HOA investments

Homeowner's associations may be non-profit, but they are subject to paying corporate income taxes. Non-profit does not mean non-taxable.

Regardless of whether or not--or how you invest cash reserves--your homeowners association needs to have a reserve study conducted. It is common sense, due diligence, and part of a board's duty of trust and prudent oversight.

Let me suggest you check out the IRS website for more information: http://www.irs.gov/pub/irs-pdf/f1120h.pdf

Interest income is considered taxable by the IRS. "The taxable income of a homeowners association that files its tax return on Form 1120-H is taxed at a flat rate of 30% for condominium
management associations and residential real estate associations."

You should know that homeowner associations are not considered "non profit" for Indiana tax purposes and must file a corporate tax return. HOAs are also not exempt from sales taxes.

"Political organizations and homeowner’s associations are not considered not-for-profit organizations and, therefore, must file as regular corporations on Form IT-20."

Here's my two cents: invest your reserves wisely. Don't be afraid to pay taxes on the interest.

Ahh... another hoosier. Much easier talking to someone familiar with your own state laws.

Thanks for the reply GeorgerwilliamsW

Mark, first check your documents and follow any requirements in them and any applicable State law on the matter. You can't invest the money in a reckless manor; for instance you can't use the money for something like day trading. Below is the policy from a HOA I found online.

Rules and Regulations on Investment of Reserve Funds

A reserve fund is maintained to provide adequate funds for future capital investments, such as fencing, landscaping, irrigation, monuments, signs and contingencies. Reserve funds shall be invested in an account or accounts which shall be separate from the annual operating account, in accordance with IRS regulations. Reserve funds shall be invested at the discretion of the Board of Directors who shall consider safety of principle as the highest priority, followed by liquidity of funds and lastly yield. Within these guidelines all funds shall be managed to maximize yield. A 20 year reserve plan shall be maintained to assist in establishing the amount of reserve funds required. The 20 year reserve plan shall be updated every three years and in any year that a major reserve expense occurs.

Before we get off track here, let's be sure we know what we are talking about. LLC is the designation for a limited liability corporation. It is contemporary, standardized, world-wide terminology for "inc". An LLC can just as easily be Chrysler LLC (yes, Chrysler is an LLC) or GRW & Co. LLC.

LLP is the designation for a limited liability partnership, typically a professional firm.

Nevertheless, state corporation laws differ on how the terms can be applied. In Hoosierland, Inc. or LLC are interchangeable.

Now, let's get back on task.

Thanks Mark for the opportunity to respond to this issue.

There is nothing in the law that prohibits HOAs from "showing a profit." It just means that the HOA has to pay taxes on the non-exempt income, just like any other corporation. No big deal.

The IRS rule is that 60 percent of your gross income must be exempt income (fees, assessments, etc. from homeowners) in order to take advantage of the special rules for homeowners associations.

Under Indiana law, homeowners associations are not-for-profit corporations. That means that certain income (fees, assessments, etc.) are exempt from state corporate taxes. However, other income, such as interest earned from investing a reserve fund is not exempt from taxes.

Suppose, for example, your HOA collects fees of $20,000 per year for snow removal from homeowners. However, it is a relatively snow-free year, and the HOA only spends $10,000 on snow plowing. The unspent $10,000 (surplus)is not profit (and not taxable in general), even though it shows up on your year-end financial statements as "net income."

You may be confusing the notion of net income with the concept of profit. In the not-for-profit world, "income in excess of expenditures" is not profit. Nevertheless, HOAs are required to pay taxes on certain non-exempt income.

I know this is a confusing area for board members--anything dealing with the IRS and state taxes is by definition.

Non-profit does not mean non-taxable. Nor does non-profit mean charitable--another common mistake.

Do understand that this is an effort to inform and educate, and is not intended to be tax advice upon which you should rely.

I hope this helps. Anybody else should chime in as well.

Mary - it's not something to get upset about. I don't think George was trying to single you out. He was just offering a point of clarification, and personally I appreciate his effort. As he mentioned, LLC is used interchangeably with Inc. in many places. Maybe not in AZ, but both George and Mark (the OP) ARE from IN, so George's explanation was appropriate to the question. Given how often we all tend to go off an tangents in this forum (reasonable since there are often regional differences), I think that it was even appropriate for George to try to keep us ALL "on task".

Dwight,

I WAS on task. Do a little reading on LLCs and you'll see what I mean. Before we all start giving advice on tax implications, it's important to know if this HOA is an LLC or not. The tax implications are quite different and that's what's being talked about. I don't care if IN considers LLCs the same as corps or not; the IRS doesn't. I certainly was NOT going off on a tangent. I know you're only trying to be the peacemaker, here, Dwight and I appreciate your efforts in that regard, but I do think Georgeer---- was remiss in telling me to stay on point.

