To file Form 1120-H, a homeowners association must spend at least 90 percent of its total annual expenditures on acquiring, building, managing, maintaining, or caring for association property. That threshold is the Form 1120-H 90 percent expenditure test, and it’s one of three qualifying tests under Internal Revenue Code Section 528.1Office of the Law Revision Counsel. 26 USC 528 – Certain Homeowners Associations The math is simple division. The hard part is knowing which dollars belong in the numerator, which belong in the denominator, and which don’t count as expenditures at all.
How the Test Works on the Return
The test is applied after the tax year closes, using the association’s regular accounting method, and it looks only at money actually spent during the year.2eCFR. 26 CFR 1.528-6 – Expenditure Test On Form 1120-H, Item C reports qualifying expenditures and Item D reports total expenditures for the year, including those tied to exempt function income. Item C divided by Item D must reach 0.90 or higher.3Internal Revenue Service. Instructions for Form 1120-H (2025)
Filing Form 1120-H is itself an annual election under Section 528, made anew each tax year.4eCFR. 26 CFR 1.528-8 – Election to Be Treated as a Homeowners Association An association that fails the test for a given year cannot make the election that year and files a standard Form 1120 instead.
Which Expenditures Qualify
Qualifying expenditures are amounts spent on association property. Both routine operating costs and capital expenditures count.2eCFR. 26 CFR 1.528-6 – Expenditure Test The regulation lists examples:
- Salaries for an association manager and secretary
- Landscaping, paving, street signs, and pool and tennis court upkeep
- Security personnel or contracted patrol services
- Insurance premiums on association property
- Legal and accounting fees
- Replacement of common buildings, heating and air conditioning systems, or elevators
- State and local taxes assessed on association property
A detail that catches associations off guard: spending on property that also produces non-exempt income still qualifies. If the community pool generates guest fees from non-members, pool maintenance is still a qualifying expenditure.2eCFR. 26 CFR 1.528-6 – Expenditure Test The test looks at what the money buys, not what income the property generates on the side.
What Counts as Association Property
Association property under Section 528 is broader than the clubhouse and pool. It includes property the association owns, property commonly held by members, property within the community privately held by members, and government-owned property used for the benefit of residents.5Office of the Law Revision Counsel. 26 USC 528 – Certain Homeowners Associations That last category can matter where a municipality owns the streets or stormwater infrastructure but the association pays to maintain them.
Allocating Mixed-Use Expenses
When an expenditure benefits both association property and non-association property, the regulation requires a reasonable allocation between the two. Only the portion properly allocable to association property counts toward the numerator.2eCFR. 26 CFR 1.528-6 – Expenditure Test If a management company handles the association’s common areas plus a separate commercial property, split the management fee on a reasonable basis such as square footage or time spent.
Administrative overhead like management fees, office expenses, and bookkeeping generally qualifies in full for an association whose sole purpose is managing community property. Those costs exist because the association exists, and the association exists to manage its property.
What Doesn’t Count
The most consequential exclusion is reserve fund contributions. Transferring money into a sinking fund or reserve account for a future roof replacement is not an expenditure for this test, even though the roof is association property. The regulation states plainly that “investments or transfers of funds to be held to meet future costs shall not be taken into account as expenditures.”2eCFR. 26 CFR 1.528-6 – Expenditure Test Reserve contributions drop out of both the numerator and the denominator.
Timing matters. Actually replacing the roof during the tax year is a capital expenditure that qualifies. Setting money aside to replace it later is not an expenditure at all.
Other items excluded from the numerator:
- Any expenditure on property that doesn’t meet the association property definition
- Excess assessments refunded to members or credited against the following year’s assessments2eCFR. 26 CFR 1.528-6 – Expenditure Test
- Costs incurred solely to produce non-exempt income, such as expenses tied exclusively to renting the clubhouse to outside parties
A Worked Calculation
Take a calendar-year association with the following annual spending:
- Landscaping and grounds maintenance: $95,000
- Property insurance: $42,000
- Management company fee: $60,000
- Pool and clubhouse maintenance: $38,000
- Property taxes on common areas: $25,000
- Legal and accounting fees: $15,000
- Security contract: $30,000
- Reserve fund contributions: $80,000
- Clubhouse rental event costs (non-member rentals): $8,000
- Newsletter and administrative costs: $7,000
Step 1. Remove reserve contributions. The $80,000 transferred to reserves is not an expenditure for this test. Strip it out entirely. It appears in neither the numerator nor the denominator.
Step 2. Calculate total expenditures (Item D). Add everything except the reserve transfer: $95,000 + $42,000 + $60,000 + $38,000 + $25,000 + $15,000 + $30,000 + $8,000 + $7,000 = $320,000.
Step 3. Identify qualifying expenditures (Item C). Every cost above qualifies except the $8,000 spent exclusively on non-member clubhouse rentals. The newsletter and administrative costs relate to managing the community, so they qualify. Qualifying total: $312,000.
Step 4. Divide. $312,000 รท $320,000 = 0.975, or 97.5 percent. The association passes.
Now change the facts. Suppose the same association also spent $30,000 on a legal dispute unrelated to association property and $12,000 marketing a commercial lot it owns. Total expenditures rise to $362,000, qualifying expenditures stay at $312,000, and the ratio drops to 86.2 percent. The association fails and cannot file Form 1120-H for that year.
What Happens If You Fail
Failing the 90 percent expenditure test disqualifies the association from the Section 528 election for that year. It files Form 1120 instead, and member dues and assessments lose their exempt function income treatment. On Form 1120-H, exempt function income is excluded from taxable income entirely and only non-exempt income is taxed, at a flat 30 percent rate (32 percent for timeshare associations) after a $100 specific deduction.1Office of the Law Revision Counsel. 26 USC 528 – Certain Homeowners Associations On Form 1120, all income is potentially taxable at the 21 percent corporate rate, with broader deductions available.6GovInfo. 26 USC 11 – Tax Imposed
The expenditure test is not the only gate. An association must also derive at least 60 percent of its gross income from exempt function income (dues, fees, and assessments from unit owners), and it must be organized and operated primarily to manage association property with no private inurement.7Office of the Law Revision Counsel. 26 USC 528 – Certain Homeowners Associations8eCFR. 26 CFR 1.528-5 – Source of Income Test Passing the expenditure test alone is not enough, but failing it is enough on its own to end the analysis.
Because the election is annual, run the calculation each year before filing. A close ratio in one year is worth revisiting the following year, particularly if the board is scaling up reserve contributions or the association is expanding activities that generate non-exempt income.