Homeowners associations across the nation are nervously watching the outcome of an Internal Revenue Service demand that the Sun City Summerlin Community Association pay taxes on some $2 million held in the HOA's savings account.
No final numbers have been set, but the HOA, incorporated in 1989 as a not-for-profit corporation with about 7,800 homes, would likely have to pay a 30 percent tax on the income, or about $600,000.
"We're trying to decide whether to fight this and take it to appeal,'' HOA board President Joe O'Connell said. "It's a tax issue, and we don't know if we should fight it or not."
While several Las Vegas Valley HOAs have come under investigation for fraud in recent years, Sun City Summerlin is a "squeaky-clean organization," O'Connell said.
"We opened our books,'' he said. "The IRS is always looking for new areas to tax. Maybe they'll go after every HOA if they know it means new taxes."
IRS spokesman Raphael Tulino said he could not comment on a specific case. Tax code provides guidance, but individual cases offer their own sets of facts and circumstances, he said.
The facts and circumstances behind Sun City Summerlin's tax problem are complicated, and stem from the way HOAs must account for money raised from fees other than homeowner dues.
The IRS found that Sun City's 2009 Form 1120 income tax return showed other income of $2 million deducted from the "carry forward" amount of HOA dues. The same practice of deferring income was shown in other tax forms, with amounts carried forward from 2007 to 2009.
Under Internal Revenue Code 528, homeowners associations are exempt from taxes on income carried forward, as long as at least 60 percent of gross income comes from membership assessments and 90 percent of that income is spent on maintaining the association's property.
At issue is income generated from sources other than HOA dues, including greens fees paid by nonresidents at Sun City's three golf courses, restaurant sales and community center rentals.
Accountant Gary Lien of Hilburn and Lien, who represents both Sun City Summerlin and Sun City Anthem, said the $2 million carryover from the membership side will cover operational losses at the golf courses, which have seen a decrease in play during the recession.
"Some of that money went to pay for losses," Lien said. "When it's all said and done, net operating loss will offset that income."
Revenue from golf is separated into member and nonmember play, so homeowners are in essence subsidizing losses from the golf course operations, he said.
That the HOA carried the money forward is enough to trigger a demand for taxes.
Community associations in Florida and Southern California say the IRS is taking "too crisp of a position," said Chris Yergensen, senior vice president and legal counsel at RMI Management, which manages about 300 HOAs around the Las Vegas Valley.
"The IRS is taking an aggressive position, not only aggressive, but unheard of," Yergensen said. "This is unprecedented. It's not done on a national basis. This is the first. It's on the radar of individual associations in other states."
The IRS audit is not a widespread problem throughout Las Vegas because most communities receive income only from homeowner assessments, Yergensen said. Only four of RMI's 300 or so clients have revenue from sources other than member dues, he said. Most of the smaller HOAs fall under a different tax category.
"Sun City has 7,700 homes, but it's not that large compared with places in Florida and Southern California where you've got boat slip rentals along the water,'' Yergensen said. "Hilton Head (S.C.) has all those golf courses."
Exactly how the upscale Las Vegas HOA ran afoul of the IRS is in dispute, and dissident homeowners say the tax problem speaks to larger management issues.
"We've got a serious problem in this HOA," resident Bob Hall said. "We're talking millions and millions of dollars taken from people who can ill afford it. We just got a $1.9 million slap by the IRS and that's just the beginning."
Hall said the community is "absolutely forbidden" to be in for-profit business, and that nobody has really tallied how many ways Sun City takes in revenues from its various businesses.
Sun City Anthem, the sister community in Henderson, was also audited by the IRS last year and told to pay about $1.3 million in back taxes on $4.8 million kept in a surplus account. The tax assessment is being appealed, accountant Lien said.
Although HOAs are not-for-profit organizations, nothing prevents them from turning a profit on some ventures. The devil is in the accounting.
Homeowners associations have two options to avoid paying taxes on income, said Mark Little, tax accountant with Bainbridge, Little and Co. in Las Vegas. They can refund excess revenue to members, or they can apply it to subsequent assessments.
Because Sun City Summerlin banked the money, the IRS treats the revenue as taxable income.
"Ultimately, the IRS looks at it as bringing in only as much money as you're going to spend," Little said. "You may have income one year and losses the next year, so we'll ... say you'll keep doing it as a nonprofit and the only thing we'll tax you on is interest revenue and nonmember revenue."
The tax code's vagaries could complicate matters even for HOAs that don't take in millions of dollars from nonmember activities.
With homeowners entering foreclosure and not paying monthly assessments, many HOAs in the valley are hurting and need to maintain larger reserves to cover unexpected expenses, Lien said.
"That's the question. How much is adequate?" he asked. "This economy has had a devastating effect on some of the smaller associations. They have 30 percent vacant units. They can't fund their reserves. Seventy percent of revenue is not enough to fund operations, so they cut back on services."
Contact reporter Hubble Smith at email@example.com or 702-383-0491.