If you talk to an association and ask them about their HOA reserve fund accounting, you may hear some pretty unfortunate stories that happened before you arrived; reserve funds that were too low to cover repairs, treasurers who were spending reserve money to cover other bills, or HOAs with no reserve fund at all.
A healthy reserve fund that’s handled properly is an essential component of a well-run HOA or community association. It gives residents peace of mind that larger maintenance projects and emergency repairs are covered, and it prevents an HOA from falling into the red.
And in an unpredictable economy, it ensures that an association can operate and keep its properties safe for its residents.
We know that reserve fund accounting shouldn’t be taken lightly. How do you, then, set up set up and keep track of an HOA reserve fund?
In this article, we’ll explore all the ins and outs of reserve funds and reserve fund accounting practices for property managers.
What Is a Reserve Fund?
If you’re just starting off as a community association manager (CAM), a reserve fund is a savings or other account where an HOA keeps a predetermined amount of money to cover the cost of non-routine repairs. Reserve funds are managed by a board of directors for the HOA, as part of their duty to keep properties up to the expectations and contractual agreements in place with its residents.
What Can Reserve Funds Be Used For?
A reserve fund can be used for any repair or upgrade that isn’t done regularly, from fixing a crack in the side of a pool to replacing an old water heater. The repairs can be expected or a surprise.
Let’s say, for example, a passing storm knocks a sizable tree onto the roof of an apartment building. The HOA can dip into the reserve fund to remove the tree and repair the roof. They can also use the reserve fund for anticipated repairs, such as re-shingling an older roof.
What’s important is that HOAs keep enough money in the reserve fund and use it for nothing but non-routine repairs.
What’s the Difference Between HOA Reserve Fund Accounting and an Operating Fund?
HOAs also maintain an operating fund, which is used to pay for day-to-day expenses. When a resident pays their monthly HOA fee, a portion of it goes to the operating fund, while another portion (probably smaller) should go to the reserve fund.
Operating and reserve funds are kept in two separate accounts.
How Much Money Should Be in a Reserve Fund?
When it comes to the amount of money in a reserve fund, there’s no magic number. It all depends on the number of properties, amenities, and other assets an HOA manages.
Whatever that number is, a reserve fund should be between 70 and 100 percent funded, ideally. That means that there is enough money in the account to cover all or almost all of upcoming replacements and repairs.
A reserve fund can have less than that set aside, however, and some will. Some HOAs will keep a partially funded reserve to keep association fees low for residents. Others budget for the renovation or repair of property items rather than complete replacement to keep costs down.
Properties whose mortgages fall under FHA, Freddie Mac, or Fannie Mae governance, for example, are only required to have 10 percent of the reserve funded. But if a big repair comes up, the HOA risks having to do a special assessment to cover the cost.
What Is a Special Assessment?
When there isn’t enough money in a reserve fund, an HOA has to conduct a special assessment. An HOA’s governing board will assess the cost of a needed repair or replacement and then divvy that cost up among residents. Some HOAs require all residents to pay an equal share, while others base the portion a resident pays on the square footage of their unit.
When and how the HOA can call for a special assessment should be laid out in its governing laws. For example, the association may need to vote on whether a special assessment should be levied beforehand.
How Do You Determine Fees for Reserve Funds?
Collecting money for reserve funds should be built into the fee structure for residents of the HOA. In other words, the monthly fee that’s charged to residents should include enough money for regular maintenance and services, as well as some money to set aside for the reserve fund.
To determine how much money they need for reserve funds and, therefore, what to build into the fees, HOAs must conduct a reserve fund study.
What Is a Reserve Fund Study?
If an HOA is creating a reserve fund for the first time, or if they’re reassessing an existing one, they conduct a reserve fund study to determine how much money they should put away.
How Do You Conduct a Reserve Fund Study?
To conduct a reserve fund study, an HOA can hire an outside firm to come in and inspect the property to determine what’s going to need fixing and upgrading in the near, and even distant, future. They will then determine how much money the HOA will need to make those repairs.
HOAs take the findings of the study to create a financial plan for their reserve fund, including how much they should put away, how it should be invested, and how much to charge residents to fund the reserve.
A reserve fund study should be done every few years to make sure there is enough money put away for a rainy day. If a property is backed by an FHA, Freddie Mac, or Fannie Mae loan, an HOA has to conduct a study every two years to keep it current.
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.
There are three accounting methods used by HOAs. Each has their pros and cons. It’s up to the HOA to determine which works best for their situation.
#1: Cash Accounting
In a cash accounting situation, income and expenses are only recorded when the money actually shows up in or has left the bank account. This is a pretty straightforward way to keep records, but it doesn’t account for pending funds from uncashed checks or missing resident fees, for example.
Particularly with expenses, you should account for pending transactions so that you don’t overspend.
#2: Accrual Accounting
Accrual Accounting does account for pending income and expenses. In each situation, a third column, called the cash column, is added to the balance sheet. HOAs record money due in the first column and money owed in the second. When the money actually lands in the HOA’s bank account or is paid by the HOA, the entry shifts to the cash column to reflect the true account balance.
This method gives an HOA a more complete picture of their finances.
#3: Modified Accrual Accounting
This method takes a little bit from both the cash and accrual accounting methods. For money earned, an HOA would use the accrual method, recording money when it is due to the association and shifting it to the cash column when cash is received. When money is owed by the HOA, expenses are only recorded when the money is actually paid, like the cash accounting method.
Whatever an HOA chooses, the goal should be to keep clear, accurate accounting records of every transaction. Of course, there are software services that can help HOA’s keep the books, and ensure all income and expenses are accounted for.
Can Reserve Fund Money Be Invested?
The short answer to that question is yes. An HOA can invest at least some of the money for a reserve fund, as long as there is enough money available for immediate needs.
Let’s say an HOA’s reserve fund study comes back with two recommendations. The first is to repaint the exterior in the next five years. The second is to replace the furnace in 10 years. You won’t need that money right away, so you can invest in bonds or mutual funds, for example.
Just make sure you have enough money set aside in a regular savings account; money you can access immediately to cover emergency expenses.
Reserve Funds and State Regulations
When an HOA creates, modifies, or spends money from a reserve fund, they must follow their state’s regulations for those funds.
Every state has different regulations for reserve funds and reserve studies.
For example, California has very specific rules for reserve funds to combat fund abuse. An HOA must complete a reserve study every three years, have a plan in place for repairs and replacements, and report every year whether or not the reserve fund can meet the HOA’s needs for the next 30 years.
In addition, California allows HOAs to borrow against their reserve fund to help shore up their income. The only catch is they must pay back what they borrowed within a year.
Before an HOA does anything with a reserve fund, they should look up the regulations for their state.
Every business, family, and individual should have a rainy-day fund to take care of larger projects and unforeseen fixes. The same holds true for HOAs. If its reserve fund is too low, or doesn’t exist at all, those unforeseen expenses fall onto residents, and could set them back thousands of dollars.
An HOA, following your guidance, should set up a healthy reserve fund and put into place tried-and-true HOA reserve fund accounting practices to keep both residents and their properties in the black—and allow you to deliver on what you were hired to do.Read more on Accounting & Taxes