Can a homeowners association get the Texas franchise tax exemption if its declaration lets it lease common property for commercial (for-profit) use?

Plain-English summary

A homeowners association applied for the Texas franchise tax exemption and was denied - because its governing declaration let it use common property for commercial, for-profit purposes.

• The exemption is residential-only. Tax Code Sec. 171.082 exempts a homeowners, residential property owners, or residential condominium association, but the exemption applies only to residential property.
• What disqualified this association. Its Declaration of Covenants, Conditions and Restrictions (page four, Section 7(h)) stated the Association "shall have the right to rent or lease any part of the Common Properties and/or Common Facilities for the operation (for profit or otherwise)...". The Comptroller held that granting the Association the right to allow commercial activity within the subdivision disqualifies it from the exemption.
• Keep filing. The association is required to file franchise tax reports until it provides additional documentation showing it qualifies for one of the Tax Code exemptions.
• An alternative route. A corporation that has obtained a federal 501(c) exemption (e.g., 501(c)(2), (3), (4), (5), (6), (7), (8), (10), (16), (19), or (25)) qualifies for the franchise tax exemption under Sec. 171.063; the only documentation needed is the IRS determination letter.

Currency note: This applies the pre-2008 franchise tax, replaced by the current margin tax (House Bills 3 and 3928) effective January 1, 2008. The homeowners-association exemption continues under current law, but confirm its present terms.

What this means for you

Homeowners and property owners associations

The franchise tax exemption is limited to residential property. If your declaration or bylaws authorize renting or leasing common areas for profit, the Comptroller may treat that as commercial activity that defeats the exemption - even if you never actually run a for-profit operation. Review your governing documents' language, not just your current practice.

Boards and community-association drafters

A broad "for profit or otherwise" leasing clause can cost the association its exemption. If exemption matters, consider whether the governing documents can be limited to residential use, and keep filing until the Comptroller confirms exemption.

Accountants advising associations

If the residential-only test fails, the cleaner path may be a federal 501(c) exemption, which qualifies the association under Sec. 171.063 on the strength of the IRS determination letter alone.

Common questions

Q: Why was this homeowners association denied the franchise tax exemption?
A: Its declaration allowed it to lease common property "for profit or otherwise" - commercial activity that disqualifies it, because Sec. 171.082 applies only to residential property.

Q: Does the association have to actually run a business to be disqualified?
A: The Comptroller relied on the declaration's language granting the right to allow commercial activity, which disqualified the association.

Q: Is there another way to qualify?
A: Yes. A corporation with a federal 501(c) exemption qualifies under Sec. 171.063 by submitting its IRS determination letter.

Citations and references

Statutes:

• Texas Tax Code Sec. 171.082 - franchise tax exemption for a homeowners/residential property owners/residential condominium association; applies only to residential property
• Texas Tax Code Sec. 171.063 - franchise tax exemption for a corporation holding an IRS 501(c) 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/200209432L

Original ruling text

September 18, 2002

Dear **:

This is in response to your letter requesting franchise tax exemption for
HOMEOWNERS ASSOCIATION, Taxpayer Number **.

Based on the information provided, the corporation does not meet the
requirements for exemption under Section 171.082 of the franchise tax statute
because this exemption applies only to residential property.

The Declaration Of Covenants, Conditions And Restrictions For HOMEOWNERS
ASSOCIATION, page four, Section 7(h) states, "The Association shall have the
right to rent or lease any part of the Common Properties and/or Common
Facilities for the operation (for profit or otherwise)..."

The declaration's use of the above language granting the Association the right
to allow commercial activity within the subdivision disqualifies the
Association from this exemption.

HOMEOWNERS ASSOCIATION is required to file franchise tax reports until
additional documentation is received to show the corporation qualifies for one
of the exemptions provided in the Texas Tax Code.

The Tax Code is online at
http://www.capitol.state.tx.us/statutes/ta/ta0017100toc.html.

For example, a corporation that has been exempted from federal taxation under
Section 501(c)(2), (3), (4), (5), (6), (7), (8), (10), (16), (19), or (25) of
the Internal Revenue Code, will qualify for the franchise tax exemption
available under Section 171.063 of the Texas Tax Code. For information on how
to apply for federal exemptions, call the IRS at 1-877-829-5500 or
1-800-829-3676 to get the application forms.

To be considered for exemption under Tax Code Section 171.063, send a copy of
the Internal Revenue Service determination letter to the Exempt Organizations
Section, Post Office Box 13528, Austin, Texas 78711-3528.

If you have any questions, you may e-mail us at or
call me toll free at 1-800-531-5441, extension 5-9704. My Austin number is
512/305-9704.

Sincerely,

Janice Womack
Exempt Organizations Section