California Home Owners Association

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					State of California
Franchise Tax Board




 Guidelines for Homeowners’ Associations
CONTENTS


INTRODUCTION  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .2


HOW DO I APPLY FOR STATE EXEMPTION?  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .2


WHAT IS REQUIRED TO QUALIFY AS AN EXEMPT HOMEOWNERS’ ASSOCIATION?  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .2


ANNUAL FILING REQUIREMENTS: EXEMPT HOMEOWNERS’ ASSOCIATION  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .4


EXEMPTION AS A CIVIC LEAGUE OR SOCIAL WELFARE ORGANIZATION .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .4


EXEMPTION AS A SOCIAL CLUB  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .5


NONEXEMPT ORGANIZATIONS  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .5


BENEFITS OF TAX EXEMPTION VS . NONEXEMPT STATUS  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .6


RAFFLES  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .6


DEFINITIONS .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .6


REFERENCES  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .9


WHERE DO I GET MORE INFORMATION?  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .  .0




                                                                                                                                                                                                                                                              PAGE 
INTRODUCTION                                                   You should submit the application at least 90 calendar
                                                               days before you need exemption in order to allow
Homeowners’ associations provide maintenance, care,            adequate time for processing .
and management of residential real property . They can be
condominium management associations, residential real          You must provide all information requested in the
estate management associations, cooperative housing            Exemption Application . Specifically,
corporations, or timeshare associations . Membership in        • The information and documents requested on:
the association is a condition of owning a unit, home, or        • Side  of the application, items a through 6h .
lot in the development .                                         • Side 2 of the application, items 7a through 7i .
                                                                 • Side 4 of the application, items 9a through 9g .
If an association meets the requirements, it can be            • The original signature of an authorized individual,
exempt from the California franchise tax . Under certain         such as:
circumstances, mutual water companies that provide               • An elected officer .
water to residential members can also qualify as exempt          • A director .
homeowners’ associations . Commercial or industrial              • An authorized representative .
property does not meet the requirement that the                • A $25 check or money order payable to the Franchise
property be used for residential purposes, and under no          Tax Board for the application fee .
circumstances will it qualify as a tax-exempt homeowners’
association . Unincorporated associations usually do not       Note: To avoid delay in processing your application, send
derive a tax benefit from exemption as a homeowners’           complete information and the fee with your application .
association while incorporated associations usually do .
See the topic “BENEFITS OF TAX EXEMPTION VS .
NONEXEMPT STATUS” in this publication . (Revenue and           WHAT IS REQUIRED TO QUALIFY
Taxation Code (R&TC) Section 2370t)                           AS AN EXEMPT HOMEOWNERS’
Depending on the activities of the association, it may         ASSOCIATION?
qualify as a civic league or social welfare organization
that is exempt under R&TC Section 2370f, or as a social       The law sets forth two general requirements or tests that
club that is exempt under R&TC Section 2370g . An             each organization (regardless of the section of law under
R&TC Section 2370f organization must benefit the whole        which it is applying for exemption) must meet .
community and cannot provide for maintenance or care           The first test is the organizational test . The organization
of private property owned by members of the association .      must have a creating document that contains the
R&TC Section 2370g organizations must primarily               appropriate language for the section under which
provide social and recreational activities for members         the organization is applying for exemption . See
and cannot provide for maintenance and care of personal        “Organizational Test for Corporations or Unincorporated
residences or property . These types of organizations are      Associations” below for samples of a creating document .
discussed briefly in this publication .
                                                               The second test is the operational test . The organization
The information in this publication answers the most           must be doing something and the section of law under
frequently asked questions about becoming a tax-exempt         which the organization is applying for exemption must
homeowners’ association .                                      permit its activities . If the organization is inactive, it will not
                                                               qualify for exemption . For homeowners’ associations, two
                                                               other tests are part of the operational test . They are the
HOW DO I APPLY FOR STATE                                       source of income test and the expenditures test . (R&TC
EXEMPTION?                                                     Section 2370t)

The procedures for obtaining an exemption from                 Organizational Test: Corporations
California state tax differ from obtaining an exemption        A corporation is created when the Secretary of State files
from federal tax . Unless you apply for and receive            its Articles of Incorporation . The articles must meet the
a written determination of exemption from us, your             requirements of the California Corporations Code and, if
organization will remain a taxable nonexempt organization      the corporation applies for exemption, the requirements of
for state purposes . Its federal status, or the fact that it   the California Revenue and Taxation Code pertaining to
filed Form 20-H, U.S. Tax Return for Homeowners’             exemption . The following example meets the requirements
Associations, with the Internal Revenue Service is             of both codes for homeowners’ associations other than
irrelevant . (R&TC Section 2370t)                             cooperative housing corporations:

Apply for exemption from state income tax by filing a
FTB 3500, Exemption Application . Go to ftb.ca.gov and
search for 3500, or you can use our automated toll-free
phone service to order the form . Call 800 .338 .0505
and select Business Entity Information . The code for
Form 3500 is 802 .



