The IRS Audit of the Sun City Anthem Community Association 2007 Tax Return
I cannot imagine that anyone looks forward to an audit by the IRS. At the July board meeting, President Jack Troia made the following announcement:
We recently received a notification that the Internal Revenue Service has selected the 2007 SCA tax return for examination. We have asked the IRS representative why the SCA’s tax return was selected and have not received any answers. An initial meeting with the IRS is planned for August, at which time we will know more about the scope and depth of the IRS examination. We will be working with our accounting firm to respond to the information requests and answer any questions that may arise as a result of the examination.
Having been repeatedly assured by the association’s accountant Gary Lein that all is in order, Jack expressed his curiosity to the IRS as to why the association’s tax return was selected for examination. While Jack may not be aware, a number of homeowners going back a few years have expressed their concern that the association may be incurring an unnecessary tax liability resulting from the board’s long-standing practice of applying Revenue Ruling 70-604 in a manner different from how the IRS has applied it to associations elsewhere. This audit is expected to resolve that dispute.
The matter of Revenue Ruling 70-604 was addressed in some detail by me last August here. Included in that article was a listing of a number of articles on this subject by noted tax expert Gary Porter. One such article is titled, The Association IRS Audit, addresses a number of potential issues the audit will likely address. You can read his article by Clicking here.
One of the key disputes in the application of RR 70-604 is who is entitled to make the annual election “at which they decide what is to be done with the excess assessments,” that is, whether “they decide either to return the excess to themselves or to have the excess applied against the following year's assessments.” While the plain understanding of the language in the revenue ruling would have you believe that the election must be made by the members (homeowners), our association takes a different and contrary view of their duty.
The association, relying on their interpretation of Nevada law, takes the position that the board may make this election determination in behalf of the members since they and not the members are the only ones who have the authority regarding the disposition of funds. As a result, the board believes that they alone can make this annual election. Their position is supported in a 2008 Tax Research Memorandum provided to the association by Gary Porter. In rendering his advice, it would appear that Mr. Porter was relying on the association’s interpretation of Nevada law, not his own interpretation. Whether Nevada law affects the application of RR 70-604 will be an important issue up for discussion with the IRS.
The second and more significant issue between the IRS and the association will be one that affects the association's tax liability. That liability issue will turn on the board's practice of carrying forward excess assessments year after year rather than returning any such excess to the homeowners at the end of the year or crediting the excess against the following year's assessments. In carrying forward those excess assessments, the board believed, wrongly according to the IRS, it was free to allocate those excess assessments to capital expenditures or for other purposes. In the process, the board was able to stabilize existing assessments at a level in excess of what was required to meet the operating and reserve needs of the association. In other words, annual dues remained artificially inflated for several years. By 2008, the excess and untaxed carryover retained by the association amounted to $4.755 million.
How did this excess assessments situation come about? Assessments, e.g., at $940/year, were initially structured to meet the needs of the community going forward. Then in late 2001, Pulte purchased Del Webb. With that acquisition, Pulte then made changes to the overall Anthem Master Plan while also downsizing Sun City by 30% and selling off the two Sun City golf courses to Troon Golf. While those decisions reduced the operating needs of the community going forward, assessments were not adjusted accordingly; they did not go down. As a result, the association's coffers began accumulating excess assessments year after year.
Under IRS rules, those excess assessments are taxable if they were not returned to the homeowners at the time they were accumulated. As a result of the 2007 tax audit, one of several possible outcomes might be to assess an additional tax liability on the 2007 tax return, assuming one is due, and require that the subsequent tax returns be amended accordingly.
Due to the unique conditions that existed in Anthem from the changes made by Pulte in 2002, I would not expect that any potential adverse tax consequences will have similar tax implications elsewhere in other senior developments in the state.
Ron Johnson, 24 July 2010