In this week's tip, we offer insight to an HOAleader.com reader at a 32–owner, self–managed HOA in Virginia. Our reader wants to know how investing his HOA's reserves in an interest–bearing account or certificate of deposit will affect his HOA's nonprofit status.

Let's give the quick and easy answer first. "It depends on the laws of your state, but in California at least, having and earning interest won't violate your nonprofit status," says James R. McCormick Jr., a partner at Peters & Freedman LLP in Encinitas, Calif., who represents associations. "Nonprofits can, in fact, make a profit."

Eric Gould, a lawyer at Couzens Lansky in Farmington Hills, Mich., who represents as many as 10 condos or HOAs at any given time, concurs. "The simple answer is that no, investing your HOA's reserves in an interest–bearing account or CD won't not jeopardize or terminate your HOA's nonprofit status," he says. "That said, it's probably worthwhile as part of the board's best practices or an occasional review—if it hasn't been looked at in a while—to ensure that indeed the appropriate election was made with the Internal Revenue Service as an exempt home owners association. Sometimes everyone thinks it's filed that way, but it may not be."

"That's the basic answer," adds Gould. "But there's a lot more that goes with that."

The fact that your nonprofit status isn't threatened doesn't mean you don't have any tax issues from such an investment. "HOAs, at least under the federal tax scheme, don't have income based on what they take in and pay out from their members," explains Gould. "But if they do have an investment, the interest they earn will be subject to tax. It won't jeopardize their nonprofit status, but it will create potential tax liability for the income they earn."

There are ways around that tax liability. "One way to minimize that exposure is to determine if there's a way to invest through a nontaxable account, like some type of fund based on municipal interest," says Gould. "If the investment is tax exempt—but even if you put your funds in a bank account or a CD—your HOA won't have much income and tax liability. But there may be a way to invest that generates tax–free income, and the rate of return may not be all that much less than other investments would provide."

What if your HOA wants a greater return than with conservative investments like bank accounts, CDs, or municipal bonds? Find out about investment risks in our new article, Smart Reserve Investments for Small, Self–managed HOAs.

Best regards,

Matt Humphrey

President