PAGE 2
            ARTICLES OF INCORPORATION                           You can amend an existing document to include these
                                                                provisions or you can adopt a new document . In either
                              I                                 case, each member of the board of directors must sign
The name of this corporation is _____________________           the new instrument or amendments .
______________________________________________ .                Operational Test
                             II                                 General Requirements: Your organization must operate
                                                                within the requirements of Revenue and Taxation Code
This corporation is a nonprofit mutual benefit corporation      Section 2370t . If the organization is not active, it does
and is not organized for the private gain of any person .       not meet the operational test and will not qualify for
The purpose of this corporation is to engage in any lawful      exemption . We will consider your organization to be
act or activity for which a corporation may be organized        operating within the requirements of R&TC Section 2370
under such law .                                                if it meets ALL of the following requirements:
                             III                                • Source of income test: 60 percent or more of
                                                                     gross income is from membership dues, fees, and
The specific purpose of this corporation is to operate               assessments . In the case of a cooperative housing
a homeowners’ association within the meaning of                      corporation, payments from stockholder members
Section 2370t of the Revenue and Taxation Code .                    to pay acquisition indebtedness or other fees are
                             IV                                      considered fees and assessments .
                                                                • Expenditure test: 90 percent or more of the expenses for
The name and address in the State of California of this              the year are for acquisition, construction, management,
corporation’s initial agent for service of process is_______         maintenance, and care of association property or, in the
______________________________________________ .                     case of a timeshare association, for activities provided
                             V                                       to or on behalf of the members of the association .
                                                                • No part of the net earnings are used to benefit any
Notwithstanding any of the above statements of purposes              private individual other than in the normal course of
and powers, this corporation shall not, except to an                 activities of the association .
insubstantial degree, engage in any activities or exercise      • Amounts received as membership dues, fees, and
any powers that are not in furtherance of the specific               assessments are transferred and held in trust to
purpose of this corporation .                                        provide for the management, maintenance, and care of
                                                                     association property if they are not used for association
               _______ (Signature of Incorporator)______
                                                                     purposes during the year .
                (Typed name of incorporator), Incorporator
                                                                Mutual Water Company Requirements: If your
Organizational Test: Unincorporated Associations                organization is a mutual water company, it must meet the
An unincorporated association may be created by a               general requirements under “Operational Test” above and
constitution, articles of association, or bylaws which          the following must be true in order to qualify for exemption:
contain the required language to meet the organizational        • Your members use the water for residential purposes only .
requirement . The following format is acceptable:               • You do not determine the amount due based on the
 . The name of the organization .                                 amount of water the member uses . Instead, you assess
2 . A statement indicating that the organization is                or charge the members for water on an equal basis or
    organized for nonprofit purposes and that the individual       based on the size or value of each member’s property .
    members will not derive profit from the organization . An   • If you use meters to charge for water used, income
    appropriate clause is:                                         from metered assessments based on quantity of water
       “This organization does not contemplate financial           used does not, when combined with other nonexempt
       gain or profit to its members and is organized for          function income, exceed 40 percent of total receipts .
       nonprofit purposes .”
                                                                Metered charges for water will be considered exempt
3 . The specific and primary purpose of the organization .
                                                                function income to the extent the amount assessed is a
    An appropriate clause is:
                                                                flat rate for a specified quantity of water . Metered charges
       “The specific and primary purpose of the association
                                                                based on use is income for services . As such, it is taxable .
       is to operate a homeowners’ association within the
       meaning of Section 2370t of the California Revenue      Note: California law does not have anything comparable
       and Taxation Code .”                                     to Section 50(c)(2) of the Internal Revenue Code
4 . A limitation clause . An appropriate clause is:             granting exemption to certain mutual ditch or irrigation
       “Notwithstanding any of the above statements of          companies . Therefore, federal exemption under
       purposes and powers, this organization shall not,        Section 50(c)(2) does not guarantee the company
       except to an insubstantial degree, engage in any         qualifies for state exemption .
       activities or exercise any powers that are not in
       furtherance of the specific purpose of
       this organization .”




