In a major victory for condominium and homeowner associations, the Internal Revenue Service adopted recommendations by the Community Associations Institute that will protect community associations from millions of dollars in potential tax liability. On Dec. 28 1998, the IRS exempted community associations from a new final rule on asset transfers between corporations and tax-exempt entities, protecting the right associations have to elect their tax status annually as either a corporation or partially tax-exempt organization.

"These rules would have been financially devastating to community associations," said Gary A. Porter, CPA, president of CAI. "Congress gave community associations the ability to change tax status annually, and this ruling from the IRS will ensure that associations can pursue this option without severe financial consequences."

The new rule requires any corporation that transfers all or substantially all of its assets to a tax-exempt entity to recognize a gain or loss as if the assets were sold at their fair market value. Under the proposed rule, community associations that choose to switch from a corporate to a partially tax-exempt status under Section 528 of the Internal Revenue Code would have faced tax liability on the fair market value of common elements, reserves, investments and cash.

In exempting Section 528 entities from the final rule, the IRS acknowledged CAI's arguments that community associations do not exemplify or even contribute to the perceived abuse the new rule is intended to target. The IRS also acknowledged that qualified condominium and homeowners associations should not be discouraged from changing tax status under Section 528 since the option was created specifically for them.

In the final rule, the IRS also adopted CAI's recommendation that community associations that convert to section 501(c)(7) organizations (social clubs) be given seven years from the date of their establishment rather than the proposed three to make the change without incurring tax liability. However, the IRS instituted a three-year time limit for community associations to convert to 501(c)(4) entities. After three years, the association will face tax liability on the fair market value of assets that are "transferred." CAI had argued for a longer period since conversion is typically not an option for most associations until they are transferred from developer to homeowner control, a change that rarely happens within three years.

The final rule, which takes effect Jan. 28, 1999, is available in the Government and Public Affairs section of CAI's web site. For more information, call CAI at 703/548-8600 or e-mail g&pa(at)caionline.org. The Community Associations Institute is a nonprofit association created in 1973 to educate and represent the nation's 205,000 community associations—condominium associations, homeowner associations and cooperatives. CAI members include homeowners, associations and related professionals and service providers.