors can attach the HOA’s bank accounts without any requirement for due process. So be careful in this situation, especially if your HOA is considering taking title via foreclosure to a home which has significant past-due property taxes.

I hope this tax information is helpful to your HOA as you wind down the year. Contact us if we can assist your HOA with any year-end issues. Thank you to CPA Ladoska Keeter at Gordon, Keeter & Co. for her assistance with this post. Best holiday wishes from all of us here at Moretz & Skufca!

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No Class Certification in Case Alleging Condominium Association and Management Company Charged Excessive Fees

The North Carolina Court of Appeals recently decided a case involving several homeowners’ claims that their condominium association, through its management company, was charging excessively high fees and late charges that were not permitted by the condominium’s governing documents.  We want to point out that these were simply allegations - the only part of this case that matters from a legal perspective is that the homeowners asked for class-action status, which was denied. 

                              

For discussion purposes, there is not much distinction between the laws that govern condominiums and homeowners associations. All condominiums and HOAs are governed by declarations that specify the particular restrictions for the condominium or subdivision.  The rule of law is that the declaration (in conjunction with the bylaws, the association’s policies and rules and regulations), specifies the fines and late fees that can be assessed against homeowners for delinquent assessments, and the laws step in to fill legal gaps in the declaration or to place limits on the association’s discretion to levy fines and late fees.

In this case, the plaintiff homeowners alleged that the condominium association permitted its management company to assess fees that exceeded the statutory limits.It should be mentioned that this is an older condominium association, meaning that an amalgam of laws control the fees and charges.  The plaintiffs also asked the court to allow the case to proceed as a class-action lawsuit against the management company and the association.  The class-action status was rightfully rejected by the lower court in our opinion.  The plaintiffs appealed the court’s denial of class-action status, and this decision upheld the denial.  This was not a final decision on the merits of the case, so the case goes on, albeit without class-action status.

From a purely legal perspective, this case did not say a lot that was new.  However, we believe that this case is important to remind associations and their management companies to periodically take stock of the fees and fines that are assessed against homeowners to determine that all charges are compliant with the governing documents and within the bounds set by the law.  The fees and fines should be set forth either in the association’s governing documents or by a properly approved resolution or policy.  The maximum amount of late fees that can be assessed, for any particular month, is $20.00 or 10% of the amount overdue, and this amount can be charged only once per month.  The laws do allow the association to assess attorneys’ fees in many circumstances, although the association must provide the homeowner with proper notice beforehand.  These are only a few examples of charges that should be considered, so be sure to check with your management company or attorney to confirm that your HOA's charges are authorized by law.

Please give me a call or drop me an email if our HOA law team can assist your HOA or management company with the compliance process, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!

Supreme Court Loosens Up Construction Warranty Claims

The North Carolina Supreme Court does not often render decisions that directly affect HOAs, but on December 19, 2014, the Court issued an opinion in Christie v. Hartley Construction that may impact your HOA, and will certainly impact many consumers and construction contractors.

In 2004, the Christies, the plaintiffs in the case, were building their dream home and the builder suggested they purchase a stucco-like material called “SuperFlex” for the exterior. If properly maintained, the SuperFlex was promised to last decades, even in heavy sun, rain, salty air, and freezing conditions. The SuperFlex manufacturer even provided a lengthy written 20-year warranty for its product.

In spite of the promised durability of SuperFlex, a mere seven years later the SuperFlex began to flex, and then to crack and blister, causing moisture to penetrate the home. But no worries, the very specific 20-year warranty would protect the Christies, right? They sued in 2011 to enforce the warranty.

Not so, said the trial court. You see, North Carolina has a longstanding “statute of repose” for improvements to real estate (which includes most types of construction work on real estate). A statute of repose is like an outside statute of limitations. Whereas when a statute of limitations begins to run can depend on when the problem is discovered, a statute of repose says that a lawsuit cannot in any circumstances be filed later than a particular time period. In this case, the statute of repose for construction defects is and always has been six years.  (The ambitious or bored among you can can read it here - look at subsection (a)(5)(a).) This six-year statute of repose is intended to prevent builders and contractors from facing the possibility of an open-ended period of potential lawsuits.

No matter what, the trial court said, the statute of repose prevents a homeowner from suing to recover damages for improvements installed more than six years ago.  The 20-year warranty was worthless after six years.  On appeal, the North Carolina Court of Appeals agreed.  According to the court, this was obviously an improvement to real property and the statute of repose is clearly six years, so the homeowners had to abide by the statute of repose and the warranty was unenforceable, even though the written warranty was very clearly for 20 years. This had been the rule for many years and was not a difficult call for the court.

But the N.C. Supreme Court thankfully reversed the lower courts.  The Supreme Court held that a very important general rule of law is that parties can freely contract, and if the SuperFlex manufacturer wanted to provide a warranty beyond the statute of repose’s 6-year period, then it was free to do so. 

If a seller of improvements to real estate has such confidence in its product that it provides a lengthy written warranty, there is no reason for it later to be able to shield itself behind the statute of repose.  In unusually harsh language, the Court stated that allowing a seller to disavow its warranty would result in “a sham, useful only to beguile the unsuspecting”.  Accordingly, the 20-year warranty stands and a number of years of legal precedent were overruled, and rightly so in our view.

Although this decision may not impact too many HOAs or condominiums since most construction lives up to its promises, there could be situations where it comes into play.  We do sometimes see situations where an HOA purchases an improvement to its real estate, (e.g. to improve its clubhouse), only to find out down the road that the construction fails.  Imagine how miffed the board and the members are when they find out that the ironclad warranty they purchased along with the construction is as worthless as the shoddy construction.  Now these HOAs may have a remedy where before they had none. 

Please give me a call or drop me an email if our HOA law team can assist your HOA or management company with the compliance process, or if we can be of assistance in any other way. We appreciate your reading our HOA law blog and encourage you to share it with others who may be interested. Thank you!