Can Reserves Be Used to Add Asset?

Reserves are supposed to be used for re[air or replacement of existing assets, such as roof replacement, replacement or refurbishing of a clubhouse heating system, repaving roads and parking areas, etc. If you've planned your reserve contributions properly, you're supposed to have enough saved up to pay for what has to be done when it needs to be done. So, there really should be no extra to pay for new assets.

There are options, though:

1. You could have a special assessment to pay for the new assets.

2. If your documents allow it, you could borrow the money to purchase the new assets, but you would have to increase your regular assessments to repay the loan with interest.

3. You could borrow from your reserve fund, but again, you would have to increase your regular assessments to repay what you borrowed. It wouldn't be interest-free because you would also have to pay the interest on what you borrowed to replace the interest you will lose on your reserve fund. Also, you would have to make sure the money is replaced in time so you will have it when you need it to meet the purpose for which the reserve fund was originally intended.

4. You could increase your regular assessments and set the extra aside to pay for the new assets. Of course, you won't be able to get the new assets right away with this option.

Nope. That's not how it works.

Example: We have a water heating system in our clubhouse. The water heater failed. Replacing the water heater is replacement of an existing asset. The reason the water heater failed is sediment from hard water. The addition of a water softener to prevent the problem in the future is not a remedy. It is the addition of a new asset and is not a capital expense. It is a capital improvement because it adds value.

The IRS looks at such things with very strict guidelines. If it maintains value, it is a capital expense. If it improves value, it is not a capital expense but adds to the basis for the cost of the asset so improved.

Our builder went out of business. They were supposed to aerate the pond on both sides and place fountains on both sides. They only did the aerator/fountain on one side of the pond. We pay to treat the pond, but it needs both. It doesn't make sense to do a special assessment to pay for an asset that will be maintained by the asset reserve. It is adding assets that should have been made to the community initially. They also did not provide adequate lighting in the playground. This is an asset that should have been provided initially. I'm just not understanding.

Here are some links that may be helpful:

What is a Capital Improvement? from HOABrief.com

Capital Improvements vs. Reserve Expenses from reservestudy.com From the article:
What is the difference between a Capital Improvement and a Reserve project? Or more specifically, when can a Capital Improvement be more properly considered as a Reserve expense? This question becomes important to Association-governed communities s they consider what funds can be used (Reserves or a Special Assessment?) and what authority (homeowner vote?) is needed to execute the project.

Operating Expenses vs. Reserve Expenses vs. Capital Improvements from a HOA management blog.

Common Area Maintenance Versus Capital Improvements article from an attorney.

Repairs vs. Capital Improvements: Do the Final Regulations at Last Clarify the Distinction?

Capitalization v Repairs Audit Technique Guide from the IRS

Can they? Sure...or more accurately probably with a vote of your board.

Should they? Probably not. But if you have excess funds in your reserve fund, and have a plan in place to make sure the reserve fund remains fully funded in light of the new asset, then I wouldn't fret.

Bottom line is that the board has the authority to make financial decisions for the HOA. If the board can soundly justify the amount of money being spent, the way in which it's being spent, and the overall financial health of the HOA, then I would personally consider it. If it's digging a financial hole, or making a financial hole even deeper, such that you have to try to explain your way out of it in a way that would concern residents then probably not.

IANAL but:

In MN I know that a few years back he law was changed and that is why we had to establish a contingency fund in addition to the reserve fund. In MN if it is not budgeted to come from reserves it can not.

That's fine Stephanie but as others have said, the money needs to be replaced and actually added to because not only do you have one fountain, you now will have two that will need replacing down the road. The reason we are cautioning you so vigorously is that there are any number of HOA's that have robbed reserves to pay for things that should have been financed by other means in order to keep assessments artificially low. Then comes the time for X to be replaced and surprise, surprise the piggy bank is empty and a massive special assessment is required. Many times this policy is encouraged by members who expect to only be there for a short time and gone before the bill comes due.

Also health of reserves is a factor many lenders are now looking closely at before they will underwrite a mortgage.

I think it depends on the health of the reserve accounts. We have done pricing on all of our assets, and we are in a very good position. We have very few assets in our community. We probably will raise dues by a small margin at the end of the year, but I want to know my options. I don't want to be in a situation where we have to. Thanks for all of your feedback. Sounds like this is a very heated subject.

Not really.

Typically, even if 100% funded, the amount needed and placed in the Reserves is calculated based on the cost of expected maintenance and the cost to replace the item at the end of it's useful life. Therefore, as Larry pointed out, if money is taken from the Reserve to pay for something that wasn't calculated for, then either that money needs to be paid back (by increased assessments or a special assessment) or the expected maintenance or replacement will need to be deferred until the money is available.

Additionally, once the new item is installed, the Reserves will need to be adjusted to fund the costs of the expected maintenance and replacement of the new item.

Stephanie, does your Association account for your Reserves as one big pot of money or does it account for the Reserves by line item (x amount set aside for this, x amount set aside for that, etc.)?

I've found that by breaking the Reserves into line items (vs. one pot of money), it's easier for individuals to see if the money is really available or not.

Now I understand. No, we have it in two pots of money. One for our private alleys and one for community assets. I have obtained quotes on what it would take to replace all of our assets. We've just funded the reserves in the past at 10%. No plan was in place. So, you're saying that we need to find out how long the assets are calculated to last and budget a certain amount to each of the subcategories annually. That makes sense to me.

I'm not sure how a company that is managing 180 properties and works very closely with lawyers could be so misguided.

Steph

The reason I asked about the fountain/aerator is we have a spring fed retention pond with a lovely fountain in the middle of it. 20 of we owners live on or can see the pond. Recently an owner (not one of the 20) questioned the cost of the fountain (electricity and future maintenance) and asked was it necessary or a was it a beautification installed by the builder? Several jumped to the challenge saying it is necessary for aeration. He replied fine, but can you show me what professional says so? He has a valid point and I am one of the 20....LOL

err, Stephanie. Sorry about that.

Yup.
Think of it like this...

Suppose you have a deck on your house that will cost $20k to replace and you know that it need to be replaced in 20 years. You would budget for, and put away in a reserve fund (the bank account of your choosing) $1000 every year. Then, when the deck needs to be replaced, you have the $20k on hand and don't need to take a big financial hit that was unexpected.

Now, 20 years is a long time to forecast, so you would probably take a look at it every 3-5 years. Maybe after 5 years you might find it'll cost $22k to replace, but will last ANOTHER 20 years. You already have $5k in the bank from the first 5 years, so you'll need $17k more over the next 20 years. You then adjust your reserve fund deposit to $850 per year. Rinse & repeat a few years later.

Some will try to factor in inflation & interest, but that's even more difficult and unnecessary imho. The goal is to get close to minimize the shock. There's no prize for having predicted to the penny how much something costs in the future.

If your association is maintaining a reserve fund that is 10% of the annual budget (often a legal minimum) then you're probably under-funded.

The flip-side is the people who will complain that they won't be there 20 years from now, so why should they have to pay money in now? To them I say "too damn bad". That's a rare case when an HOA might actually increase value of a home. I suspect a buyer would be reluctant to pay top dollar if they knew the HOA was slacking on reserves and that they might be expected to pay a few thousand $$ to replace/repair that which has not been budgeted for.