Quick answer: Form 1120-H taxes an HOA at a flat 30% but excludes member dues and assessments entirely. Form 1120 taxes at 21% but pulls assessments into income and applies the Section 277 membership-organization limits. The election is annual, so an association can compare and choose the lower tax every single year.
Most homeowners associations file Form 1120-H without ever running the alternative. Most of them are right to — but not for the reason they think, and not in every year.
What the Election Actually Does
Internal Revenue Code Section 528 says a qualifying homeowners association “shall be subject to taxation under this subtitle only to the extent provided in this section.” Electing it on Form 1120-H removes exempt function income — member dues, fees, and assessments — from gross income entirely, and taxes only what is left.
The flat rates:
- 30% for a condominium management association or residential real estate management association
- 32% for a timeshare association
Those rates apply to capital gains too. There is no preferential capital gain rate on Form 1120-H.
This is not a 501(c) exemption. It is a statutory carve-out that an otherwise-taxable corporation elects, one year at a time.
The Qualification Requirements
Section 528(c)(1) sets out five requirements, and a sixth — the residential test — lives in the definitions and is quantified by regulation.
The 60% income test
At least 60% of gross income must be exempt function income. What matters is not the label on the charge but whether it comes from owners in their capacity as owner-members rather than as customers for services. Dues based on assessed value or unit size qualify. Developer payments on unsold units qualify.
What does not count: amounts from non-members, tax-exempt interest, interest earned on sinking fund reserves, amounts for work on privately owned property that is not association property, and fees for special use of facilities that are not available to all members by paying regular dues.
There is a useful carve-back. A fee for special use is exempt function income if it is paid no more than once in any 12-month period and the privilege lasts the whole period. An annual pool or tennis fee qualifies. A fee to rent the clubhouse for one evening does not.
The 90% expenditure test
At least 90% of expenditures must go to acquisition, construction, management, maintenance, and care of association property. Both operating and capital spending count. Legal fees, accountant’s fees, insurance premiums on association property, security, paving, and pool and court maintenance all qualify.
The point most boards get backwards: transferring money into reserves is not an expenditure for this test. The regulation says investments or transfers of funds held to meet future costs “shall not be taken into account as expenditures” — explicitly including a transfer to a sinking fund for roof replacement. A large reserve funding transfer does not blow the 90% test. It simply drops out of both the numerator and the denominator.
The 85% residential test — measured two different ways
This is where published guidance is most often wrong. Treasury Regulation Section 1.528-4 is titled “Substantiality test,” and the measure depends on the type of association:
| Association type | How the 85% is measured |
|---|---|
| Condominium management association | At least 85% of the total square footage of all units is used for residential purposes |
| Residential real estate management association | At least 85% of the lots are zoned for residential purposes |
| Timeshare association | No substantiality test applies |
Square footage for condos. Lot count and zoning for subdivisions. Not interchangeable. The test is applied based on conditions on the last day of the tax year.
Auxiliary areas count as residential — laundry rooms, pools, tennis courts, storage, parking, even schools and fire stations for a subdivision. But commercial shopping areas and their parking are not residential lots.
The short-term rental trap. Regulation 1.528-4(d) provides that a unit is not used for residential purposes if, for more than half the days in the association’s tax year, it is occupied by a person or series of persons each staying less than 30 days. For a resort-area condominium with heavy short-term rental activity, this can disqualify the association entirely. It is the most under-analyzed provision in Section 528.
No private inurement
Net earnings cannot inure to members except through providing for association property or through a rebate of excess dues, fees, or assessments. Critically: if an association pays rebates out of amounts other than exempt function income — out of interest income, say — that is inurement and it destroys Section 528 status for the year.
The election is made every year, and it is locked for that year.
Choose wrong and the association either pays a flat 30% on income it did not need to expose, or fails the exemption tests entirely. Running both computations with the actual numbers takes an afternoon, and it has to happen before the return is filed, not after.
What Actually Gets Taxed on Form 1120-H
Everything that is not exempt function income: interest on operating and reserve accounts, dividends, laundry and vending income, cell tower and antenna leases, clubhouse rental to non-members, guest fees, non-member parking, newsletter advertising, and even taxable state tax refunds.
