Originally published on Forbes.com Aug 5th, 2014
Unless they have vast reserves earning significant investment income, homeowners associations can avoid any significant tax liability by filing Form 1120H, which allows the organization to exclude assessments. Despite that option, some homeowners associations go to the trouble of applying to be 501(c)(4) social welfare organizations. (501(c)(4) status is at the heart of the IRS targeting scandal. Politically oriented organizations were applying for 501(c)(4) status since social welfare organizations do not have to disclose donors. Lois Lerner, who should have stayed at the Federal Election Commission, threw the IRS into that breach and under the bus. Regardless, the homeowners associations also get turned down from time to time. IRS turning down HAs does not generate quite as much sturm and drang. The most recent rejection was Private Letter Ruling 201429030.
Gategate
Private Letter Rulings are redacted, so I get to make up a name for the HA. I’m going to call it Gategate, because it seems to be somewhat attached to gates. My inference from the ruling is that the HA is more of a vacation spot than a place where people live permanently since it talks about having both campsites and mobile home sites. There are different deals on how the electric bills are handled.
What the 501(c)(4) ruling turns on is whether the HA is providing benefits to a “community”. That presents a little bit of a definitional problem.
Rev. Rul. 74-99 states that it was not possible to formulate a precise definition of the term “community”. The ruling merely indicates what the term is generally understood to mean. Whether a particular homeowners’ association meets the requirements of conferring benefit on a community must be determined according to the facts and circumstances of the individual case.
On the subdivision where the sites are, the HA maintains roads, water and sewage, a swimming pool, a recreational facility, boat slips, bathhouses, and something mysterious which has been redacted.
The HA also maintains a golf course and clubhouse, which is not in the subdivision. The golf course is open to the public. The road leading to the golf course splits with one branch leading to the subdivision. There is an electronically controlled gate that is used to limit access to the subdivision to members and guests.
Taxpayers Position?
“We have consulted with an independent CPA firm regarding our current tax exempt status. We believe our association meets the requirements found in Revenue Ruling 74-99 to be classified for tax exemption under 501(c)(4) of the Code because of the following:
1. Our association serves a community which bears a reasonable recognizable to an area ordinarily identified as governmental,
2. Our association does not conduct activities directed to the exterior maintenance of private residences, and
3. The common area or facilities it owns and maintains must be for the use and enjoyment of the general public.
Our position in meeting these requirements is as follows:
1. The golf course is available to anyone living in the surrounding area.
2. Our community should be recognized as the general public as a whole.
Essentially they are saying that the membership of this private organization should be recognized as if it were the general public.
It Does Not Work That Way
The Service was not buying it.
Inspection of the subdivision showed that entrance to the subdivision and its common facilities located within the subdivision such as the swimming pool, recreation hall, boat slips, bath houses, and are restricted to members by a gate which can be opened with a card. These common facilities within this gated subdivision are for the use of its members and their guests.
By restricting access and use of its common facilities as noted above, with the exception of the golf course and clubhouse, fails to qualify as a social welfare organization under IRC Section 501(c)(4). This position is supported by Revenue Ruling 74-99 as clarified by questions 1 and 2 of Revenue Ruling 80-63.
By limiting the use of the majority of the common areas to its members, it does not qualify as a community as required by Rev. Rul. 74-99.
What Is It That They Were Up To?
I understand why the big-time dark money organizations were applying for 501(c)(4) status. It allows them to conceal their donors. But the homeowners associations have me puzzled. 501(c)(4) does not get you the ability to get tax-deductible donations and an HA that is not accumulating vast amounts of cash can avoid most income tax liability by filing 1120H.
I ran the question by Evan Mckenzie, whose blog, The Privatopia Papers, covers the rise of private governance and the law of homeowner and condominium associations. I have a friend who thinks that the United States is a fascist dictatorship. I don’t agree, but I will tell you, if we ever become one, some of the best enforcers will be drawn from the ranks of condominium and homeowner association boards. Here is what Mr. McKenzie wrote me:
The logic of these rulings is pretty clear, I think. HOAs that offer no benefits to the larger community, and that do everything they can to exclude all non-members, shouldn’t be able to file tax returns as if they were charitable institutions. But the recurring nature of these claims to 501 c 4 status by gated communities highlights the inherent contradictions of private government. Are they voluntary associations of homeowners dedicated to making the “community” a better place? Or are they businesses operating according to the principles of corporate enterprise, aimed at maximizing property values?
When people are trying to sell these places or influence the press or state legislatures to leave them alone, the developers and lawyers and property managers who create and run these places love to invoke the warm and fuzzy “community association” image. They are always waxing eloquent about the New England town meeting, local democracy, community self-governance, neighborhood betterment and so forth.
But as soon as anybody suggests that the association should be more public-regarding, suddenly it is a business. Suddenly it is all about following rules and laser-like focus on property values. And any concept of benefiting the people outside the gates goes right in the dumpster. It is all about the officers and directors having a narrowly focused obligation to the owners (as if they were corporate shareholders) and the public be damned. So you can get NIMBY-type politics out of these associations, but little else. Let the outsiders use the pool? Forget about it! And if you read the standard CC&Rs, they are in fact completely dedicated to an inward-looking, myopic focus on their own property.
What I am saying is that the issue the IRS is dealing with is built into the schizophrenic nature of common interest housing as institutionalized in this country. The truth is that they are set up as business operations, and that’s the way they nearly always operate. But the industry has cloaked them in non-profit sector rhetoric.
Let The IRS Collect Taxes
I have noticed quite a few cases of organizations seeking 501(c) status of one sort or another (There are actually 29 different types) for reasons unrelated to anything having to do with federal taxation. Among them is the ability to sell liquor or run gambling operations, which some states apparently tie to federal exempt status. Then there is just the warm fuzziness of being able to call yourself an exempt organization. These issues are far away from the primary IRS mission which is to collect over $2 trillion dollars. Somehow, though we have made our tax collection agency the Swiss utility knife of social policy, which includes granting imprimaturs of social utility on a plethora of organizations.