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504.1 The majority of CIRAs will not qualify for tax exemption under IRC Section 501. For those few that will qualify, they will qualify either under
IRC Section 501(c)(4) as a “social welfare organization,” or under IRC Section 501(c)(7) as a “recreational organization” (HTL—Appendix 2J).
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There are two main reasons that associations seek tax exempt status
One reason is to eliminate the risks associated with filing Form 1120. The other reason is to reduce or eliminate federal taxes.
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IRC Section 501(c)(4) organizations pay no taxes on exempt function activities, including
investment earnings.
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However, the net income of unrelated business activities (such as newsletter advertising)
is still subject to taxation.
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IRC Section 501(c)(7) organizations are treated similarly, except
that investment earnings are taxable, as well as transactions with nonmembers
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504.2 Unlike the election under IRC Section 528, which is made annually by filing Form 1120-H, qualification for exemption under IRC Section 501 requires
a formal application process, and submission of Form 1024, (Application for Exemption) to the IRS.
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504.4 CIRAs generally do not qualify as tax-exempt organizations primarily because they serve only
their members and do not serve the “community” as defined by the IRS in Revenue Ruling 80-63
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Condominium associations that perform maintenance of building exteriors are deemed to primarily serve their members
and thus will not qualify for exemption under either IRC Section 501(c)(4) or (7)
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504.5 Section 501(c)(4) requires that the exempt organization serve a
“community,” but does not define “community.”
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504.6 The Internal Revenue Code defines 501(c)(4) organizations as follows:
- Civic leagues or
- organizations not organized for profit but operated exclusively for the
- promotion of social welfare, or local associations of employees, the
- membership of which is limited to the employees of a designated person
- or persons in a particular municipality, and the net earnings of which
- are devoted exclusively to charitable, education, or recreational
- purposes.
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504.7 To qualify for the 501(c)(4) exemption, a CIRA (other than a cooperative) must meet the following requirements:
- a. The CIRA must serve a
- “community” that bears a reasonably recognizable relationship to an area
- normally identified as a governmental unit.b.
- It must not conduct activities directed to the exterior maintenance of
- any private residence. (That automatically excludes condominium
- associations from qualifying under IRC Section 501(c)(4); only homeowners' associations are able to qualify if they do not perform exterior maintenance on private residences.)c. Common areas of the CIRA must be for the use and enjoyment of the general public.
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504.11 “Gated” Associations The IRS routinely takes the position that, if an association is a “gated community,”
- the association has denied access
- to the public, and, therefore, it does not serve the “community” as
- defined in the code, regulations, and revenue rulings. Having a gate
- does not necessarily disqualify an association from obtaining exempt
- status, however.
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Homeowners' Associations under Section 501(c)(7)504.14 The major benefit of an IRC Sec. 501(c)(7) (HTL—Appendix 2J) exemption is that an association's net membership income
is not subject to taxation.
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One disadvantage to the Section 501(c)(7) exemption, as compared to the Section 501(c)(4) exemption
is that associations must pay taxes on interest income.
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504.15 IRC Sec. 501(c)(7)
applies to “social” or “recreational” organizations. That section and
its related regulations require that an organization be operated exclusively
for “pleasure, recreation, and other nonprofitable purposes” to qualify under IRC Sec. 501(c)(7)
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