Deductions directly connected to producing that income are allowed. The standard is a “proximate and primary relationship” to the income. Where facilities or personnel serve both purposes, expenses are allocated on a reasonable basis — the regulation’s own example allocates 10% of a $10,000 manager salary to non-exempt income production for a $1,000 deduction.
Then subtract the $100 specific deduction. It is flat, per return, per year, not indexed, unchanged since 1976, and it cannot create or increase a loss. It is unavailable on Form 1120.
Also on the plus side: 1120-H filers owe no estimated tax and no AMT, and the form is one page with no balance sheet and no Schedules L, M-1, or M-2.
The Form 1120 Alternative and Section 277
The corporate rate is 21%, nine points below 1120-H. So why doesn’t everyone file it?
Because the base is bigger, and Section 277 makes it worse. An HOA that does not elect Section 528 is a membership organization under Section 277, which forces a two-bucket computation. Deductions attributable to furnishing goods and services to members are allowed only to the extent of member income. Excess member deductions carry to the succeeding year — as member expenses again.
The IRS position, stated in Revenue Ruling 2003-73, is that investment income is nonmember income, so it “cannot be offset by expenses of providing goods and services to members.” The Tax Court held the same in Concord Consumers Housing Cooperative (89 T.C. 105): interest on reserve and escrow accounts is not income from members, and the fact that the invested principal came from member assessments does not change that.
The result: on Form 1120, reserve interest is taxed at 21% with essentially no shelter from operating expenses, and an operating deficit is stranded. Form 1120 only wins when the member bucket is already at or below zero.
Running the Numbers
Scenario A — typical association. Assessments $200,000; operating expenses $195,000; reserve interest $10,000; $500 of allocable investment expense.
- 1120-H: ($10,000 − $500 − $100) × 30% = $2,820
- 1120 with a valid Rev. Rul. 70-604 election on the $5,000 excess: $9,500 × 21% = $1,995
- 1120 without a valid 70-604 election: $14,500 × 21% = $3,045
An $825 saving that turns into a $225 loss plus penalties if the election does not hold. Rarely worth the risk at this scale.
Scenario B — large investment income, break-even operations. Assessments $400,000; expenses $400,000; reserve interest $25,000.
- 1120-H: ($25,000 − $100) × 30% = $7,470
- 1120: $25,000 × 21% = $5,250
Form 1120 saves $2,220 a year. This is the genuine case for it — and it requires disciplined two-bucket accounting every year.
Scenario C — a special assessment year. This is the one that matters. Operating assessments $150,000; a $100,000 special reserve assessment; operating expenses $150,000; reserve interest $8,000.
- 1120-H: the entire $250,000 is exempt function income. Tax = ($8,000 − $100) × 30% = $2,370. The $100,000 reserve transfer is ignored for the 90% test.
- 1120: worst case, the $100,000 is member income and the transfer to reserves is not deductible — ($100,000 + $8,000) × 21% = $22,680.
A tenfold difference. This single scenario is why most associations should default to 1120-H.
Revenue Ruling 70-604, Honestly
Rev. Rul. 70-604 holds that excess assessments “returned to the stockholder-owners or applied to the following year’s assessments are not taxable income to the corporation.”
Four constraints are built into the ruling’s own facts, and they are load-bearing: it involves a condominium management corporation; managing the common elements is its sole activity; the members hold a meeting each year at which they decide what to do with the excess; and there are exactly two permitted dispositions — refund, or application against the following year’s assessments.
What it does not do: it is not a reserve-funding device, it does not shelter investment income, and it is not a permanent deferral.
Two honest cautions. First, a Form 1120-H filer does not need Rev. Rul. 70-604 at all — member assessments are already excluded. Second, whether a board resolution suffices or a full membership vote is required, and whether consecutive-year elections are sustainable, are not resolved by any published, authoritative IRS guidance. Anyone who tells you flatly that the board can just make the election every year is stating a risk position as if it were settled law. The defensible practice is a membership resolution plus board ratification, documented in minutes, adopted before the return is filed.
The consequences of getting it wrong are real. In Mission Heights Homeowners Association, a federal district court granted summary judgment for the government on every issue, finding the association had neither refunded the excess nor applied it to the following year’s assessments.
The Election: Annual, and Switchable
- A separate election is required for each tax year. It is made simply by filing a properly completed Form 1120-H.
- Deadline: the due date including extensions — the 15th day of the 4th month after year end for calendar-year associations. Associations with a June 30 fiscal year end use the 15th day of the 3rd month.
