As a rule, special assessments imposed on members are not tax deductible. If, however, an owner's unit is a rental property, then special assessments
could qualify as a tax-deductible expense (if the owner's tax adviser agrees). The following question addresses tax deductible interest payments.
QUESTION: We plan to levy a large special assessment for infrastructure upgrades and capital improvements. We will get a bank loan secured by the special assessment. One of our owners (a CPA) wants it structured so the interest is tax deductible for owners. He said it could be done if he can borrow the money from the HOA so the interest becomes “Qualified Residence Interest” since it would meet the following IRS conditions: (i) acquisition debt – incurred to acquire, construct or substantially improve the taxpayer’s main or second home; (ii) debt must be secured by the home; and (iii) debt is limited to $1 million. Can it be done?
ANSWER: I contacted half a dozen CPA firms that specialize in community associations and received the following responses:
#1. I have not seen it done before. What usually occurs is if the unit owner wants the interest to be deductible they get a 2nd mortgage on their house from a bank/financial institution and pay their portion of the special assessment in full. I am not sure the HOA can or should step into the shoes of a bank. To do so would require title searches, recording trust deed loans, liens, etc. While associations do have some of this for assessment collections, to do so on this large scale does not seem feasible to me. And, who will analyze if there is sufficient equity in the house to make the loan? And, would the association want to make a 4th trust deed loan if that was the situation? And, wouldn’t there be a difference if it was a 1st trust deed vs. a 2nd trust deed or personal residence vs. investment property–-as far as nonrecourse vs. recourse loan?
#2. I have never seen any special assessment where the interest portion for those owners that elected to pay the special assessment in installments and interest was imposed was qualifying residence interest though I would not know what any owner reported on their personal income tax return. If the association were able to secure the special assessment by a separate individual agreement against the member’s residence, possibly the interest could qualify. This is more of a legal challenge than an income tax issue. Considering that the association should charge each owner legal and other costs for the ability to avail themselves of this scheme and that the association should also charge each owner a monthly fee just to process the monthly payment plan and that interest rates are fairly low, it would probably not be cost effective for an owner to do this at all.
#3. I would think this would be very problematic because the association would separately have to loan to each owner and file a lien, etc. on each home or unit. In order to meet his needs, this would seem to be both onerous and expensive. And in turn, would the increased cost, which is eventually paid by the owners, really provide a substantial benefit in the end? Also, this would mean each owner would have to probably pay the vendors directly, since they would have the funds what a nightmare. And, would the association’s loan covenants restrict this? Can an association even loan to homeowners?
#4. I've never seen this done either. Maybe it can, but as others have pointed out its very problematic. I spoke to a lender's attorney over the weekend. Two additional issues were brought up:
a. The HOA may be subject to fair lending practices, meaning they'd have to make all of the truth in lending disclosures.
b. This loan may be considered non-recourse. I don't believe that the costs and risks of this are in the best interest of the HOA. The suggestion that the homeowner get his/her own loan and pay off the assessment in full makes the most sense.
#5. It seems to me that the problem would be with the secured debt. According to IRS Publication 936, secured debt is one which an instrument is signed that:
a. Makes your ownership in a qualified home security for payment of the debt,
b. Provides, in case of default, that your home could satisfy the debt, and,
c. Is recorded or is otherwise perfected under any state or local law that applies.
If the association could loan the funds, it would seem that there would have to be a separate loan for each owner. If it was possible, it would be expensive and why would the association want to put itself in that position? From a fiduciary standpoint, would this be a prudent business decision for the association?
I'm not familiar with this scenario and would be interested in what the others say. I'm also not a personal tax person. But.... the loan is being made to the association and not the owners. The loan interest could be deducted on the HOA's tax return, although some say it could not. I've seen where the loan interest is allocated to the individual owners, but I don't agree with this. The loan is being used for common area repairs and improvements--not someone's home. The debt is not being secured by anyone's home. There is no collateral. Presumably, the bank asked for a resolution approved by the homeowners for the special assessment.
: Whenever tax questions are raised, a CPA and/or tax attorney should be consulted.
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