Is Your Association's Nonprofit Status at Risk?

Is Your Association's Nonprofit Status at Risk?

by Lea Countryman McClure, CFO & Vice President of Accounting for MMI

It's that time of year again: budget season. And, with budgets come the inevitable discussions of possible increases to assessment fees. Of course, everyone's goal continues to be keeping association assessments as low as possible while paying for ongoing expenses and adequately maintaining reserve funding. Although increases to assessments may appear unavoidable, many associations look at adding additional revenue streams to increase their total income. While this out of the box thinking can be extremely beneficial, additional revenue streams apart from assessment income can pose some challenges. When is the turning point where your IRS nonprofit status could be at risk? What is the effect on membership? 

With everyday costs on the rise, costs to run a community are also climbing. Community associations have varying access to additional revenue streams. Jose Mejares, a San Diego based CPA specializing in association accounting, has come across many of these additional revenue streams in his 23 years of practice.

Some typical revenue sources include laundry facilities; vending machines; community room rentals; storage room rentals; garage parking rentals; sale of non-refundable keys to nonmembers; recreation facilities; transportation vans; dock and boat rentals; golf courses; restaurants; unit-owned rentals; guest fees; resale certificates; punitive damages; and onsite maintenance to homeowners (non-common area). Additional sources include cell towers, commercial sections and profit-sharing contracts between the association and cable providers.

While these revenue streams are innovative and can be beneficial, there are some things to consider when looking al potential options. "These other sources of revenue arc beneficial to associations unless they violate statutes, governing documents or a way of life that most homeowners are accustomed to," says Mejares. For example, if homeowners complain that their views are compromised due to a cell tower, this could be a problem for the association." Furthermore, Mejares adds that these revenue sources can be problematic if they limit the association's ability to serve the community (both association members and non-association members), thus potentially putting the association's nonprofit status at risk. 

There are also potential tax impacts associations should be aware of when considering additional income sources. Jeremy Newman, CPA and President of Newman and Associates, Inc. based out of Carlsbad, CA, cautions that associations should be aware of exempt versus non-exempt and member versus non-member income as they relate to the tax impact of such revenue items on their community.

"Typically exempt associations are not precluded from earning income from business activities if the revenue is used for the direct benefit of the community and/or financing the association's social welfare programs," Newman says. "The business activity should not, however, become the association's primary business activity. The business may require the filing of a federal unrelated business income tax return, which would potentially result in taxes being due." Mejares says that, since most associations file Form 1120H, it is imperative that the board work with management and an outside tax preparer to continue to meet the 60% income and 90% expenditure test for the potential new income stream.

The 60% test states the association's gross income must be at least 60% of assessments and the like. Similarly, 90% of the association's expenses must be for the purpose of carrying out one or more of its exempt functions. When an association has additional income from sources other than assessments, it is important to consult with experts to verify that the association's nonprofit status will not be put at risk.

Ensuring the revenues help offset expenses is an important focus. As the cost of living continues to increase, there will continue to be added pressure on associations to find additional sources of income to continue paying for upkeep on the property, while simultaneously decreasing the cost burden to owners. 

As community managers, we have the opportunity to help communities think outside the box while still staying within the existing constraints of the association. Through ample planning and consulting with outside tax professionals, our associations may be able to add an additional revenue source to benefit the community and its pocketbook. 

Article was previously published in CACM's Vision Magazine. 

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