Proper Use Of Reserve Funding

Associations maintain reserve funds so that they can deal with long term needs in maintaining and replacing the common elements. These reserves do not fund the association’s everyday expenses or needs; the operating fund serves that purpose. Without an appropriately funded reserve fund, many associations require special assessments to make the necessary repairs when needed.

Choosing to impose a special assessment when issues arise is ultimately unfair to the members of the association who are title owners when the expenses arise. Any owner who sells their unit prior to a major repair received the full benefit and useful life of the common element without contributing to the cost of maintaining that common element. Well-funded reserves may also increase market value of the homes in your community.

Once a reserve fund is established, it should only be used for appropriate expenditures.

1. Use the reserve funds for repair or replacement of major capital items. This includes all common elements under the associations duty to maintain and repair, for example, roofs, streets, pool replacement, and clubhouse repairs, to name a few. Occasionally, after a major expense is paid for out of the reserve fund, there is a time period where contributions to the reserve fund must be increased to build the funds back in order to maintain the association. This can occur with unexpected repairs or when the estimates for repairs that were planned were below the actual cost of repairs.

2. Minor repairs should be made from the operating account and should be budgeted for. The Board when considering the budget must determine what is a minor versus what is a major repair.

3. Developer transition related items should be paid for from the reserve fund. If a developer is responsible for replacements to the common elements and because of transition litigation, refuses to perform the necessary repairs, the association should make those repairs out of the reserve fund money, and any money recovered from the developer should be used to reimburse the reserves. If no money is received, the association must re-evaluate its reserve fund and adjust contributions to make up for the prior use of the funds.

4. An association with a sizable reserve fund may need to pay income taxes on any interest earned on the fund. The association can charge any income tax that is paid on that interest income back to the reserve fund.

5. Occasionally, a major project arises and the association does not have sufficient funds set aside to cover the expenses, and it does not wish to special assess; so it obtains a loan to cover the gap in funds. This type of loan uses future association dues as collateral for the loan. The interest expense on these types of loans may be charged to the reserve fund. The expenditure itself, the debt service, and the future assessments required for debt repayment should be included in the reserve account budget.

6. It is a mistake to borrow funds from your reserve accounts to cover items in your operating budget. Borrowing funds in this manner can have negative tax consequences and can lead the association down an unhealthy financial path, which could potentially ruin the association financially. To combat this type of problem, it is important to monitor the operating budget regularly to make sure that any deficit for the year is appropriately addressed in any subsequent year, and that the fees are adjusted accordingly to preserve the reserve funds and ensure they are used for their proper purpose.

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