April 25, 2013

REVENUE RULING 70-604

By: Marc Whitfield, CPA, CFST, MBA – Tax Manager

CIRA’s (Common Interest Real Estate Association: The IRS name for homeowner, condominium, property owner, and time-share associations) that file Form 1120 will have net membership income or excess membership deductions.  Revenue Ruling 70-604 allows the CIRA to defer tax on net membership income by removing excess membership assessments from taxable income. 

The provisions of the rule simply state that excess assessments over and above the amounts used for the operation of the condominium property that are returned to the owners or applied to the following year’s assessments are not taxable to the corporation.

This must be an annual election.  The Association must follow one of the two options, i.e. refund the excess to the association members or apply the excess to reduce the following year’s assessments.  There is no authoritative guidance about how to make the election although it is highly recommended that Associations follow the suggestions below:

• The election should be made by the members, in the form of a resolution, and adopted by the membership.  The Board can then reaffirm the election.
• The election must be made before the tax return is filed. The ruling simply states that a meeting is held each year. It doesn’t specify if it should be held before year end or merely before the tax return is filed
• It is not necessary to state the specific dollar amount.  Since the election could be made before year end, the Association would not know the amount of any excess and the ruling simply states that “any excess assessments’ may be carried over or refunded.
• ­IRS is asserting the election is a 1 year carryover only.  They are specifically looking to make sure in the following year there is a book loss that equals the excess carryover.  If there isn’t, the excess assessments will be considered taxable income.  Therefore, once the Association knows the amount of the excess assessments carried over, they should revise the budget accordingly and reduce the assessments by that amount, unless they choose to refund the excess to each owner. This will reduce the exposure the Association has.

Associations that file Form 1120-H, do not have to worry about this Revenue Rule as exempt member income is not taxable, regardless if it exceeds exempt expenses.  The only real issue with filing an 1120-H is that the Association may end up paying more in tax since non exempt income is taxed at a flat 30% rate instead of the normal graduated rates that corporations pay.  However, this increase in tax may be well worth the additional amount paid as the chance of reclassifying income when filing an 1120-H usually will result in exempt income, which is not subject to tax. 

If you have any additional questions, please feel free to contact our office at 1-855-STROEMER.