Homeowners’ Associations – Nonprofit or Not?

Posted by Amanda C. Redick, on October 2, 2014

Homeowners’ associations are typically structured as nonprofit corporations in order to enable them to take advantage of federal and state tax benefits offered to nonprofit entities.  It is important to note, however, that homeowners’ associations are not tax exempt organizations under Internal Revenue Code (“IRC”) § 501 (c)(3) for federal income tax purposes.  Homeowners’ associations may apply to become exempt under IRC § 501(c)(4) (which governs organizations formed and operated primarily for the benefit of the community) or IRC § 501(c)(7) (which governs social clubs), but in actuality most homeowners’ associations are formed for the purpose of maintaining social facilities and administering and enforcing covenants and restrictions applicable to the subdivision and therefore do not meet the stringent requirements of IRC §§ 501(c)(4) and (c)(7).  Most Homeowners’ Associations, however, can easily qualify for limited taxation under IRC § 528, which only imposes a tax on thirty percent (30%) of the association’s taxable income.  This provision does include income and expenditure requirements that must be met in order to qualify for the lower tax, but most associations are structured to fit easily within these requirements.[1]

In Indiana, homeowners’ associations can be organized under the Indiana Nonprofit Corporation Act of 1991, and in particular, Homeowners’ associations formed in Indiana qualify as mutual benefit corporations, which is a special type of nonprofit corporation.  This distinction becomes important in the case of a homeowners’ association that goes defunct and dissolves because property of a mutual benefit corporation can be distributed to the members of the corporation upon dissolution under Indiana Code §23-17-22-5(7).  If an association’s members vote to dissolve the association corporation, or if the association is administratively dissolved and not subsequently reinstated, the association may have significant assets remaining in the form of reserves or member dues that have not yet been allocated to association expenses, and most associations do not carry a significant amount of debt to which those excess funds would need to be allocated.  In such a case, the statute provides that those assets could be distributed to the association’s members.  A general nonprofit corporation, on the other hand, would have to distribute those assets to another nonprofit corporation or to the state for public purposes, which one can imagine would not please the homeowners who expected the money they paid in dues to benefit their neighborhood.[2]

Typically these associations dissolve, however, not due to any affirmative action taken by directors or the association members, but rather because they go inactive and are administratively dissolved for failure to file entity reports or state taxes.  Eventually, new homeowners come along and try to get these association entities reinstated or form new entities, so it is best to also include in the association’s articles of incorporation a provision allowing for association assets to be conveyed to another mutual benefit corporation upon dissolution in order to avoid the default provision under Indiana law requiring distribution of the assets to the members in the case where the association is ultimately reinstated.  Such a provision is also helpful in dealing with the real estate assets owned by the association, as typically these assets are owned by the association in trust for the members.

[1] “Homeowners’ Associations Under IRC 501(c)(4), 501(c)(7) and 528”, 1982 CPE Textbook, available at

http://www.irs.gov/pub/irs-tege/eotopicr82.pdf; accessed October 2, 2014.

[2] Ind. Code § 23-17-22-5(a)(6) (2014).

**Reiling Teder & Schrier, LLC is an Indiana Limited Liability Company. The information contained in this website has been prepared by Reiling Teder & Schrier, LLC for informational purposes only, and is not legal advice. The information on this website should not be relied upon to make any decision, legal or otherwise. If you have any specific questions or inquiries regarding any of the information contained in this website, you should consult with an attorney licensed in your state. The information contained in this website pertains only to matters of Indiana law and the laws of other states may be completely different from the laws of the State of Indiana.