When the Taxman Cometh, Will You be Prepared?

August 5, 2011

Today, a couple of great presenters spoke to those of us at the HOA Luncheon which is put on by the Utah Chapter of Community Associations Institute each month at the Cottonwood Country Club (these are not exclusive events, all are invited).  Chuck Balacy of Mutual of Omaha Bank / Community Association Banc, and TD Croshaw of Huber, Erickson & Bowman (HEB) presented some good information.  Chuck talked about reserve investment options, maximizing interest rates and HOA loans.  TD talked about HOA tax filing options and options to lower HOA taxes.

The high points were:

Reserve Investment Options and HOA Loans:  1.  Bank loans are a good option for obtaining funding for an association in certain circumstances and the bank doesn’t even lien the property; the bank’s security is the future assessment payments received from the owners.  2.  However, always use a bank specializing in HOA loans, as it is a unique area of lending.  3.  A good bank with an HOA focus will have a representative (such as Chuck Balacy) come out to a board meeting and discuss investment and banking options at no charge so the board can maximize the return on their investment of reserves with the absolute minimum of risk (we’re not talking about investing in technology company IPOs or even the stock market in general).

Taxes:  1.  HOAs can choose to file under either Section 528 or Section 277 of the tax code, with potentially very different ramifications.

2.  Section 528 was set up specifically for HOAs and Form 1120H is a simple one page form and all income is taxed at a flat 32%.  The HOA must meet the 60% exempt function revenue test, the 90% exempt function expense test, and 85% of the sq footage of all the units must be for residential use.   Taxable income is calculated from “nonexempt function income.”  All “exempt function income” is non-taxable. Under 528, HOAs are not entitled to net operating loss deductions and there is a possibility of more income being taxed compared to electing 277.

3.  Under Section 277, the HOA is taxed like a regular corporation and Form 1120 is more complex and has a tiered tax rate.  Additionally, compliance risks are much higher.  Risks include reserves being taxed, excess member income being taxed, and prepaids are income in the year paid and therefore contribute to the excess member income.  Taxable income is calculated from nonmember income, all member income is considered non-taxable.

4.  Neither method is a “one size fits all” and the best option may change from year to year.  A good HOA specialist tax accountant, like HEB, will compute the taxable income under both options and consider the risks versus the value of filing under each option to ensure the HOA pays the least amount of taxes while avoiding the risk of audit, penalties and back taxes.

5.  Are HOAs audited by the IRS?  Yes.  I don’t have any official figures, but TD Croshaw of HEB has personally seen three HOA audits recently.

(This is not an advertisement or endorsement for HEB or Mutual of Omaha Bank, my only intent is to provide simple, straightforward value to HOA boards, and that includes pointing out specialists in given areas from time to time without bias).

Curtis G. Kimble

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A Follow Up on Fidelity

August 2, 2011

As a quick follow up to my post on June 28, 2011, regarding embezzlement and fidelity insurance, this complaint underscores the importance of fidelity coverage even more.  Even if you never have an issue with misuse of funds or embezzlement, a lack of fidelity coverage could affect the ability of owners to buy and sell units within your association.

FHA, Fannie Mae and Freddie Mac all require that condominium associations carry some level of fidelity insurance, even if the association has professional management which handles the day to day aspects of collecting assessments.   Even a conventional loan with 20% down is likely to be sold by an initial lender on the secondary lending market and thus the loan must meet Fannie Mae and Freddie Mac standards.

While Wells Fargo didn’t exhibit best practices in the situation described in the link above, it’s always the best practice for an HOA to carry fidelity insurance coverage.

Curtis G. Kimble

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Embezzlement in an HOA?

June 28, 2011

If there’s one thing you do as a board member (and I mean if it’s literally the only thing you do as a board member because you’re too busy to be involved, or because the president or the property manager does everything), you need to make sure there is current fidelity insurance coverage for the association (protecting against loss of money from  dishonesty, embezzlement, forgery, etc.).

