Not All Member Fees are Exempt Function Income
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There is a common misconception among homeowner and condominium associations that file form 1120-H, which is, they often believe that fees charged to members are not taxable. Actually many member fees are taxable, including rental fees, parking fees, laundry fees, swimming pool fees to name a few. In order to determine whether a fee charged to a member of an association is taxable or not, you have to look at the “nature” of the fee.
Under treasury regulation 1.528 which is used for form 1120-H, the IRS separates out income as either exempt function income or non-exempt function income. Exempt function income is not taxable and non-exempt function income is taxable. Exempt function income consists of income which is attributable to membership dues, fees or assessments of owners, “in their capacity as owner-members rather than in some other capacity such as customers for services.” For example fees charged to members for using the laundry room facilities would be taxable income to the association, whereas yearly dues charged to all members for maintaining the association sidewalks would not be taxable.
There are cases where it might not seem so clear cut. For example a yearly fee of $500 charged to all members for the use of the swimming pool would be exempt function income, and not taxable, but an entrance fee charged to individual members for use of the swimming pool would be taxable income for the association. This is because the entrance fee is charged to the members as customers rather than as owners.
To make filing your federal form 1120-H simple, it helps to separate out all the member fees between exempt function and non-exempt income. This can be done by creating separate accounts in your accounting software, segregated by the type of income.
Doug McLain, CPA