                                                                                                                     PAGE 3
ANNUAL FILING REQUIREMENTS:                                      • Use the same tax rate that is used for taxable
                                                                   corporations .
EXEMPT HOMEOWNERS’                                               • The association is not subject to the minimum
ASSOCIATION                                                        franchise tax .
                                                                 • Estimated tax payments may be required .
If your homeowners’ association has been granted
tax-exempt status, it may be required to file Form 99           Taxable Income
and/or Form 00 . The requirement to file either form is         Taxable income is the association’s total gross income
independent of the requirement to file the other form . The      minus exempt function income and any deductions
amount and type of income received are the determining           directly connected with the production of the gross
factors . For specific details, refer to the forms and           nonexempt function income . Taxable income includes:
instructions for the taxable year in question .                  • Interest (including interest from members) .
                                                                 • Dividends .
Form 199, California Exempt Organization Annual                  • Nonmember receipts .
Information Return                                               • Gains from the sale of property .
The requirement to file Form 99 is generally based on           • Health service fees from members .
the normal amount of total gross receipts and pledges .          • Meals or food service fees from members .
Normal is defined as a three-year average .                      • Housekeeping service fees from members .
If gross receipts and pledges are normally:                      • Laundry use fees from members .
• Less than $25,000, you are not required to file                • Amounts received from members for use of a facility for
    Form 99 .                                                      an evening, weekend, week, etc .
• Greater than $25,000, you are required to file                 Expenses
    Form 99 .                                                   Expenses or losses relating to production of exempt
Use this table to decide if you must file Form 99               function income cannot be used as deductions or offsets
                                                                 against taxable income . Identifying expenses attributable
 If your organization has       File Form 199 if the gross       to taxable nonmember income can be difficult . Direct
 existed                        receipts/pledges exceed          expenses, such as fees on the sale of property, are
  year or less                 $37,500                          deductible because they are directly related to the
 More than  year, but less     $30,000 average for both         income from the sale . Deciding whether other expenses
 than 3 years                   years                            are deductible is not so clear cut . For instance, the
                                                                 association may have expenses for accounting and
 3 years or more                $25,000 average for the          bookkeeping services, collecting member dues and fees,
                                current year and the             making deposits and paying bills . The organization will
                                immediate preceding              incur these expenses whether or not the activity produces
                                2 years                          taxable income . If the bank account accrues interest,
File Form 99 on or before the 5th day of the 5th month         that interest is taxable income . The association may
after the close of your organization’s taxable year . If the     incur some additional expense in causing that interest to
taxable year ends on December 3, the return is due on           accrue . However, the additional expense is incidental
May 5 .                                                         to – rather than directly related to – the accrual of the
                                                                 interest income . Our policy allows a deduction for the
If you file Form 99, you pay a filing fee with the return .     greater of one percent of taxable nonmember investment
The amount depends on when you file, and when you                income or $00 to organizations unable to determine and
make the payment .                                               fully substantiate deductions directly attributable to the
                                                                 nonexempt function income .
The fee is $0 if:
• You file and pay by the original due date .
• You file and pay after the original due date, but on or
  before the extended due date .                                 EXEMPTION AS A CIVIC LEAGUE OR
The fee is $25 if:                                               SOCIAL WELFARE ORGANIZATION
• You file by the original due date, but pay after that date .   An association may qualify for exempt status under
• You file and pay after the extended due date .                 R&TC Section 2370f as a civic league or social welfare
For further information regarding due dates or extended          organization if it can show that it operates primarily for a
due dates, go to ftb.ca.gov and search for 199 .                 public purpose rather than for the benefit of its members .

Form 100, Corporation Franchise Or Income Tax Return             Some ways this may be done are:
If the nonexempt function income (income subject to tax)         • The community served by the association is a
for the year exceeds $00, the organization must file              geographic unit similar to a governmental subdivision .
Form 00 and:                                                    • The association does not maintain the exterior of
• The due date is the 5th day of the 3rd month after the          private residences .
    close of the taxable year . If the taxable year ends on
    December 3, the due date is March 5 .