- Revocation requires the Commissioner’s consent, via a private letter ruling with a user fee. Expensive enough that it rarely happens.
- Late relief exists. An association that fails to make the election gets an automatic 12-month extension to make it, provided corrective action is taken within 12 months of the due date including extensions. This is the most valuable and least known item in the instructions.
Because the election is annual and independent, an association can switch year to year with no Form 3115 and no IRS consent. The IRS invites the comparison in its own instructions: compare the tax computed both ways, and “the association may file the form that results in the lowest tax.”
Reserves and Special Assessments
Under Form 1120-H this distinction largely does not matter — member assessments are exempt function income whether operating or reserve. That is the core structural advantage.
Under Form 1120 it is everything. Two 1975 revenue rulings draw the line, and they are usually described wrongly as “capital improvements versus repairs.” The actual distinction is real property versus personal property. Rev. Rul. 75-370 keeps segregated special assessments for real property replacement (roofs, elevators) out of gross income on an agency theory — but expressly does not apply to funds for painting, repairs, gardening, or janitorial services. Rev. Rul. 75-371 treats a segregated pro rata assessment for personal property as a contribution to capital, and separately holds that contingency reserves are includible in gross income.
To sustain either position on Form 1120 you need membership approval, pro rata assessment, specific earmarking, a separate non-commingled account, advance written notice of the capital nature, and actual spending on the designated property.
Frequently Asked Questions
Can we file 1120-H one year and 1120 the next?
Yes. The election is annual and independent. No consent, no Form 3115. What requires consent is revoking an election for a year in which you already filed Form 1120-H.
We missed the deadline. Are we stuck with Form 1120?
Not necessarily. There is an automatic 12-month extension to make the Section 528 election if corrective action is taken within 12 months of the due date including extensions. Beyond that window you are on Form 1120 for that year.
Does a big reserve contribution break the 90% test?
No. Transfers of funds held to meet future costs are excluded from the expenditure computation entirely — they are not counted as bad expenditures, they simply do not count at all.
Is reserve interest exempt function income?
No, under either regime. On Form 1120-H it is taxable at 30%. On Form 1120 it is nonmember income that operating expenses cannot offset. Associations are often surprised that an operating deficit shelters investment income under neither approach.
Our condo has ground-floor retail. Do we still qualify?
It depends on square footage. A condominium management association needs at least 85% of total unit square footage used for residential purposes, measured on the last day of the year. Significant commercial space requires an actual calculation, not an assumption.
Do cooperatives qualify?
No. The regulations expressly exclude cooperative housing corporations and similar ownership forms from Section 528.
Where Judgment Genuinely Matters
The 85% test in a mixed-use building requires a real square-footage analysis, and hybrid entities have to be characterized before they can be tested. The 30-day short-term-rental rule requires actual occupancy data. The line between a fee for a common activity and a fee for services is facts-and-circumstances, and associations offering concierge, cable, or booking services are genuinely at risk on the 60% test. Allocating dual-use expenses against laundry, vending, or antenna revenue needs contemporaneous support.
And the decision to file Form 1120 at all deserves more scrutiny than it usually gets. The savings are typically modest; the exposure is that every dollar of assessments becomes taxable gross income subject to Section 277 bucketing, on a return with a far larger audit surface.
For most associations, most years, Form 1120-H is the right answer — but that should be a conclusion you reach by running both, not a habit.
Related: HOA accounting fundamentals. See also our tax preparation services.
Have us run both returns before you file — the comparison takes far less time than an amended return.
Sources: IRS Instructions for Form 1120-H, IRC Section 528, and Rev. Rul. 2003-73. General information only — state treatment varies and is not covered here.
Associations are not the only entities where the tax form follows from how funds are classified — nonprofit bookkeeping covers the parallel question in the exempt-organization context.
The 1120-H versus 1120 comparison is one part of a full association engagement. If you want the return, the fund accounting and the board reporting handled together, see our HOA accounting services.
The income that actually gets taxed on either return is usually reserve interest. See HOA reserve fund accounting for how reserves are tracked and why that interest is not exempt function income.
Talk to an accountant who works in your industry
Precision Accounting & Consulting works with contractors, law firms, medical practices and property owners across the country. If something on this page raised a question about your own books, send it over and we will give you a straight answer.