Academy/Taxes, Audits & Financial Compliance
Exempt-function income
The one test that decides whether your dues are taxed.
Exempt function income is money your association collects because someone owns property, not because they used something specific. It includes dues, fees, and assessments billed to every owner simply for owning, never for how much of a facility they use. At least 60% of gross income must be exempt function income to file Form 1120-H.
What actually counts
Exempt function income is dues, fees, or assessments tied to ownership itself. If every owner pays the same charge simply because they own a unit or lot, whatever it funds, landscaping, the pool, the roof, that charge is exempt function income. The trigger is ownership, not use.
"membership dues, fees, or assessments from (a) owners of condominium housing units; (b) owners of real property in the case of a residential real estate management association; or (c) owners of timeshare rights"
Source: 26 U.S.C. Section 528, Legal Information Institute, Cornell Law School
Why the label matters
A qualifying association can elect Form 1120-H and exclude exempt function income from federal taxable income, but only if at least 60% of the year's gross income qualifies as exempt function income. Gross income here includes everything, including nonmember revenue and interest, so an association with a busy clubhouse rental business or a large reserve account can fail that test even while feeling like an ordinary residential HOA.
See Section 528 basics and Form 1120-H for how the election works once you know your mix.
What does not count
Some charges look like assessments but do not qualify, because liability depends on use rather than ownership. IRS guidance lists nonmember payments, special facility charges, and interest on reserve or sinking funds as common non-exempt items, and calls out one directly:
"Members' payments for transportation."
Source: Instructions for Form 1120-H, IRS
Interest is the one that catches boards most often. Reserve fund interest is taxable whether the association files Form 1120-H or Form 1120, because it is earned on money, not paid for ownership. See Non-exempt income and Interest income for the full list and how it gets taxed.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
Your association charges every unit owner the same flat assessment, part of which funds the pool. A separate line item bills only owners who register their kids for swim lessons, based on how many lessons they take. Which portion is exempt function income?
Your association rents its clubhouse to a wedding party with no connection to the community. The rental fee is booked as "assessment income" in the ledger. For Section 528 purposes, is that classification accurate?
The board is proud that reserve funds sit in an interest-bearing account, and assumes the interest is shielded the same way exempt function income is. Is that assumption correct?
Sources
- Instructions for Form 1120-H (2025), IRS
- 26 U.S.C. Section 528, Certain Homeowners Associations, Legal Information Institute, Cornell Law School
Related elsewhere in the Academy
Taxes, Audits & Financial Compliance
Next, see how this 60% figure feeds directly into the Form 1120-H election.
Whether a specific charge counts as exempt function income depends on how it is billed, by ownership or by usage, not on what your ledger calls it. Confirm any borderline fee with a CPA who works with associations before assuming it is tax-free.