Thank you George,

I'm sorry if I appeared to be more upset than I really was. Alot is lost in this type of "conversation". :-(

However, after doing a little research on LLCs (and having read the same info you posted), I really thought it wise to know whether or not this assn really is an LLC. As I'm sure you've discovered, the tax ramifications of an LLC can be very complicated. Frankly, I don't know that an HOA can really be an LLC. But, of course, that would be something best left to the professional opinion of the professionals (CPAs, Tax Attorneys, etc.).

Thx for posting the info George.

Thank you, Mark, for the clarification. I would venture to say your assn is a nonprofit corp -- period.

Glad to hear you found the comments to your message beneficial.

We aim to please! LOL

I have never come across IRS rules or regs on reserve funds in 15 years. And to do due diligence, I, too, have searched IRS regs and IRS publications for reserve fund (sinking fund, etc.) requirements and found nothing. There is really no reason that the IRS would have any interest in how reserve funds are managed.

This language sounds like meaningless "lawyerese" that I run across quite frequently in HOA documents. The sole purpose seems to be just to confuse board members unnecessarily.

Glen,

Sorry, I didn't catch that, perhaps because your quoted material was not in quotes! :-) Notice in my response to Susan's message that you quoted, I apparently said: ". . .in case there is an IRS rev. ruling. . .". As I said, I haven't been able to find one. Darn, I was hoping you would have that info for me. :-(

I'm glad to know OH has a requirement for a reserve fund; at least for condos. AZ has no such requirement.

With regard to what you say about the $100,000 limit. A banker told us we could get around that by having more than one name on the account or by having more than one account. I need to check this out with FDIC. Because, if it's as you say, then I must open another bank account NOW!!! Thx for the info and the link. Can't always believe what someone tells you!!

Susan,

I agree with you. However, I'm not aware there is a law which says they cannot. I have heard of some who do invest in the market! IMO, they should only be "investing" in money market accounts and/or CD's.

This is a great question, Susan. Thanks for asking.

First of all, one does, indeed, invest in a certificate of deposit or a money market fund. They are truly considered investment vehicles.

Investing simply is, "to put money to use, by purchase or expenditure, in something offering potential profitable returns, as interest, income, or appreciation in value."

Second, some states may have statutes or regulations that limit the vehicles homeowners associations can use for either their reserve fund or operating funds.

Third, please don't think that investing in stocks is "playing in the stock market." Properly managed, investing in stocks and other securities is appropriate for long-term goals, such as a 30-year reserve fund. So much depends on the objectives of the investment and the way in which it is managed.

There are many investment opportunities that are as "safe" as a bank savings account, but provide higher returns. Money market accounts, US Treasury funds, some mutual funds, etc. may be good choices for a homeowners association.

In the end it all comes down to the knowledge and experience of members of the board of directors, their fiduciary duty, the level of comfort with risk (everything is risky to different degrees), and how often investment funds need to be accessed for expenditure purposes.

It would make no sense to invest short-term cash reserves in a bond fund, but it might make a lot of sense to invest them in a treasury bill fund.

Every member on a homeowners association board does not need to be a financial expert. The important thing is to have an investment policy and to monitor adherence to that policy. That is something most board members are capable of doing. Actual investment performance and investing decisions can be reviewed by an investment committee of board and non-board members alike. It is a great opportunity to involve other qualified and talented members in affairs of the association without actually having them be full board members.

Rather than provide anecdotal evidence here's what the FDIC says:

Coverage Over $100,000

The FDIC provides separate insurance coverage for deposit accounts held in different categories of ownership.

You may qualify for more than $100,000 in coverage at one insured bank if you own deposit accounts in different ownership categories.
Common Ownership Categories

The most common ownership categories are:

* Single Accounts
* Certain Retirement Accounts
* Joint Accounts
* Revocable Trust Accounts

http://www.fdic.gov/deposit/deposits/insuringdeposits/index.html

They have a great FAQ page with lots of examples-- Right from the horse's mouth.

Mark,

Maybe I missed the ammount, but how much $$$ do you have on hand to invest?

Here's a question from a different angle: The idea of a reserve fund (sinking fund) is great but here is my question. -- How can a BoD sit on our money and not spend it on the items that have been approved? The BoD continues to raise our dues, increasing the reserves, but never spends anything out of those reserves. How can this happen?

Is there a point in time when the BoD should be refunding some of those funds for non-use? Just curious!!

but our BoD doesn't spend the money for what it is earmarked for ... and they are still asking for more.

They tried to get the association to approve a special assessment for a bridge repair they did not know how much it was going to cost, but wanted the homeowners to write them a check.