PAGE 4
• The association owns and maintains:                         • It has not filed the FTB 3500A, Submission of
  • Areas and facilities of direct governmental concern         Exemption Request, with a copy of the federal
    such as roadways, parklands, sidewalks, and                 determination letter under IRC Section 50(c)(3) .
    streetlights which are available to the general public;   • It filed FTB 3500, but we denied exemption because
    OR                                                          the organization did not qualify .
  • Recreational areas and facilities for the use and         • We revoked the organization’s exemption because
    enjoyment of the general public . The association will      the organization:
    not qualify if it owns and maintains parking facilities     • No longer qualified for exemption .
    only for its members .                                      • Failed to comply with exempt organization
                                                                    filing requirements .
Homeowners’ associations that may qualify under R&TC            • Failed to pay a balance due .
Section 2370f include a neighborhood watch and an
organization representing the concerns of an entire           Filing Requirements For Nonexempt Organizations
community before elected or appointed public bodies .         If your organization is incorporated, but not exempt, it
                                                              is required to file Form 00, Corporation Franchise or
Filing Requirements                                           Income Tax Return, by the 5th day of the 3rd month after
Exempt civic leagues or social welfare organizations may      the close of each accounting period and pay at least the
be required to file Form 99 . The requirements are the       minimum franchise tax .
same as for exempt homeowners’ associations .
                                                              If your association is unincorporated and not exempt, it is
These organizations may be required to file Form 09,         required to file Form 00 and pay tax at the corporate rate
Exempt Organization Business Income Tax Return, if they       on any taxable income for the year . However, the association
have unrelated business income in excess of $,000 . For      is not required to pay the minimum franchise tax .
more information regarding filing requirements, go to
ftb.ca.gov and search for 109 .                               Note: Corporations and unincorporated associations that
                                                              are not exempt should not file Form 99 . They should file
                                                              only Form 00 .
EXEMPTION AS A SOCIAL CLUB                                    Taxable Income: Nonexempt Membership
An association may qualify for exemption under R&TC           Organizations
Section 2370g if all of the following are true:              As an entity that is not exempt, you may exclude all
• It owns and maintains recreational facilities .             income from business activities for, or with, members and
• Only members can use the facilities .                       income from nonprofit activities with nonmembers when
• No part of the association’s earnings benefit the private   determining taxable income . All other income is taxable .
  interest of any member .                                    Income which comes from outside the normal scope
• No more than 35 percent of its total income is from a       of the association’s activities is considered taxable
  combination of nonmember and investment income              income (e .g ., interest (including interest from members),
  and is within this 35 percent limitation; no more than      dividends, and capital gains) .
  5 percent of gross receipts may be derived from
  nonmember use of club facilities and/or services .          Expenses: Nonexempt Membership Organizations
• It does not own or maintain residential property that is    An expense must be directly related to the item of income
  not part of the recreational facilities .                   to be deductible from that income . You may not deduct
• It does not enforce the covenants regarding                 expenses that are attributable to nontaxable income
  architecture or appearance of structures .                  from taxable income . For more information, see Taxable
                                                              Income under “ANNUAL FILING REQUIREMENTS:
Filing Requirements                                           EXEMPT HOMEOWNERS’ ASSOCIATIONS .”
Exempt social clubs may be required to file Form 99 . The
requirements are the same as for exempt homeowners’
associations .
                                                              BENEFITS OF TAX EXEMPTION VS.
These organizations also may be required to file              NONEXEMPT STATUS
Form 09, Exempt Organization Business Income
Tax Return, if they have unrelated business income in         The benefits of exemption vary, or may even be
excess of $,000 . For more information regarding filing      nonexistent, depending upon several factors . The
requirements, go to ftb.ca.gov and search for 109 .           questions to be considered are:
                                                              • Is the organization incorporated?
                                                              • How much income is received?
NONEXEMPT ORGANIZATIONS                                       • Of that income, how much of it is taxable?

An organization is not exempt from state franchise or         An incorporated organization must consider the minimum
income tax if:                                                tax that may be due if it is not exempt . Also, the types of
• It has not filed the FTB 3500, Exemption Application,       income that are taxable vary depending upon whether
   and been granted exemption .



