Tax-exempt, Or Not-for-profit?

We are frequently asked, “If we are a not-for-profit corporation, why do we still have to pay taxes?”

Tax exempt and not-for-profit are two completely different concepts in the world of community associations. The notion of being not-for-profit stems from the fact that the association’s income is only the maintenance fees collected from the members. The income generated from these maintenance fees is not taxed as income.

Exemption from income tax is not the same as being exempt from having to pay sales taxes and other types of governmental tariffs. If the entity were a “501” entity, then there would be sales tax exemption and the payment of maintenance fees would be deductible as a charitable deduction. We are familiar with a “501(c)(3)” entity. These are charitable organizations such as churches, schools or museums. Your contribution to that organization is deductible. While that would be nice, no one can rightly say that a community association is organized for charitable, religious, educational, scientific or literary purposes.

Now being that this is a tax question, there are other nuances to consider. For example, there is such a thing as a 501(c)(4) entity. This entity is more like a community association. In fact in the past, some homeowner associations (not condominium associations) have been exempt from taxation as a 501(c)(4) entity. However, due to recent court cases and IRS rulings, in order for a homeowners' association to qualify for exemption under IRC 501(c)(4):

1. It must serve a “community” that bears a reasonably recognizable relationship to an area ordinarily identified as governmental;

2. It must not conduct activities directed to the exterior maintenance of private residences; and,

3. The common areas or facilities it owns and maintains must be for the use and enjoyment of the general public.

This is not the “community” as in community association we understand; rather it is construed as having a reference to a governmental subdivision or a unit or district thereof. The association would have to be formed and operated for the common good of the “community” and not primarily for the mutual benefit of its members. Clearly restricting access to the general public from the association’s streets, sidewalks and green spaces directly violates the “service to the community” requirement.

As an alternative to exemption under IRC 501(c)(4), a homeowners association whose primary function is to own and maintain certain recreational areas and facilities may elect exemption as a social club under IRC 501(c)(7). However, a homeowners association may not qualify under IRC 501(c)(7) if it administers and enforces covenants for preserving the architecture and appearance of the development. An association may qualify for 501(c)(7) where it provides only qualifying social and recreational activities.

So unless an association can meet the strict “community” standards or where it only provides qualifying social and recreational activities, it will be not be tax exempt, just not-for-profit.

If you would like to discuss this matter further please do not hesitate to contact our office.

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