One of the most important aspects of a well-run HOA is establishing financial and structural security. Primarily, that security applies towards an HOA that maintains the financial stability and careful planning necessary. Board members play a crucial role in providing this type of security within an HOA through HOA reserve funds.
What is an HOA Reserve Fund?
To understand what an HOA reserve fund is, think about spending and costs within an HOA in short and long-term. It’s best to keep expected and unexpected costs in mind. An operating fund is what details the daily costs of an HOA.
The operating fund’s main purpose is to provide the board with ample funds to pay for items like routine maintenance costs or administrative supplies.
An operating fund is the expected costs that the board establishes a budget for based upon its generated income. The operational fund works like any other bank account, and the board members can use it to absorb any costs.
An HOA’s reserve fund primarily focuses on preparation and security. This provides ample funds necessary for costly projects within an HOA.
These projects include emergency maintenance issues and renovation projects the board has planned for. Board members play a crucial role in raising enough funds over time to cover potential costs.
Typical uses of the reserve fund can include:
- repairing structural issues within the community: landscaping, roofing, or construction
- remodeling of amenities or properties, or any other expense that wouldn’t be accounted for in an HOA’s budget
There is always the inevitability of usage and natural decay to structures that HOA boards need to prepare themselves for financially.
How do you determine the necessary amount an HOA Reserve Fund needs?
The trickiest aspect of establishing the HOA reserve fund is understanding the size and scope of an HOA. Rather than there being a set number of dollars that every HOA must have, board members must instead:
- determine potential long-term needs
- what dollar amount would give the board spend
- strategize how the board plans to raise funds within the community
A useful tool known as a reserve study can assist in solidifying an HOA’s needs.
A reserve study is an evaluation designed to help establish which areas of the HOA that board members need to repair, rebuild, or replace.
This evaluation is a comprehensive approach that takes the guesswork out of reserve fund budgeting. Boards may not have experience handling budgets. The third party approach assures an objective analysis of where the board should start. Estimations and financial calculations through consistent study kickstart the process that assists board members, raising money for the reserve fund.
Once figures are established, the board has to raise enough money through a gradual collection process with its residents.
Say the reserve study estimates that within 5-10 years a complete renovation of the community dog park will be necessary. It could cost anywhere between $15,000-20,000. Now, the board faces a choice: alter yearly or monthly budgetary expenses or raise money through resident dues. A combination of both could work as well.
Board leadership and contributions from each resident ensure that the HOA reserve fund meets the study’s time frame.
What happens when an HOA reserve fund is underfunded? Can it be overfunded?
It is a natural concern for both residents and board members to fear underfunding. Underfunding compromises the long-term security of an HOA. Boards and residents must ensure that the money flowing into the reserve fund is in constant use. This way, the HOA is guaranteed a return on its investment.
A reserve study is a great place to start when determining how much a board needs to save. It’s also important because it shows what amount the board should aim for when filling the reserve fund to 100%.
While optimally, an HOA board would reach the complete amount of funds necessary to fund any long-term projects or unexpected expenses, it’s also within reason for the board to aim for 70-75% capacity in most cases realistically.
However, this can be a case-by-case determination. The bigger an HOA is, the more funds may need to be allocated. However, securing anything over 70% of the reserve fund’s optimal size prevents it from becoming underfunded, leaving board members scrambling for dollars and residents frustrated and confused if and when a large-scale project arises.
On the other hand, the board must also take into account the optimal range the reserve fund should be in, mainly as a way of not overfunding the account and either drawing too much money from other budgetary concerns or by overcharging residents in contributions and dues. It might seem like having too much money in the reserve fund couldn’t possibly be a bad thing, but board members must also remember that finding and securing the money for these projects is a delicate balance financially.
Are HOA reserve funds taxable?
HOA reserve funds are not taxed when: a reserve study has been carried out, the funds have been appropriately accounted for, or, they are used in their designated fashion. Taxing money that is earned by the HOA becomes more difficult when boards begin to use reserve fund dollars for operational tasks. Board members can employ a management company, accounting firm, or law firm to assist in navigating their respective state’s tax law.
Where should HOA board members begin?
- The optimal solution for most HOA boards is to begin by hiring a third party to conduct a reserve study, if they haven’t already, and to establish the most current estimates of potential long-term costs within the HOA.
- From there, working with an accounting firm or management company to explore both budgetary options for allocating reserve funds, and for pulling financial support from the HOA’s residents, in the most effective way possible, would be the next course of action.
- Once board members have established what they need financially, along with a plan to secure said funds, the next step is making sure that the HOA reserve fund remains at a healthy amount.
Following this process not only secures the future of the HOA for every single member but creates the best possible version of the community that can consistently repair and renovate whatever necessary.