Homeowners Association (HOA)

A homeowners association is a legal entity, most often a nonprofit corporation, that holds and maintains property shared by the owners in a planned development, condominium or cooperative, and enforces a set of recorded restrictions on how the individual units may be used. Membership is automatic and inseparable from ownership: buying a unit makes you a member, and there is no way to resign while keeping the property.

The authority for all of it is a recorded document, usually called the declaration or the covenants, conditions and restrictions. Because that document is recorded against the land rather than signed by each buyer, it binds every successive owner, which lawyers describe as covenants that run with the land. That is the single most misunderstood feature of the arrangement. An owner who objects to a restriction is not in the position of a party to a contract they can decline to renew; they bought property that already carried it.

The governing documents have an order of authority, and it decides arguments. State common-interest-community law sits at the top and cannot be overridden by an association. Below that is the recorded declaration, which creates the community, defines the units and the common elements, and states the substantive restrictions. Below that are the bylaws, which govern how the association operates: the board, elections, meetings, quorum, voting. At the bottom are the rules and regulations the board adopts within its delegated authority. A board rule inconsistent with the declaration or with a statutory right is generally unenforceable, which is why an owner in a dispute reads from the top of the stack rather than from the letter they received.

Assessments are the association's income and they are secured. Regular assessments fund the operating budget and the reserves; a special assessment is levied when a cost exceeds what has been reserved. In a common-interest community the obligation to pay is generally secured by a statutory lien on the unit, which arises automatically rather than by agreement. The Uniform Common Interest Ownership Act, a model act that many states have adapted, provides at section 3-116(k) that the lien may be foreclosed "in like manner as a mortgage on real estate," and at section 3-116(p) limits foreclosure where the sums due consist of fines alone. States that have not adopted the model act reach the question their own way, so whether and how quickly an association can foreclose is a state-by-state answer rather than a general one.

Whether anything caps an assessment is a question with a different answer in different states. Some states constrain a board directly: California, for example, bars a board from imposing assessments that aggregate more than 5 percent of budgeted gross expenses without member approval, while carving out emergencies from that limit. Others leave the ceiling, if any, to the declaration. So neither of the two things owners commonly assume is safe to assume: not that assessments are simply uncapped, and not that a required owner vote is a reliable ceiling. The question has to be answered from the state's statute and the declaration together. What is available everywhere is the paperwork: the budget, the reserve study and the recent minutes, which together show whether the association is funding what it will eventually have to replace.

Enforcement runs in several directions and not all of them involve money. Depending on the documents and the state, an association may levy fines, suspend the use of common amenities, suspend voting rights, obtain an injunction, record a lien, and in some cases foreclose. It may also be constrained: many states require notice and an opportunity to be heard before a fine, and federal fair housing law limits how rules may be applied and requires reasonable accommodations in some circumstances.

The federal tax definition is narrow and does a different job. Section 528 of the Internal Revenue Code defines a homeowners association as a condominium management association, a residential real estate management association or a timeshare association that is organized and operated to acquire, construct, manage, maintain and care for association property, and that meets two proportion tests: at least 60 percent of gross income must consist solely of membership dues, fees or assessments from owners, and at least 90 percent of expenditures must go to association property. An association meeting those tests may elect to file Form 1120-H, under which its assessment income is exempt function income that is not taxed, and only its other income, typically interest on reserves, is taxed. The rate is a flat 30 percent, or 32 percent for a timeshare association, after a $100 specific deduction. That definition governs a tax filing choice and nothing else: what an association may do to an owner is a matter of state law and the recorded documents.

A developer records a declaration creating the community and the association, then turns control over to the owners once enough units are sold. The board adopts an annual budget, assesses the owners for it, maintains the common property, funds reserves for major replacements, and enforces the covenants. An owner who does not pay is subject to the association's lien.

A hypothetical example of the tax election. An association collects $400,000 in assessments for the year and earns $6,000 of interest on its reserve account. First the eligibility test: assessments are $400,000 of $406,000 of total gross income, which is about 98.5 percent and comfortably above the 60 percent floor, and the association spends effectively all of its money on the common property, clearing the 90 percent expenditure test. It therefore elects Form 1120-H.

Under that election the $400,000 of assessments is exempt function income and is not taxed at all. Only the $6,000 of interest is. Assuming no deductions directly connected with earning it, the association's taxable income is $6,000 minus the $100 specific deduction, or $5,900, and the tax is 30 percent of $5,900, which is $1,770. Note what this does and does not mean for an owner: it decides the association's tax bill, not whether the association may fine them, lien their unit, or raise the assessment next year.

Pros

• The shared property is maintained and insured by a body with the authority to collect the money to do it, which is the only workable arrangement for a building with shared structure.
• Amenities that no individual household could fund, such as a lift, a pool or private roads, become affordable across the membership.
• The restrictions cut both ways: the rule that limits what you may do also limits what your neighbors may do, which is what preserves the character buyers are paying for.
• The financial position is documented in a budget and a reserve study that a buyer can generally read before closing, so the risk is diligence rather than guesswork.

Cons

• The covenants bind whether or not you agreed with them, and amending a declaration usually requires a supermajority of owners.
• Assessments can rise, and a special assessment can arrive at a scale that has no relationship to the monthly figure quoted in the listing.
• Enforcement powers are real: fines, liens and, in many states, foreclosure of the assessment lien.
• Governance quality varies enormously and is difficult to assess from outside, yet it determines whether reserves are funded and whether repairs happen before they become emergencies.
• An association's financial or physical condition can affect a buyer's ability to obtain a mortgage on a unit, which is a constraint on your own resale quite independent of your own creditworthiness.