Reserves & Operating expenditures

I know the HOA must not mingle Reserve savings (aka sinking funds) with Operating expenses, for IRA reasons. Is there any problem with using Operating funds to supplement Reserve expenditures? Specifically, if the HOA set aside $10,000 for additional landscaping, and the bill is $11,000, can we add $1,000 from an Operating funds cushion? Would the IRS care?

Surely you have line items in your operating budget for landscaping, Susan, there's a line item for the contract. Often there's a line item for plant replacement because reserves shouldn't be used for anything that lasts a year or less and many HOAs budget a certain amount for annuals. There's often a line item for stuff like pest control, mulch, etc.

Your reserves account most likely is for replacement for larger items like trees or completed special areas, perhaps an entry monument area. Additions to landscaping may not be paid for out of reserves. That would be a capital expenditure. Either your board has created a line item for it for 2023 in your operating budget. OR your operating budget has perhaps a Contingency line item, which can pay for a new landscaping area.

Reserve accounts are never called "sinking funds" in HOA lingo. And as JohnC wrote, the IRS does'nt care.

Yes, you are generally not prohibited from using operating account money to pay for something that could be covered by reserves. This may be state specific and I don't know your state law, but generally it is fine.

Our HOA is experiencing similar issues in preparing the upcoming years budget. We were advised that creating proceedures on when and how to use reserves whether operational capital Reserves, replacement reserves or owners capital reserve. Provides consistency on the utilization. Reserve Processes also eliminate questions utilization of expenses vs reserves as well as making the budget formulation easier, remember to address how the reserves are replenished.

Anyone can google and see that the source of this quotation is attributable to an attorney named "Bob Diamond." E.g. https://www.hoaleader.com/public/Limits-on-Employing-Your-HOAs-Reserve-Funds.cfm#:~:text=%22The%20catch%20in%20dealing%20with,your%20reserves%20into%20taxable%20income.

If someone has anything to demonstrate that what Diamond said is not a line of cr-p, I'd like to see it. Whatever Diamond means, I think any competent HOA accountant knows how to treat transfers from the reserves to the operating account such that there lawfully is no income tax owed. I'd expect circumstances to have to be highly extraordinary for there to be any problem with a HOA spending any of its money, from the operating account or the reserve account, on any item that the HOA is required to maintain, for the short or long term.

Adding the remaining part of the Bob Diamond quote in the linked site for context: "However if you properly structure your use for the money, like by making a loan to your operating fund, you can use that cash for anything you want. But you have to pay it back. I'd advise any board to consult with their accountant and maybe their lawyer to make sure they structure that properly to protect the nontaxable nature of the reserve funds."

I think that's the point - if you did use reserves for operating expenses on a whim and did not pay back the reserve fund, the IRS could make you pay tax. It's like piercing the veil between a person who owns and LLC and the LLC itself by mingling funds. You only get the benefit of using form 1120-H (https://www.irs.gov/forms-pubs/about-form-1120-h) if the HOA keeps a clean division between reserves and operating money and uses reserves only for IRS-approved purposes.

I apologize Susan. I posted BS. The IRS does have specific guidance on using HOA assessments, placed in the reserve account, for non-reserve components. The guidance is to help HOAs avoid assessment income becoming taxable income. See ​https://altitude.law/resources/newsletter/association-taxation-and-reserves/:

"The Internal Revenue Service (“IRS”) excludes from an association’s taxable income those amounts [of collected assessments?] which are properly kept and used for capital contributions. [snippage] For assessments to be classified as capital contributions, the association must comply with the following criteria in the Revenue Rulings:

Notify unit owners in advance that a specific portion of their assessments represents capital contributions to the association. This can be accomplished by including the reserve fund contributions as a line item in the annual budget.

Designate reserve fund contributions for specific future capital expenditures. This can be accomplished by having a reserve study conducted. The reserve study should list the funds required for each expected future capital expenditure. Associations that are currently setting aside funds for future capital expenditures and have not conducted a reserve study would not meet this requirement.

Monies earmarked for reserves should be utilized only for the major repair and replacement of assets and not for other purposes.
Segregate reserve funds from operating funds. This means separate bank accounts must be established for reserve funds and might prohibit inter-fund borrowing.

Maintenance items such as painting, staining, and caulking are not considered capital replacements for tax purposes."

Three sites that say what condo attorney Bob Diamond says:

https://www.davis-stirling.com/HOME/H/HOA-Taxes
"This article on "Reserves as Capital Contributions" [https://pl-cpas.com/index.php/publication/reserves-as-capital-contributions] explains the requirements for reserve assessments to be considered capital contributions for tax purposes. Failure to comply with all these requirements may cause the IRS to challenge the exclusion of reserve assessments from taxable income. [The linked article provides the IRS ruling numbers]

https://www.buildium.com/blog/hoa-reserve-fund-accounting/:
"As we mentioned before, reserve funds are held in a separate account from operating and other funds. This is called fund balance accounting. It allows an HOA to manage and allocate funds for specific uses and keep clear records of where every dollar goes.

This is very important for two reasons. First, if reserve money is not in a separate account, the IRS can look at it as taxable income to the HOA. Second, it’s absolutely essential to keep track of what comes in and goes out of the HOA. Residents want to know where their money is. And, should the HOA be audited, the treasurer will have to account for every dollar the HOA has earned and spent."

https://emspm.com/hoa-reserve/ (web site run by a management company)
"HOA Reserves and Taxation
Are reserve funds taxable? Homeowners association reserve funds are not considered taxable income. But, if you use your reserves to pay for operating expenses, you automatically make them taxable.

It is also worth noting that the account in which you put your reserves can determine whether or not it is taxable. If you keep your reserve funds in the same account as your operating funds, then the IRS will deem it as taxable income. Along with setting up internal controls, taxation is a good reason to keep your reserve in a separate, interest-bearing account. Though, the interest you earn on your reserves is still taxable.

SusanH34, after doing the aforementioned reading, including what you saw at the altitude.law link, off the top of my head I agree a board agreeing to transfer operating funds* to spend on reserve components is not problematic from a tax standpoint (or perhaps any standpoint), especially compared to the reverse (meaning transfers from reserves to operating). It comes down to simply deciding that more than was originally planned should be contributed from the operating account to the reserves.

As you may know: I think directors must keep in mind that 'budgeting, including reserve planning, is not an exact science.' Yes, in many states budgets have to be approved. But there's no law that says the budget, dollar for dollar and line for line, has to be followed. The latter would be ridiculous.

Some states have laws about certain types of mid-year amendments to a budget that was approved.

I note that none of what appears at https://www.davis-stirling.com/HOME/U/Unexpected-Expense seems to apply.

* specifically from the cushion built into the operating budget via the operating budget's 'contingency fund' line item that should be a part of every annual budget.