Can a homeowners association get the Texas franchise-tax exemption if its deed restrictions let some lots be used for commercial or business purposes?

Plain-English summary

A homeowners association submitted its deed restrictions to support a franchise-tax exemption. The Comptroller's Exempt Organizations Section reviewed them and denied the exemption under the homeowners-association statute.

• Why it was denied. Both the original Deed Restrictions and the amended Declaration allowed certain lots (designated with the prefix letter "B") to be used for business or commercial purposes. The exemption from franchise tax under Sec. 171.082 (for certain homeowner associations) only applies to residential property and does not allow for commercial use. Because commercial use was permitted, the association did not qualify under that section.
• An alternative path. If the association has a federal exemption, or obtains one, under IRC Sec. 501(c)(2), (3), (4), (5), (6), (7), (8), (10), (16), (19), or (25), it should qualify for the Texas exemption under Sec. 171.063. To be considered, it must send a copy of the IRS determination letter to the Comptroller's Exempt Organizations Section; the Comptroller would then notify the association whether it qualifies.
• In the meantime. The association remains responsible for filing all franchise tax reports with appropriate payments until an exemption is granted.

Currency note: This letter describes the pre-2008 franchise tax. House Bills 3 and 3928 replaced it with the current margin tax effective January 1, 2008. The homeowners-association and 501(c)-based exemptions continue under current law, but confirm their present terms before relying on them.

What this means for you

Homeowners and property owners associations

The residential-only exemption is strict: if your governing documents permit even a subset of lots to be used commercially, you can lose the Sec. 171.082 exemption regardless of actual current use. Review your deed restrictions and declaration language, not just how the neighborhood looks.

Associations that might have a federal 501(c) exemption

There is a second door. An association that holds an IRS determination under one of the listed 501(c) paragraphs can seek the Texas exemption under Sec. 171.063 by filing that determination letter with the Comptroller's Exempt Organizations Section - but must keep filing and paying franchise tax until the state grants the exemption.

Common questions

Q: Does allowing commercial lots really disqualify an HOA from the Sec. 171.082 exemption?
A: Yes. That exemption applies only to residential property and does not allow for commercial use, so deed restrictions permitting business/commercial lots defeat it.

Q: Is there any other way for the association to be exempt?
A: Yes - if it qualifies for a federal exemption under one of the listed IRC Sec. 501(c) paragraphs, it should qualify under Texas Tax Code Sec. 171.063 after submitting its IRS determination letter.

Q: What must the association do while its status is pending?
A: Continue filing all franchise tax reports and making the appropriate payments.

Citations and references

Statutes:

• Texas Tax Code Sec. 171.082 - franchise-tax exemption for certain homeowners associations; applies only to residential property, not commercial use
• Texas Tax Code Sec. 171.063 - franchise-tax exemption for organizations exempt under listed IRC Sec. 501(c) paragraphs
• Internal Revenue Code Sec. 501(c)(2), (3), (4), (5), (6), (7), (8), (10), (16), (19), (25) - federal exemption categories that support the Sec. 171.063 exemption

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=FIT
• Opinion: https://star.comptroller.texas.gov/view/200207265L

Original ruling text

July 11, 2002

Dear **:

Thank you for providing the additional documentation regarding **
Homeowners Association, Taxpayer No. **.

A review of this documentation discovers both the original Deed Restrictions
and the amended Declaration that is in the process of be ratified by the
property owners allow for certain lots to be used for commercial or business
purposes. Section 5 of the ** Estates Property Restrictions
states, [All lots designated with prefix letter "B" may be used for business,
...] and Article II. General Provisions, Section 2.01 Definitions., Item D.
states, ["B Lots" or "Tracts" shall mean and refer to that portion of any of
the plots of the Property shown upon the Plat and Re-Plats as set forth above,
on which there is or will be built structure to be used for commercial or
business purposes.]

The exemption from franchise tax under Section 171.082 (for Certain Homeowner
Associations) only applies to residential property and does not allow for
commercial use. As the result, the corporation does not qualify for exemption
under this section.

If the corporation has a federal exemption, or receives one in the future,
under Section 501(c)(2), (3), (4), (5), (6), (7), (8), (10), (16), (19) or (25)
of the Internal Revenue Code, it should qualify for the exemption under Section
171.063. To be considered for exemption on this basis, send a copy of the
Internal Revenue Service (IRS) determination letter to the Exempt Organizations
Section, Post Office Box 13528, Austin, Texas 78711-3528. After reviewing the
IRS document, we would notify the corporation whether it has qualified for the
exempt status. In the interim, the corporation is responsible for filing all
franchise tax reports with appropriate payments. To obtain forms or assistance
in completing the forms, contact our Tax Assistance Section toll free at
1-800-252-1381.

If you have questions about the exempt status, you can e-mail us at
, or call me toll free at 1-800-531-5441, extension
3-4142. My direct number is 512/463-4142.

Sincerely,

Wanda K. Carter
Exempt Organizations Section