QUESTION: Our association has done a reserve study and now is taking the necessary steps to increase the reserves. The association owns one of the units free and clear and rents it out. The unit is worth over $500,000. Shouldn’t this count toward the reserve account?
ANSWER: The $500,000 estimated value of the unit can be included in the HOA’s balance sheet but not in its reserve funding calculations. Assuming the unit is a condominium, there is very little that needs to be reserved for inside the unit–carpet, cabinets and maybe painting. Depending on the size of your budget, most items in the unit will be addressed through routine annual maintenance.
Property Taxes & Insurance. Non-reserve items that are sometimes overlooked are the need to insure the unit and pay property taxes.
Separate Interest. If the unit was acquired through foreclosure, it will have a parcel number. In that case, property taxes must be paid and a separate general liability and property insurance policy purchased for the unit.
Common Area Unit. If the unit is part of the common areas, then property taxes are not an issue. That happens most often when a “manager’s unit” is created by the developer and included in the common areas. Accordingly, the unit is covered by the association’s insurance. However, boards should not assume it’s covered–they need to verify it.
Taxable Income. Rent money collected from the unit is subject to taxation as non-dues income. In addition, when the unit is sold the association will incur transaction costs and pay taxes on any gain on the sale. The gain on this asset sale produces “non exempt function” income, which is taxed at ordinary corporate rates. These rates go up to 35% for federal and 11% for California. There is also a “basis” for gain or loss issue to resolve when the unit is sold. Therefore, the net realizable value may be substantially less than $500,000.
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