HOA Special Assessments Explained
HOA special assessments are one-time fees levied on the homeowners of a community that are used to fund maintenance or other projects that would not be covered by the association’s budget. Sometimes these costs include maintenance or improvements of common areas such as clubhouses or pools, while at other times they go to other updates or improvements of the homes in the community. In some cases, special assessments may go toward the construction of new homes in a previously vacant part of the neighborhood, thereby increasing the number of residents. They are commonly voted in on by the HOA board and are usually assessed in proportion to the square footage of the owners’ homes.
They can often vary from $300 to thousands of dollars or more depending on the scope of the project in question. They are usually assessed based on characteristics of each property for which a special assessment is being levied. For example, if the HOA board decides that it needs extra money because a particular subdivision in the community has an omission in its roof that was never sealed, after determining what the total eligible cost would be, they may portion out the fee of the work to be done. If the work would cost $12,000 total, and there are 12 homeowners whose roofs need to be repaired, the HOA may decide that each homeowner would owe $1,000 to make the repairs. This fee is assessed above and beyond the normal monthly assessments that the homeowners already pay, and are used only to pay for the work that it is assessed for. In addition , special assessments cannot continue indefinitely. An association cannot levy a special assessment each year, and always claim it is too "special" to be included in the annual assessments that home or unit owners are used to paying each month.
For property owners who own a rental home in an HOA community, the special assessment is the owner’s financial responsibility, not that of the tenant unless it was agreed to in the lease or rental contract. They are forwarded to the tenant if the lease states that it is the tenant’s responsibility, and sometimes are charged separately with rent. Homeowners are generally charged for the special assessment along with their normal monthly assessment when the payment is due. Special assessments differ from regular assessments in these ways:
If the assessment was not voted in on by the homeowners of a community, then it was likely voted in on by the HOA Board. condominium associations, HOAs and other common interest communities are governed by MO statutes 415.120 – 415.130 of the code which require any special assessment levied by the board to be ratified by a majority of the members of the community. In addition, the HOA board must make a reasonable effort to notify the homeowners of any special assessment in accordance with Chapter 415.170.
Special assessments can be subject to the same deductions as regular HOA assessments, and tenants can deduct their portion of the special assessment amount if it is explicitly stated in their lease agreement. If you do it correctly – you can deduct the amount of HOA assessments paid for each of your properties.
Tax Consequences for Investment Properties
Rental property owners are in a unique tax situation. Rental properties are typically either single-family homes or two- to four-plexes. For any property "production or management of income" is a key purpose, but, for typical single-family homes or two- to four-plexes, appreciation of the property also plays an important role.
Rental property owners typically depreciate the value of the home for tax purposes. In addition to home and property tax deductions, rental property owners are entitled to depreciation deductions as well. Any HOA special assessments paid by the owner should be capitalized into the basis of the property as part of the property improvement, unless the special assessment qualifies as an impact fee, which must be deducted in the year paid. Should the property be sold for a gain (i.e. appreciation had occurred), the amount of the special assessment paid would be included in the calculation of the taxpayer’s basis which would reduce the gain on the sale. Although the HOA special assessment paid would increase the owner’s basis in the property, the special assessment would not be deductible as HOA fees are not "ordinary and necessary" rental expenses per IRS regulations.
Can I Deduct HOA Special Assessments?
HOA special assessments are deductible expenses if the underlying cost is one that would otherwise be deductible. For example, if an HOA special assessment is related to repairing the community swimming pool, the unit owner can claim the expense as a deductible rental expense to the extent the property qualifies as a rental property.
If the assessment is not related to the unit, such as to renovate a common area in the community with no benefit to the unit, then the expense will likely not be deductible as an expense of the rental property but rather as an improvement to the common area.
In general, improvements to items with a useful life of more than one year must be capitalized. However, the Code allows the immediate deduction of capital improvements costing less than $200. Currently, any amount in excess of $200 should typically be capitalized.
There are of course other more complex rules in this area which may apply to specific situations, and you should consult with tax advisors to determine the appropriate method of accounting for the capitalized or non-capitalized improvement.
