Academy/Taxes, Audits & Financial Compliance
Non-exempt income
Not every dollar your association collects gets the tax break. Here is what still counts as taxable, and why.
Non-exempt function income is any HOA income that doesn't come solely from membership, including nonmember payments, usage-based facility charges, and interest on reserves. It's taxable whether the association files Form 1120-H or Form 1120. The label in your books doesn't change how the IRS classifies the money.
What counts as non-exempt income
Exempt function income is dues, fees, or assessments where a member's liability comes purely from owning property, not from using anything specific. Everything else is non-exempt, and IRS guidance for Form 1120-H lists several common examples: payments from nonmembers, special facility charges, interest earned on reserve or sinking funds, and a specific carve-out for transportation charges.
"Members' payments for transportation."
Source: Instructions for Form 1120-H (2025), IRS
A per-use pool pass, a fee for renting the clubhouse, a charge tied to how much a member actually uses a gate or amenity: all of it lands on the taxable side, even when the association's books call it an assessment.
Interest is the most common trap
Boards often assume money sitting in a reserve fund is shielded because it exists to fund property maintenance. It isn't. Taxable interest earned on that fund is non-exempt function income and gets reported separately on Form 1120-H, whether the association files that form or the regular Form 1120. Only interest that is independently tax-exempt, such as interest from certain municipal obligations, is excluded, and even that goes on its own line rather than being folded into exempt function income. See Interest income for the full rule.
It's taxed no matter which return you file
Federal law does not exempt an association by default. As the statute puts it directly:
"A homeowners association shall be subject to taxation under this subtitle only to the extent provided in this section."
Source: 26 U.S.C. Section 528, Legal Information Institute, Cornell Law School
Filing Form 1120-H excludes exempt function income from tax, but the non-exempt income covered here still gets taxed at a flat rate. Filing the regular Form 1120 instead puts everything, exempt and non-exempt alike, on the table at the standard corporate rate. Either way, nonmember payments, usage-based charges, and interest do not disappear. Whether this income is also subject to state income tax or state sales tax varies by state; check with a CPA licensed there.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
A pool fee varies based on how many passes each homeowner buys. Is this exempt function income?
The association earns $4,000 in interest on its reserve fund this year. How is that interest treated on Form 1120-H?
The association rents its clubhouse to a nonmember for a wedding. What happens to that rental income at tax time?
Sources
- Instructions for Form 1120-H (2025), IRS
- 26 U.S.C. Section 528, Certain Homeowners Associations, Legal Information Institute, Cornell Law School
Taxes, Audits & Financial Compliance
Want to see how non-exempt income actually gets taxed on the return? Read Form 1120-H next.
Whether nonmember payments, facility fees, or interest also trigger state income tax or sales tax varies by state and by what is being charged for; confirm with a CPA licensed in your state.