Reserve fund account taxed?

Started by LoisC • 5 replies • 6651 views

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LoisC (Washington)
Posts: 17

Posted:

Our CC&R require that the HOA maintain separate accounts for current operations, reserves, and a reserve account for insurance. Our small condo complex with 28 units, are 25 years old and we have only had two accounts since the start: maintenance reserve and insurance reserve. I asked why we did not maintain a reserve fund account from our MC and was told that a reserve fund account would be taxed so they keep the money for capital expense with the operating expenses. I’m not a financial person so I didn’t question it at the time but other BOD members are now wondering if this is correct. Would this be a state tax or is every HOA with a reserve fund taxed? I could see taxing the interest that a reserve fund might generate but why not then tax the other accounts too? Washington state just passed a law requiring condo HOA to update reserve studies annually and make mandatory disclosures to purchasers. This does not mandate that HOA create reserve accounts, but I would prefer seeing the accounts separate and prospective owners probably would too.

RogerB (Colorado)
Posts: 5,067

Posted:

Lois, when an HOA qualifies and uses IRS form 1120-H only the income from outside sources, such as earned interest, is taxes. And most HOAs qualify to use this form. Not sure about your state taxes but think your MC may be wrong.

KirkW1 (Texas)
Posts: 1,665

Posted:

What does your auditor say about your accounting (and mixing of funds)? If you don't have an audit, you need one.

DeeB (Arizona)
Posts: 18

Posted:

Lois,

Your MC has it backwards. Reserve funds for major repairs and replacements are non-taxable, simply because of the nature of the funds, they are received to be used for capital expenditures in the future. The IRS actually requires you to deposit any reserve assesments received for major repairs and replacements into a separate account. The interest earned on these accounts are taxable income. Your insurance reserves would be considered operating assessements and expenditures, these could be deposited with your other operating assessements with limited consequence from the IRS. But if your governing docs address that they should be also deposited into a separate account then your gov docs rule. Per IRS Rev. Ruling 70-604 any surplus operating assesements at the end of a year can be considered taxable income if 1) you do not reimburse your HOA members in a pro rata basis the surplus or 2) The HOA members, (not the Board) do not elect to carry over the operating surplus to the next years operating budget. This election needs to be made annually and the next years budget must show how that years budget has been reduced because of the applying of the prior year surplus. This election must be done before the tax return is prepared for that year. You do not have to wait to the end of the year to make the election. Simply have your HOA members vote on IF there is an operating surplus that it will be carried forward to the next years budget at any time during the year. Then make sure this vote is well documented. Your bookkeeper needs to be tracking all operating receipts and expenditures separate from the reserve receipts and expenditures. A reserve surplus is non-taxable.

LoisC (Washington)
Posts: 17

Posted:

Dee - I just read another thread about reserve funds and I don't think the operating funds could be taxed either, but it sounds like it should all be in separate accounts and earmarked for different purposes. I like the operating fund (which would contain the insurance reserves too), reserve fund (capital expenditures) and contingency fund (for emergencies). I questioned my MC at our last meeting 6/2 and he says I misunderstood what he said, but he is now checking with an accountant. The WA law is now in place so he things this might change the answers.

We have not been audited in the five years I've lived here so perhaps it's time.

Thanks for responding.

MaryA1 (Arizona)
Posts: 7,043

Posted:

Lois,

The info Dee posts is a bit misleading. The quoted Rev. ruling only applies if the HOA files a form 1120 (corp. tax return). However, regardless of whether the HOA files an 1120 or an 1120-H (specific to HOAs), it is a good practice to keep operating funds separate from reserve funds; for at least 2 reasons:

1) A checking account may not be interest bearing. Depositing reserve funds in a money market account will generate interest which may become substantial depending upon the size of the reserve fund.

2) Co-mingling the two would make it hard to keep track of who much is operating funds and how much is reserves.

A talk with your accountant is a good step to take; I'm sure he will know what's best for the HOA and IAW IRS rules.

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