Should HOAs be tax free social welfare entities?

I am talking about federal tax exemption status for HOAs under 501(c)4. HOAs do not qualify for educational nonprofits, (c)3, or recreational services under (c)7. Of the 342,000 HOAs (CAI data) less than 1,300 have a (c)4 exemption as a social welfare organization. In general, a social welfare organization must provide social benefits to the community at large, or general public.

Now, getting tax free revenues is applaudable as almost all homeowners would agree. After all, they are being double-taxed at the state and local level. But, like on the national scene, the tax break goes not to the individual homeowner, but to the HOA corporation. The dream, the fantasy, of the homeowners is that these savings would trickle down to its members as lowered assessments. I wouldn’t hold my breath. There is no mandate in any of the rulings that might apply to an HOA to pass on the tax breaks to its members. Is it a good thing? Could be, providing . . . .

On the other side of the coin comes the constitutional and ethical question as to why should HOAs get a tax break in the first place? They operate and function outside our constitutional system of government that denies citizens individual property rights and fundamental rights as enjoyed by those not living in an HOA.

The CC&Rs do no mention social welfare as its purpose, but confines itself to maintaining property values and enforcing the CC&Rs as it main purpose. Some going as far as saying either, “for the members” or “for the community.” It’s a serious contradiction in purpose to say “private” and to say “including the general public” in one breath. It’s an oxymoron.

In 1989, a ruling by the Federal Circuit court hold that a WV HOA was not entitled to tax benefits, stating,

“When a group of citizens elects . . . to separate themselves from society and to establish an entity that solely advances their own private interests [an HOA], no potential for general social advancement [benefit] is implicated. Wholly private activity, however meritorious, confers no such benefit which would render a compensatory exemption [tax break] appropriate”[2].

That says it all!

There have been several rulings over the years trying to qualifying the broad, vague wording of the IRS rules, which is the love of CAI lawyers – parsing sentences and redefining traditional meanings of words. Gary Porter[1] — a California CPA and active HOA tax specialist is a CAI member and past national president of CAI (1998-99) — was the leading proponent of this “word game” that held that HOAs were quasi-governments and, as such, constituted a community as defined by the IRS. His views were heard by the IRS and cited in the Sun City Grand, Surprise AZ application in support of a tax exemption.

In short, the heart of an HOA is thrown out the window — its private, contractual nature for its members – and replaced by a social welfare organization for the benefit of the surrounding community. Since the beginning of HOA time, this has been the fundamental legal basis for HOA governments.

However, in spite of the Circuit Court ruling, in 2015 it seems that the IRS bought this argument. It determined that SCG could be both, a private organization and a “surrounding community” at the same time.

Now, how about all the other HOAs? Not a word was made public about this achievement in the 3 years since 2015. I wonder why?

Notes
1. “IRC Section 501(c)(4) and Gated Associations,” Gary A. Porter, CPA (July 2, 2018).
2. Flat Top Lakes Assn v. United States of America, 868 F. 2nd 108 (4th Cir. 1989).

Published in: on July 3, 2018 at 9:04 am  Comments (3)  

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3 CommentsLeave a comment

  1. It’s another case of CAI wearing two hats, depending on the circumstances of the moment. When it benefits them, CAI insists HOAs are private entities that need not be constrained by Constitutional limitations. One prominent CAI attorney from California recently published a news column lamenting the fact that the CA Legislature views commonunity associations as quasi-governmental in nature. He made these remarks to express his opposistion to a bill sponsored by CCHAL, to make elections in common interest community associations more fair and democratic. SB1265 was approved by the Legislature, nonetheless. (http://leginfo.legislature.ca.gov/faces/billNavClient.xhtml?bill_id=201720180SB1265)

    But when there are tax dollars to be saved — or paid to association-governed communities for disaster recovery — suddenly HOAs are just like local governments, and should be able to reap the same benefits and privileges of public entities.

  2. HOA is the lowest form of government and most are non profit corporations. I would think that double taxation is a bad idea for HOA. I am not sure what my HOA pays in tax but will check into it. Again, I am in another dyfunctional HOA with egomaniacs running the board. It is deplorable how these people evade enforcement of CCR’s, city codes and ARS if it suits their purpose. Selective enforcement is a serious issue with HOA boards. As a panel speaker at the National Whistle Blower Summit on 7/30/18 in Washington DC, I will be exposing HOA issues related to the municipal court system.

  3. George, your points are worth studying and investigating. A question if a Board approves having Board members or their friend’s personal legal fees paid out of the HOA funds, should that be considered taxable income and reported to the IRS? Of course, we all know that HOA funds should never be used for personal benefit or expenses. Correct?


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