                                                                                                                   PAGE 5
or not the organization is exempt . For example, interest          DEFINITIONS
on government obligations is taxable to the nonexempt
corporation but not taxable to the exempt organization .           The following information and definitions are important
                                                                   in determining whether your organization qualifies for tax
An unincorporated association may not derive any tax               exemption as a homeowners’ association .
benefit from exemption since member income (and
nonmember income received on a nonprofit basis) can                Association Property
be excluded under R&TC Section 24405 . Unlike an                   Real or personal property held by the organization or held
incorporated association, interest earned on government            in common by members of the organization is considered
obligations is not taxable regardless of whether or not            association property if it is available for the common benefit
the association is exempt . An unincorporated association          of all organizational members and tends to increase the
without exemption should not file Form 99 . However, it           enjoyment of the private residences by their owners (e .g .,
must file Form 00 to report taxable income .                      swimming pools and tennis courts) . On the other hand,
                                                                   facilities or areas set aside for nonmembers, or used
If the organization is exempt, Form 99 may be required            primarily by nonmembers, are not association property
along with payment of the fee . The fee is $0 if paid on          (e .g ., property owned by an organization for the purpose of
time or $25 if paid late . Also, there is a penalty if the Form    leasing it to nonmembers is not association property) .
99 is filed late . That penalty is $5 per month up to a
maximum of $40 .                                                   Property held privately by members of the association
                                                                   qualifies as association property if:
                                                                   • It affects the overall appearance or structure of the
RAFFLES                                                              property (e .g ., exterior walls, roofs, and landscaping) .
                                                                   • There is a covenant relating to the exterior appearance
As of July , 200, certain exempt organizations (including          or maintenance that applies to all property in the project .
homeowners’ associations, civic leagues, social welfare            • There is a mandatory assessment at least once a
organizations, and social clubs) may conduct raffles if they         year on all members of the association for maintaining
meet the requirements specified in California Penal Code             this property .
Section 320 .5 . Following are some of the requirements            • Membership in the association is a condition of every
specified in that section . Please note, the list is not             person’s ownership of property within the project .
all-inclusive:
• Organization                                                     Areas and facilities traditionally thought of as being
    The organization must:                                         owned by a governmental unit are included in association
    • Be exempt under the California Revenue and                   property (e .g ., roadways, parklands, sidewalks,
       Taxation Code .                                             streetlights, etc .) .
    • Register each year with the Registry of Charitable           In the case of a timeshare association, association
       Trusts in the office of the California Attorney General .   property is property that the timeshare association,
• Selling Tickets and Conducting Raffles                           or members of the association, have the right to use
    • The tickets must be paper and must have a                    because of recorded easements, covenants, or recorded
       detachable coupon or stub, both of which have a             instruments related to the timeshare project . (Effective for
       unique and matching identifier .                            taxable years beginning January , 998, or later .)
    • A person must manually draw the winning ticket .
• Use of the Funds                                                 Condominium Management Association
    The organization must:                                         This is an organization created for the purpose of
    • Use the funds in California .                                managing a condominium development . It is composed
    • Use at least 90 percent of the gross receipts from           of owners of separate units within a condominium project .
       any raffle for the organization’s own support or            The owners also are co-owners or tenants-in-common in
       beneficial purposes, or for charitable purposes .           the common areas of the project .
       However, the association may not use any of these           Cooperative Housing Corporation
       dedicated funds to compensate any person in                 A cooperative housing corporation is an incorporated entity
       connection with the operation of the raffle .               that holds title to improved real property . The members of
Questions                                                          the association receive a right of exclusive occupancy in a
The Registry of Charitable Trusts, in the office of                portion of the property through stock ownership .
the California Attorney General, is responsible for                Note:
administering the law . If you have any questions regarding         . For federal purposes, a cooperative housing
the detailed requirements or how to register, please                   corporation does not qualify for exemption as a
contact that office by either:                                         homeowners’ association .
• Phone: 96 .445 .202                                            2 . A limited-equity housing cooperative is included in
• Mail:      OFFICE OF THE ATTORNEY GENERAL                            the definition of cooperative housing corporation.
             ATTN: NONPROFIT RAFFLE PROGRAM                            However, the organizational requirements for a limited-
             1300 I STREET SUITE 1130                                  equity housing cooperative are different from those for
             PO BOX 903447                                             homeowners’ associations in general . See the definition
             SACRAMENTO CA 94203-4470                                  for “Limited-Equity Housing Cooperative .”