What Affects Deductibility
There are several variables that can affect the deductibility of a special assessment. For instance, the purpose of the assessment may be a factor. A special assessment to repair a leaky roof or to renovate an existing structure may be deductible, whereas an assessment to build a new clubhouse or swimming pool may not. However, special treatment for improvement items applies to improvements that extend the useful life of the property, adapt the unit for a new use, or have a useful life beyond the current tax year. Such items as repairs to the clubhouse or routine landscaping maintenance will not qualify for special treatment. The deduction of the repair or improvement item may be disallowed if it results in a "betterment to the unit." A betterment occurs when an improvement: In determining whether a repair or replacement qualifies for the safe harbor, improvements to adjacent property can potentially be taken into account. However, the IRS has said that only improvements to common areas can be considered. The classification of a particular expenditure as a repair or improvement item remains highly factual, and confusion can result when difficulties arise in distinguishing between what is a repair and what is a capital improvement to a unit. If the special assessment increases the property’s value or useful life, it will likely be considered a capital improvement and must be capitalized (added to the basis of the property) rather than expensed. If the special assessment is to improve an individual unit, there is a lot of uncertainty—a first floor unit with an assessment to "elevator-proof" the unit so that the owner does not have to worry about being trapped on an upper floor with a power outage might be deductible as a repair, whereas an assessment to replace the windows in the unit with new windows might be considered a capital improvement that must be capitalized.
The timing of the deduction may also be an issue. Special assessments paid in the same year that the assessment is declared by the Board and in the same year that the repairs are made or are to be made are more likely to be deductible in the year that the assessment is paid. However, if the repairs are to be made in a future year, the IRS guidelines discourage deducting the assessment in the year it is paid and instead suggest deducting only the repairs in the year they are made. In the case of a monthly special assessment, the deduction is allowed in the year that the monthly assessment is billed and not necessarily paid.
Examples and Other Cases
Jack purchased a house to rent. Shortly after, the homeowners association assessed owners $500 for common area improvements. In this situation, the $500 special assessment is a deductible expense for federal income tax purposes since it is used to improve the common area. The same facts apply if Jack rented the house to his brother, father or anyone else.
Bill purchased a condo to rent. After moving in, the association assessed the owners $2,000 to repair the roof of the building. Bills common area costs are related to the maintenance of the actual building, so the special assessment would not be deductible under the tax rules because it is not used for improvement . If Bill had rented the property to his brother, father or anyone else, the result would be the same.
Sue and her husband bought a house to flip. After Sue and her husband closed on the purchase of the home, the association assessed the owners $2,500 for street repairs. Here, the special assessment may be deductible, but only to the extent it can be allocated to damaged property. The initial special assessment facts provide a $2,500 basis. If Sue and her husband can reasonably determine that the assessment was entirely for street repairs, then all $2,500 will be deductible in the year incurred. However, if the special assessment includes both a street repair and an improvement, then only the portion allocated to repair can be deducted.
Consult a Professional
The above discussion is not legal advice, and I always recommend seeking professional tax advice prior to claiming any deductions on income tax returns or when doing tax planning. Individual circumstances will vary tremendously, and there may be factors not even discussed above that the individual would need to do some additional individual research on. There is actually a new IRS compliance campaign in 2018 that focuses on this kind of deduction, further showing that you don’t want to be wrong here.
This is all to say, that if the IRS doesn’t agree with any point in the above discussion, it could mean penalties. The IRS can impose a substantial penalty in an audit if it disagrees with how an item has been deducted or depreciated. There are many other secondary issues that come up as well, so make sure to consult a professional before claiming any deductions on your income tax return.
Wrapping Up
Tax Deductibility of HOA Special Assessments on Rental Property
In sum, an HOA special assessment on rental property can be tax deductible as ordinary and necessary business operating expenses if it meets certain requirements . However, because the actual application of the tax laws on this issue are quite complicated it should be brought to the attention of your CPA or tax advisor so that they can evaluate this issue on a specific basis.