Rev. Rul. 83-74

ISSUE

Under the circumstances described below, may a homeowners association revoke an election made under section 528 of the Internal Revenue Code to be treated as a tax-exempt organization to the extent of its exempt function income because of incorrect tax advice provided by its professional tax advisor?

FACTS

In 1980, X, a homeowners association as defined in section 528 of the Code, appointed A, a professional tax advisor, to audit its financial books and prepare its federal income tax return for its 1979 calendar year. A completed the audit and prepared the Form 1120-H (U.S. Income Tax Return for Homeowners Associations). The Form 1120-H was timely filed after it was signed by X's managing agent. Subsequent to the due date for filing the federal income tax return. X's Board of Directors determined that A's audit was inaccurate and dismissed A.

Thereafter B, another professional tax advisor, was retained by X to review the audit of X's financial books for its 1979 calendar year and the tax returns filed for that year. B discovered that A had understated X's interest income on the federal income tax return filed for X's 1979 tax year. In addition, X and its managing agent were told immediately after the discovery by B, 4 months after the federal income tax return was filed, that the filing of Form 1120-H is elective and that a Form 1120 (U.S. Corporation Income Tax Return) could have been filed instead. If the Form 1120 had been filed for X's 1979 tax year, a net operating loss from a prior tax year could have been claimed. When X learned this fact, it immediately asked the Service in a written request if it may revoke the election. If permission to revoke the election made under section 528 is granted, X plans to file a Form 1120 for its 1979 tax year.

LAW AND ANALYSIS

Section 528 of the Code generally provides that certain homeowners associations may elect to be treated as tax-exempt organizations, but only to the extent of their exempt function income. Exempt function income consists solely of amounts received as membership dues, fees, or assessments from owners of residential units or residential lots.

Section 528(d)(2)(B) of the Code provides that no net operating loss deduction shall be allowed under section 172.

Section 1.528-8(a) of the Income Tax Regulations provides that a separate election to be treated as a homeowners association under section 528 of the Code must be made for each tax year. The election is made by the filing of a properly completed Form 1120-H.

Section 1.528-8(f)(1) of the regulations provides that an election to be treated as an organization described in section 528 of the Code is binding on the organization for the tax year and may not be revoked without the consent of the Commissioner.

X has requested permission to revoke its election under section 528 of the Code for its 1979 tax year. X's request to revoke its election resulted from B telling X that the tax advice provided by A when the return was filed was inadequate. This situation is analogous to those situations concerning taxpayers who have not made a particular election provided in the regulations because of inadequate or incorrect advice from either an attorney or accountant knowledgeable in tax matters and subsequently seek extensions of time under section 1.9100-1 of the regulations in which to make the election. Under section 1.9100-1 the Commissioner has discretion, upon good cause shown by the taxpayer, to grant a reasonable extension of time fixed by the regulations for making an election, provided certain conditions are satisfied. Rev. Proc. 79-63, 1979-2 C.B. 578, which discusses the application of section 1.9100-1, indicates that an extension would be granted to a taxpayer that uses due diligence to determine the requirements for the election, takes prompt action in requesting an extension of time fixed by the regulations for making an election or application for relief, within a reasonable time after discovering a deadline has already passed, and in other respects satisfies the conditions of the revenue procedure. The application of similar factors is appropriate to determine whether taxpayers may revoke previous elections made under section 528.

In the present situation, X timely filed on the advice of A, a professional tax advisor, a Form 1120-H for its 1979 tax year, which automatically caused a section 528 election to be made. X showed due diligence by timely selecting A to prepare its federal income tax return because X knew very little about tax matters. A prepared the Form 1120-H for X and X's managing agent signed the form in reliance on A's tax advice. Because of X's lack of knowledge about taxes, X assumed that it was required to file the Form 1120-H and make the section 528 election.

After learning that A's audit was inaccurate, X acted promptly and diligently in retaining B, a professional tax advisor, to review the audit and tax forms prepared by A. When B learned that a Form 1120-H was filed for 1979, B immediately told X that it could have filed a Form 1120 for that year thereby avoiding the section 528 election. X promptly filed with the Service a request to revoke the section 528 election. This election was made by X as a result of inadvertence. These actions, coupled with X's prompt request for revocation, indicate that X did not take any action inconsistent with its intent to file a proper federal income tax return for 1979.

In addition, granting the revocation in the present situation would neither prejudice the interests of the Government nor cause undue administrative burden, nor would it be inconsistent with the objectives of the underlying statute and the regulatory election.

HOLDING

Under the circumstances described above, permission to revoke the election made under section 528 of the Code will be granted.