PAGE 6
Dual Use of Facilities or Personnel                              • Holds a leasehold interest of at least 20 years duration
If facilities or personnel are used, both for exempt               and conditioned on the corporation’s continued
functions of the association and production of nonexempt           qualification as a limited-equity housing cooperative .
function income (income subject to tax), the expenses              The property must revert to a public or charitable entity .
shall be allocated between the two activities . Only
that portion of the expenses directly connected to the           The articles of incorporation or the bylaws require:
production of nonexempt function income is deductible .          • The corporation to buy back the stock or membership
The association should be prepared to fully substantiate           interest of resident owners who cease to be
that the deductions taken against taxable income are not           permanent residents .
exempt function expenses . The position of the Franchise         • The corporation to sell the stock or membership
Tax Board as to directly related expenses is discussed             interest bought back from former members to new
under ANNUAL FILING REQUIREMENTS: EXEMPT                           members at the same price it paid for the stock or
HOMEOWNERS’ ASSOCIATIONS .                                         membership interest .
                                                                 • The affirmative vote of two-thirds of the resident owners
Exempt Function                                                    or shareholders to amend the articles of incorporation
This is the purpose for which an exempt organization is            or bylaws .
formed . In the case of an exempt homeowners’ association,
it is the acquisition, construction, management,                 Nonexempt Function Income (Income Subject to Tax)
maintenance, and care of association property .                  • Amounts received from nonmembers .
                                                                 • Interest earned on amounts set aside for future repairs
Exempt Function Income                                             or improvements .
This is an amount received as membership dues, fees,             • Amounts received for work done on privately-owned
or assessments from members as owners, rather than as              property, which is not association property (e .g .,
customers, of the association’s services .                         painting of interior walls) .
                                                                 • Amounts received from members in return for their
Dues, fees, or assessments will not be considered
                                                                   transportation to or from shopping areas, work
exempt function income unless each member’s liability
                                                                   locations, etc .
for payment arises solely from membership in the
                                                                 • Amounts received from members for special use of the
association . Amounts based on the value or size of
                                                                   organization’s facilities .
property are considered exempt function income .
                                                                       Exception: Amounts received from member-tenants
However, amounts based on the extent a member makes
                                                                       of residential units owned by members for special
use of the facility are not exempt function income .
                                                                       use of an association’s facilities will be considered
Generally, for membership dues, fees, or assessments                   as exempt function income if:
on a residential unit to be exempt function income,                • The member paid only once in any 2-month period .
the unit must be used for, or expected to be used for,             • The privilege obtained from the payment lasts for
residential purposes .                                                 the entire 2-month period or portion of the period in
                                                                       which the facility is commonly in use .
Note:                                                                  Examples:
 . Dues, fees, or assessments paid to an organization by           . An annual fee for use of tennis courts or swimming
    a developer on unfinished or finished units or lots that           pools is considered exempt function income .
    are unsold are exempt function income, even though             2 . A payment for the use of a building for an evening,
    the developer does not use the units or lots .                     weekend, week, etc ., is not considered exempt
2 . Excess assessments made during a tax year that                     function income .
    are rebated to members or applied to their future            • Amounts that would be taxable income under
    assessments are considered exempt function income              Section 2370t except they are excluded from gross
    for that tax year . However, if the excess assessments         income under general tax law (e .g ., interest earned
    are applied to a future year’s assessments, they also          on obligations of the United States) are nonexempt
    will be considered exempt function income for that             function income . As such, this income ordinarily would
    specific future year .                                         be taxable . However, since it is not subject to California
Limited-Equity Housing Cooperative                                 corporation income tax, it is also not taxable to the
This definition is found in Section 33007 .5 of the California     exempt homeowners’ association .
Health and Safety Code . A limited-equity housing                Qualifying Expenditures: 90 Percent Test
cooperative is a corporation that is organized on a              At least 90 percent of the association’s expenses
cooperative basis and is one of the following:                   must be to acquire, construct, manage, maintain, and
• Incorporated under the Nonprofit Public Benefit Law .          care for association property . They can be for current
• Holds title to real property as the beneficiary of a trust     operating expenses or for capital expenditures . Qualifying
  that provides for the distribution of the property to a        expenditures include expenditures on association
  public or charitable entity upon termination of the trust .    property, even if the property may produce income
• Holds title to real property subject to conditions that        that is nonexempt function income (e .g ., expenditures
  will result in distribution of the property to a public or     on a swimming pool are qualifying expenditures even
  charitable entity upon dissolution of the corporation .



