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By: Gary Porter, RS, PRA


Many have asked about the application of the IRC Section 118 rules for regular, monthly assessments. This question may be broken down into two sections; capital purpose, and nature of assessment.

Capital Purpose

Rev. Ruls. 74-563, 75-370 and 75-371 provide several specific examples of what common reserve components will, and will not meet the IRC Section 118 "Capital Purpose" requirements. Examples of specific capital purposes include:

Rev. Rul. 74-563

- Paving community parking area

Rev. Rul. 75-370

- Roof replacement
- Elevator replacement

Rev. Rul. 75-371

- Pool area furniture replacement

Examples of items that do not qualify for a specific capital purpose include painting (Rev. Rul. 75-370) and contingency
(Rev. Rul. 75-371). This definition can be expanded to include any replacement fund component that is not capital in nature, such as tree trimming, termite repair, insurance, etc.

This is an extremely important issue whether the Association is filing Form 1120-H or Form 1120.

When filing Form 1120-H, capital contributions must be excluded from income when performing the 60% exempt function income test.

When filing Form 1120, capital contributions are excluded from member, and gross income. This represents a "book to tax difference", as gross income for financial statement purposes under generally accepted accounting principles, will include reserve additions as income.

Nature of Assessment

All three Revenue Rulings were requested on the basis of special assessments, as opposed to regular monthly assessments. The fact that assessments are not special assessments does not have any bearing on whether or not the payments will qualify as a contribution to capital. Revenue Ruling 75-371 outlines a three point test which defines which items will qualify as a contribution to capital:

  1. Members must be notified in advance of the purpose of the assessment,
  2. Assessment must be for a designated "Capital Purpose",
  3. Amounts collected should be segregated from operating cash.

Very specifically, there is no requirement that the payment be a special assessment as opposed to a regular monthly assessment. There is only the requirement that the assessment meet the three part test indicated above.

Rev. Rul. 75-371 fully supports this position by stating that; "Section 118 of the Code provides an exclusion from gross income with respect to any contribution of money or property to the capital of the taxpayer"; and "but the exclusion does not apply to any money or property transferred in consideration of goods or services rendered"; and further, that "...the dominant factor in determining whether the amounts were contributions to capital or payment for goods or services was the motive or purpose and intent in making the contribution". Revenue Ruling 75-371 also cites IRC Section 61, stating "Section 61 of the Code defines gross income as all income, from whatever source derived, except as otherwise provided by law."

IRC Section 118 States: "In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer".

Existing tax law fully supports the position that the "capital portion of regular monthly assessments will qualify as contributions to capital. Such "capital portion" will generally be represented by the association's monthly reserve account contribution, less any painting, contingency, or other "non-capital" items included in reserves.


Gary Porter, CPA began his accounting career with the national CPA firm Touche Ross in 1971. He is licensed by the California Board of Accountancy and the Nevada Board of Accountancy. Mr. Porter has restricted his practice to work only with Common Interest Realty Associations (CIRAs), including homeowners associations, condominium associations, property owners associations, timeshare associations, fractional associations, condo-hotels, commercial associations, and other associations.  Mr. Porter is a registered Reserve Specialist with the state of Nevada.

Gary Porter is the creator and coauthor of Practitioners Publishing Company (PPC) Guide to Homeowners Associations and other Common Interest Realty Associations, and Homeowners Association Tax Library. Mr. Porter served as Editor of CAI’s Ledger Quarterly from 1989 through 2004 and is the author of more than 200 articles. In addition, he has had articles published in The Practical Accountant, Common Ground and numerous CAI Chapter newsletters. He has been quoted or published in The Wall Street Journal, Money Magazine, Kiplinger’s Personal Finance, and many major newspapers.

Mr. Porter is a member of Community Associations Institute (CAI), American Resort Development Associations (ARDA), and California Association of Community Managers (CACM). Mr. Porter served as national president of CAI in 1998 – 1999.