Reserve Fund Accounting

I am seeking some clarification on how reserve funds should be accounted for. If I understand correctly, all funds being set aside as reserve funds should be held in a separate account. Are those funds supposed to be transferred out of the operating account and listed as a liability on the balance sheet? Or are the funds supposed to be accounted for on the balance sheet as retained earnings and treated as a cash asset?

What are the tax implications (if any) when accounting for the reserve funds in either of those scenarios?

We have an operating fund and budget, and reserve fund. When assessments are paid, a portion goes to the reserve fund, which is a separate account. If we spend reserves on a capital improvement, tge amount needed is transferred from reserves to the operating account, and a check is written from that.

All this is reflected on our income and expense report. Reserves also has an income-expense report do you can see the deposits and transfers, as well as the reason for the transfer. Reserves are listed as an asset on our balance sheet.

All of that said, this is something you really need to discuss with an accountant, especially on the tax implications. Your documents may also have instructions on how this is supposed to work, do pull them out and read them.

There are some variations that I have seen. I must warn you I an not an accountant. I am just going to tell you what I do at the end of the year. If you had a profit at the end of the year, you should have two different entries. One to transfer the money from your operating account to reserve account and the other to account for the change in equity or liability. Say you had a profit of 10000 at the end of the year and plan to move entire amount to reserves

Reserve Savings Account Debit 10000
Operating Account Credit 10000

Retained Earnings Debit 10000
Restricted Reserves - Deferred Maintenance Roof Credit 10000

I have the Restricted Reserves as an equity account. For me, I think it is easier to explain to other owners that this is the money that has been saved for capital expenditure than explaining it as a liability.

Best practices is for reserve funds to be held in a separate bank account. If reserve funds and operating funds are commingled in one bank account, tax implications loom.

?

On the HOA's income and expense statement, transfers from the operating account to the reserve account are counted as (1) an expense to the operating account and (2) income to the reserve account.

On the HOA's balance sheet, all funds in the operating account are an asset. All funds in the reserve account are an asset.I suggest reading the following (courtesy of another HOATalk thread):

1.
"The catch in dealing with reserves is that you don't pay income tax on reserve funds," says [condo attorney Bob] Diamond. "So if you use them for an improper purpose, like to cover ordinary operating expenses, you convert your reserves into taxable income." See https://www.hoaleader.com/public/Limits-on-Employing-Your-HOAs-Reserve-Funds.cfm

2.
"This article on "Reserves as Capital Contributions" [https://pl-cpas.com/index.php/publication/reserves-as-capital-contributions] explains the requirements for reserve assessments to be considered capital contributions for tax purposes. Failure to comply with all these requirements may cause the IRS to challenge the exclusion of reserve assessments from taxable income." The linked article provides the IRS ruling numbers. See https://www.davis-stirling.com/HOME/H/HOA-Taxes

3.
"As we mentioned before, reserve funds are held in a separate account from operating and other funds. This is called fund balance accounting. It allows an HOA to manage and allocate funds for specific uses and keep clear records of where every dollar goes. This is very important for two reasons. First, if reserve money is not in a separate account, the IRS can look at it as taxable income to the HOA. Second, it’s absolutely essential to keep track of what comes in and goes out of the HOA. Residents want to know where their money is. And, should the HOA be audited, the treasurer will have to account for every dollar the HOA has earned and spent." See https://www.buildium.com/blog/hoa-reserve-fund-accounting/

4.
"HOA Reserves and Taxation
Are reserve funds taxable? Homeowners association reserve funds are not considered taxable income. But, if you use your reserves to pay for operating expenses, you automatically make them taxable.