                                                                                                                      PAGE 7
though guests’ fees are not exempt function income) .         Residential real estate management association:
Expenditures used both for association property and other     The lots (including unimproved lots) or buildings will be
property must be allocated on a reasonable basis . Some       considered used by individuals for residences if at least
examples of qualifying expenditures are:                      85 percent of the lots are zoned for residential purposes .
• Salaries of an association manager and secretary            Lots are considered zoned for residential purposes even
• Security guards                                             if they may be used for parking spaces, swimming pools,
• Legal and accounting fees                                   tennis courts, schools, fire stations, libraries, churches, or
• Current operating expenses for tennis courts,               some other purpose that is auxiliary to residential purposes .
   swimming pools, and recreation halls                       However, shopping areas are not residential areas .
• Replacement of common buildings and facilities
                                                              Timeshare Association
• Real estate taxes imposed on association property
                                                              A timeshare association is an organization in which
Residential Real Estate Management Association                members own a common interest in real property and
An association composed, generally, of owners of              take turns occupying it .
single-family dwellings located in a subdivision,
                                                              Timeshare associations may qualify for exemption as a
development, or similar area is formed to enforce the
                                                              homeowners’ association under R&TC Section 2370t for
covenants relating to architecture and appearance of the
                                                              taxable years beginning January , 998, or later .
development and to maintain the common areas .
                                                              Prior to January , 998, if a unit or building was occupied
Substantially All Test
                                                              by a person or series of persons each of whom occupied
Substantially all means almost all . The test is, of
                                                              the unit or building for fewer than 30 days, the unit or
necessity, somewhat different depending upon the type of
                                                              building was not considered to have been used for
residences that are owned by members of the association .
                                                              residential purposes . Consequently, it did not qualify for
Condominium management association: At least                  exemption as a homeowners’ association .
85 percent of the total square footage of the units in the
association project is used by individuals for residential
purposes . The term used for residential purposes includes
the following:
• A unit constructed for use as a residence but
   never occupied .
• A unit, which is not occupied but has been in the past,
   if it was constructed for use as a residence and the
   individual who occupied it used it as a residence .
• Units that are used for purposes auxiliary to residential
   use such as laundry areas, swimming pools,
   tennis courts, storage rooms, and areas used by
   maintenance personnel .




PAGE 8
REFERENCES
                    Topic                              California Laws                 Federal Laws
 Exempt homeowners’ association              Revenue and Taxation Code       Internal Revenue Code Section 528
                                             Section 2370t
 Exempt civic leagues and social             Revenue and Taxation Code       Internal Revenue Code Section
 welfare organizations                       Section 2370f                  50(c)(4)
 Exempt social clubs                         Revenue and Taxation Code       Internal Revenue Code Section
                                             Section 2370g                  50(c)(7)
 Davis-Stirling Common Interest              Civil Code Sections 350-376   N/A
 Development Act
 Definition of a limited-equity housing      Health and Safety Code          N/A
 cooperative                                 Section 33007 .5
 Raffles                                     Penal Code Section 320 .5       N/A



WHERE DO I GET MORE INFORMATION?
To order FTB 3500, Exemption Application:
 .   Call 800 .338 .0505 .
2 .   Select Business Entity Information .
3 .   Select Forms and Publications .
4 .   Enter the three-digit code 802 when instructed to do so .
Download form at ftb.ca.gov and search for 3500 .

Internet and Telephone Assistance
Website: ftb.ca.gov
Phone:   800 .852 .57 from within the United States
         96 .845 .6500 from outside the United States (not toll-free)
TTY/TDD: 800 .822 .6268 for persons with hearing or speech impairments

Asistencia Por Internet y Teléfono
         ftb.ca.gov
Sitio web:
Teléfono:800 .852 .57 Dentro de los Estados Unidos
         96 .845 .6500 Fuera de los Estados Unidos (cargos aplican)
TTY/TDD: 800 .822 .6268 Personas con discapacidades de la audición y del habla

Mail
You can also order forms by writing to:
               TAX FORMS REQUEST UNIT
               FRANCHISE TAX BOARD
               PO BOX 307
               RANCHO CORDOVA CA 9574-0307




                                                                                                             PAGE 9
FTB PUB 028 (REV 04-2009)