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Contingencies in the Reserve Study

We are right in the middle of the reserve study busy season and are again being asked by a number of our clients whether or not it is permissible for them to have contingencies within their reserve study.

In some Associations, this is just a given. In other Associations, there are member factions that will react quite strongly against the inclusion of contingency in the reserve study.

study in Germany

There are a number of issues to consider when addressing the issue of adding a contingency factor into a reserve study.

1. Is a contingency reserve permissible under state statute?

2. Is a contingency reserve permissible under the Association’s governing documents?

3. Is a contingency line item permissible under tax law?

If you’re determined to have a contingency factor within your reserve study, once you get past the above issues, you then have a decision to make as to HOW contingencies will be included within the reserve study.

1. Will contingency be a separate line item expense within the study? If so:

-will it be a flat dollar amount?

-will it be a percent of current year expenditures projected in future years?

-will it be a percent of reserve fund assessments?

-will it be the excess operating income that is transferred annually from the operating budget?

2. If contingency is not treated as a line item within the report, can it then be factored into the study as a percentage of future expenditures?

And the last question:

3. Will your reserve software support the reserve calculation method you prefer?

As you can see, there a number of factors to consider in response to the simple question we are often asked of “Can we add a contingency factor to our reserve study?”

Some reserve preparers are adamantly opposed to ever including contingencies within the reserve study, perhaps because of the multiple unknowns identified above. Other reserve preparers don’t seem to have a particular problem with contingencies, but generally have a specific manner in which they prefer to present the contingencies.

Let’s take a look at each of these issues identified above:

1. State statutes – The answer to this is not as transparent as we may wish, simply because most state statutes are silent on the issue of contingencies. Statutes primarily address the physical common area components for which the Association has maintenance responsibility, if they address content of the reserve study at all. I have not seen contingency specifically listed within state statutes. That doesn’t mean it doesn’t exist; it just means that I haven’t seen it. Many interpret state statutes as being specific about reserves not being able to be included in the reserve study by the absence of a discussion on the matter. Others state that you are not necessarily prohibited from having a contingency reserve simply because it is not enumerated in statutes; many other things are also not specifically listed in statutes. However, depending upon how a contingency factor is added to the reserve study, it may not be an issue. (See item “2” above.)

2. Governing documents – The position here is very similar to that of state statutes. Most governing documents do not have any language at all that addresses the issue of contingency within the reserve study. Therefore you are left with the same question of whether or not it is permissible to include contingencies in the reserve study simply because of the absence of any language addressing the issue.

3. Tax law – For what may be the only time we can ever say this, the fact is that tax law is quite specific on the issue of contingencies within a reserve study. Many people may disagree with the following statement simply because it is exactly the opposite of what they have been told numerous times, but the fact is the IRS takes NO position with respect to contingencies in the reserve study.

The IRS cannot force any taxpayer (Association) to include or exclude ANY item from the reserve study. The only thing that the IRS can do is to react to what has been included in the reserve study by telling you the appropriate tax treatment of that item. While the HOA industry thinks in terms of operating versus reserve, the IRS thinks in terms of capital versus non-capital. They are not the same thing.

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