It is also worth noting that the account in which you put your reserves can determine whether or not it is taxable. If you keep your reserve funds in the same account as your operating funds, then the IRS will deem it as taxable income. Along with setting up internal controls, taxation is a good reason to keep your reserve in a separate, interest-bearing account. Though, the interest you earn on your reserves is still taxable." See https://emspm.com/hoa-reserve/ (web site run by a management company)

5.
https://cozbycpa.com/wp-content/uploads/2019/06/CozbyCPA-AssocReserveFunds-Presentation.pdf . Scroll down to "What is a Reserve Fund - Taxes"

The above site is overwhelmingly speaking to non-HOA, for profit corporate "reserves."

Sites that speak to HOA reserves being an asset (or equity), not liability:

https://boardlineacademy.com/hoa-budget/

https://mpsfinancial.com/mps-newsletter/f/deconstructing-your-hoa's-balance-sheet

https://clarksimsonmiller.com/hoa-balance-sheets-review/

https://cabuilderservices.com/hoa-reserve-funds/

I am going to go out on a limb here and speculate that this treasurer is referring to tax form 1120, Schedule L "Balance Sheets per Books."

To review: By far most HOAs file (with the IRS) either tax form 1120 or tax form 1120-H. With some caveats, tax form 1120 requires submission of this Schedule L balance sheet. Tax form 1120-H does not require submission of a balance sheet. Which form to use just depends.

The instructions for Form 1120 Schedule L say that "The [schedule L] balance sheets should agree with the corporation's books
and records." Schedule L 's Assets section, Line 1 says simply "Cash." The instructions for Line 1 say to include certificates of deposit on this line.

I am not an accountant. I am working from amateur efforts with a former HOA and a single college course in accounting, plus several years experience as a volunteer personal income tax preparer. The latter only means I know how to look up IRC sections and can sometimes parse the IRC wording for practical purposes.

Pretty much (or exactly) yes.

But I am just some rand-o on the net. I see one post-o above by me so far. There are maybe three people here at HOATalk that I think could speak about this more intelligently. Until they weigh in, may I suggest you review both some sample and some real life HOA balance sheets? E.g.:

http://hoa-partners.com/files/Understanding-Financial-Reports.pdf

https://ironhorsegolfclub.com/wp-content/uploads/2018/08/2017-IH-Audit-Final-Draft.pdf

https://www.camsmgt.com/files/SAMPLE%20BALANCE%20SHEET.pdf

https://fallcreekhouston.com/wp-content/uploads/2022/02/2020-Financial-Report.pdf

For more, google on

"association" "balance sheet" filetype:pdf

I agree.

Understood. However I recommend that the HOA start having owners vote annually on an "excess income resolution." This California site explains this well: https://www.davis-stirling.com/HOME/E/Excess-Income-Resolution

This forum is seeing more and more reports of HOAs routinely taking this owners' vote at the HOA's annual meeting. The vote is some insurance that should the HOA accountant need some flexibility in filing tax forms (so as to minimise the HOA's tax bill), the HOA accountant has this flexibility //under the IRC and so IRS regulations//.

Sorry to add more to the Board's plate. The vote is truly a formality. Owners should always vote for this "resolution."

Good (that they are intending to have one). So far the Idaho HOA statute is as barebones as a HOA statute could be. However I am a little acquainted with an Idaho HOA member working some with his/her representatives in the Idaho legislature and their attorney staff (as we speak). The work is specifically and exclusively on amendments to the Idaho HOA statute. Is a requirement for a reserve study coming? Maybe but I think not for a few years. Certain legislators show signs of being a bit unhappy with the rogue/irresponsible behavior of Idaho HOA Boards. Or the legislators are hearing from too many constituents about problems with their HOAs and so are seeking amendments.

Are there a lot of amenities at this HOA? Significant HOA-owned infrastructure? E.g. Is the HOA responsible for roads or similar big ticket items?

I do not own this site. But I do recommend reading at HOATalk often. The importance of reserve studies is discussed often. Most HOA members do not understand why the HOA has to save up via a reserve account.

Anyone who has seen me rail here against certain posters objecting to having false information corrected knows I could not possibly be the moderator/owner, with the power to ban people from the site.