Corporate and Securities

HOA Basics

By
Mary Neil Price

HOAs get a bad rap among homeowners, and in far too many cases, that is regrettably justified. My legal education on the subject stems from personal experience.

In 2019, I took advantage of the unprecedented rise in residential real estate prices in Nashville, Davidson County’s 37215 area code, and fled south toWilliamson County. The house I bought checked a lot of boxes – it was a fifteen-minute commute to my office via I-65, the lot was flat, and best of all, the back yard was completely safe for my dogs, sporting a six-foot high wooden privacy fence.  Having lived on a 4-acre wooded lot close to Radnor Lake for some twenty-five years, relief from the constant threat of downed trees from ice or windstorms was also very appealing. Tree removal is very expensive (depending on the size of the tree), and, unless it hits the house or some other structure, is not generally covered by homeowners’ insurance, even if the downed tree is completely blocking your driveway.

I had no prior experience living in a subdivision with an HOA, but this subdivision was relatively small with only fifty homes, and the monthly dues were uncharacteristically low. More on that topic later under “HOA Reserves – How much is Enough?”.

Three months later, I attended the annual HOA members meeting, figuring that was a good way to get to know my new neighbors. During the meeting, the members were called upon to fill a variety of open positions including chairman of the decorating, welcoming and government relations committees. I volunteered to be the secretary. As a practicing attorney, writing minutes is definitely in my wheelhouse. It was only after the meeting, that I learned that being the secretary also meant being on the board.

Shortly thereafter, COVID hit, and I spent some of my newly found spare time locating and reading the HOA’s bylaws in order to get a handle on meeting and voting requirements, notices, what constitutes a quorum and the like. What I found was the original set of bylaws established by the original subdivision developer, who had gone bankrupt in 2010 and was no longer in the picture, even though the bylaws gave him the authority to appoint a majority of the board. Which brings me to…..

 

Tip #1: READ THE BYLAWS OF THE HOA

If you live in a condominium development or a neighborhood with an HOA, the bylaws are essential to understanding how the HOA is supposed to operate.  What I discovered was that the developer’s authority to appoint the board of directors of the HOA had never been changed. In fact, the bylaws were all geared towards protecting the developer’s control of the subdivision, which would have been appropriate while the subdivision was under construction but gave the current homeowners virtually no governance rights over their own neighborhood. At the next board meeting, I explained this to the other board members, concluding that our HOA bylaws were overdue for a major rewrite. “Oh, no,” they assured me, “the developer has been totally out of the picture since 2017.”  Further, a special assessment had been imposed and collected to accomplish just that.  It took two attempts and twelve months to get an updated set of bylaws in place. 

 

Tip #2: SPECIAL ASSESSMENTS

Do HOAs have the right to impose special assessments on the homeowners? The short answer is yes. However, special assessments should be just that- special, not money to cover routine expenses or maintenance costs. As such, special assessments generally will entail some sort of capital improvement or project.And one typical provision of HOA bylaws is that the membership will need to approve any capital expenditure over a certain amount, which brings us back to Tip #1: Read the bylaws. The Board of Directors and management of an HOA have no authority to impose a special assessment without going through the process specified in the bylaws.

 

Tip #3: HOAS ARE NOT CHARITABLE INSTITUTIONS  

Just because your HOA is a nonprofit organization (and the vast majority of them are, regardless of where you live), does not mean that your HOA is a charitable organization or that donations are deductible from your federal income taxes. Foran organization to be a charitable organization, it must have a determination from the IRS that it meets the requirements of Internal Revenue Code Section501(c)(3). Typical HOAs do not meet these requirements, nor should they.

Section 501(c) of the Internal Revenue Code lists out all the different types of nonprofits. There are twenty-nine of them, covering everything from the NFL to credit unions.

[i] Most HOAs fall under (c)7: I.R.C. § 501(c)(7) — Clubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder.

This means that HOAs are required to file federal tax returns. Fortunately, there is a short form available if at least 60% of the HOA’s income is derived from dues, fees, interest and special assessments and at least 90% of that income is spent on maintenance of the common areas or acquisition of additional common areas. The form is called the 1120-H and is due on March 15. Miss that date and the HOA must file the long form, which requires a great deal more time and information. As U.S. government websites go, in my humble opinion, the one maintained by the IRS is among the best and includes a plethora of information on tax-exempt organizations.

 

Tip #4: CONDITIONS, COVENANTS AND RESTRICTIONS 

Subdivisions with HOAs are generally subject to the terms and conditions of something called the “CCRs” which is a set of rules of public record in the register of deeds office where the subdivision is located. When you buy a home or a lot in such a subdivision, you agree to abide by those CCRs, just like any other encumbrance that might be on the property that is of public record. The role of the Board of Directors and the management of the HOA is charged with enforcing those rules. However, the HOA has no authority to impose rules that are not specified in the CCRs.  Problems can and do arise in interpreting the CCRs. Some rules are easier than others. For example, there might be a rule that provides that garage doors are not allowed to face the street. That rule is often interpreted to mean that garage doors can’t face the street the front door (and therefore the address of the house) faces. This allows houses located on corner lots to have garage doors, and is a practical, common-sense interpretation of the rule. Other rules can be pre-empted by state or federal law. For example, the CCRs might prohibit homeowners from displaying yard signs. I am not a big fan or yard signs myself, but the Tennessee legislature recently decided that prohibiting political yards signs violates the First Amendment’s guaranty of free speech. First Amendment trumps the CCRs. Nonpolitical yard signs, such as advertisements are still fair game.  But what about those yard signs commemorating a child’s graduation from high school (or kindergarten, or rehab or whatever)? Can those be prohibited? Technically, yes. Is it a good idea for an HOA to make homeowners take them down? No, because it only creates unnecessary ill will in the neighborhood.  But what if the yard sign has been up so long that it has become an eye sore? Happily, in MiddleTennessee the wind usually prevents this scenario from materializing, but this is the sort of thing that sometimes comes up.

 

In conclusion, criticism of HOAs seems to most often stem from inconsistent interpretations of the rules (e.g., what constitutes adequate landscaping) or overreaching interpretations. Ultimately, the job of the HOA is to enforce the rules and maintain the common areas in a way that protects the homeowners’ value in what may be their primary asset.  

[i] The NFL was considered a tax-exempt organization from 1942 to 2015. A fascinating topic, but beyond the scope of this article.

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