On October 2, 1995, the IRS published a “deletion’s copy” of Tax Advice Memorandum (TAM) No. 9539001 requested by the Jacksonville, Florida district IRS office relating to the audit of a time-share association. Even though over ten years have passed since issuance, this TAM still has authoritative significance and gives added insight into the IRS’s position on certain issues relating to filing form 1120. Does a timeshare audit affect condominium and homeowner’s associations? The answer appears to be yes.
In the eyes of the IRS, all residential associations are the same. When a residential homeowner’s association files tax form 1120-H, the IRS considers it a homeowner’s association. When that same residential association files form 1120, the IRS considers it a nonexempt membership organization which is identical to a time-share association. Associations benefit from filing form 1120 rather than form 1120-H because the tax rate for form 1120 is 15% for the first $50,000 of taxable income compared to a flat rate of 30% for form 1120-H. Associations may elect on an annual basis to file either form 1120-H or form 1120. However, filing form 1120 puts associations at risk if they do not comply with all IRS procedures. The above mentioned memorandum details numerous failings of the time-share association, which filed form 1120, to adhere to IRS procedures.
The following list, borrowed from the winter edition of The Ledger Quarterly, addresses the IRS’s rulings, and describes steps to be taken by associations in order to safely file form 1120:
- Maintain three separate categories of bank accounts:
– Operating accounts
– Capital reserve accounts
– Non-capital reserve accounts such as painting and contingency reserves.
- Conduct a reserve study that supports the specific capital use for the reserves.
- Prepare a budget that agrees with the reserve study.
- Separately account for operating and reserve transactions in the association’s financial statements and general ledger.
- Have the members annually approve the association’s election under Revenue Ruling 70-604. The Board of Directors may not approve this on behalf of the membership.
- The association may not conduct any inter-fund borrowing between the operating bank accounts and the capital reserve bank accounts.
- If operating and reserve assessments are collected together, deposit them first into the operating account. The reserve dues should then be transferred to the appropriate reserve bank accounts within two weeks.
- Take reserve expenditures directly from the reserve bank accounts. If reserve expenditures are paid from the operating account, that account should be reimbursed in the exact amount of the reserve expenditure at least monthly.
The above list describes association responsibilities. Tax return preparers should also be aware of additional tax return issues and supporting schedules addressed by this TAM.