Recently, I’ve had involvement with an association where two of the three board members were simply not involved at all in the operation of the association and the third board member embezzled funds, failed to pay bills, and let the insurance lapse.  Finally, one of the lawsuits that had started to come in because of unpaid bills got served on one of the other board members and that clued him into the fact that something was amiss.   Of course, the embezzling board member had let the insurance coverage lapse long ago so there was no coverage and the association had to levy a large special assessment just to pay the outstanding bills.

Embezzlement, forgery, and other similar things may sound like exotic, foreign things that only happen in big corporations or in the movies, but it happens wherever you are and in HOAs of all sizes.  The HOA I mentioned above had less than 20 members.  No one is immune.  Besides the situation above involving a board member, I’ve had experience with an HOA where an employee of the property management company siphoned HOA funds for his personal use.

Even if you are actively and directly involved as a board member and you even look at monthly bank statements for your HOA, make sure they are the original bank statements, not something generated by a personal computer.  In the HOA in this story:  Police say woman stole from condo group, the treasurer used a computer to generate statements that made it appear that she was spending money on maintenance work that was never done. 

Curtis G. Kimble 

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How the New Laws Affect You: Non-Condos

June 2, 2011

For non-condo HOAs (all HOAs except condominiums), here’s a summary of how the new Utah HOA laws that went into effect on May 10, 2011, affect you most, as well as some recommended “action items.”  Contact us for help with any action item.  Also, see the other posts on this blog for more detail on the new laws.  This blog does not contain a comprehensive list of the new laws, just those that affect your daily operations the most.

1.  Register or No Lien.  Register as an HOA (separate and apart from registering as a nonprofit corporation) with the State of Utah and keep it updated when directors change, or else you can’t enforce any liens against delinquent owners.  *Action item:  subscribe to this blog (on the right side of this page under “Email Subscription”) and we’ll post the info on how to register as soon as we know about it.

2.  Insurance.  All HOAs in Utah must have property and liability insurance coverage for their common areas (this was not required before in non-condominium HOAs).

Unless the CC&Rs require each homeowner to insure the homeowner’s dwelling, all HOAs with attached housing (such as townhomes) are required to have 100% replacement cost coverage for all permanent improvements, including fixtures and betterments to an attached dwelling made by a homeowner.  The association must set aside an amount equal to the amount of the deductible (or $10,000, whichever is less).  The master policy must be primary, even for unit related losses.   However, the law gives the HOA a method to allocate or transfer risk to the homeowner or homeowner’s policy.  For claims against the association’s master policy which are associated with a particular home, the association can require that homeowner to pay the deductible if a notice had already been sent to all homeowners stating they will be responsible for the deductible on the association’s master policy.  *Action item: send notice to all owners regarding payment of the deductible, and make sure your deductible is somewhere in the $2,500 to $10,000 range to reduce minor or frivolous claims against the master policy by homeowners that drive up the premiums.

3.  Rules.  As of May 10th, rules can no longer be changed or adopted without giving notice to all homeowners 15 days in advance of the board meeting where the rule change will be considered and allowing homeowners an opportunity to be heard at that meeting.  The new or changed rule must then be sent out to all homeowners within 15 days of being adopted.  The homeowners can call a special meeting and disapprove a new rule within 60 days from the date it was adopted, if 51% of the total votes in the association vote to disapprove at the special meeting.

4.  Payoff Info.  An association is now prohibited from charging a fee for providing payoff information needed for closing on a unit, unless the fee is authorized by the CC&Rs, bylaws or rules, and, no matter what, the fee can’t exceed $50.  Payoff information must be provided by the HOA within five business days from when a closing agent makes a proper request for it (has to be in writing, signed and dated by the owner, etc.), or the lien is not enforceable at closing.

When a unit owner is closing on a unit and the owner needs payoff information because he or she has not been paying their share of the common expenses, providing that payoff information is an administrative burden on the HOA that is appropriately paid for by the offending/delinquent owner, not by the other paying owners.   *Action item:  adopt a rule authorizing a fee for providing payoff information.

5.  Reserves.  Every five years, a homeowner-elected board must perform, or hire someone to perform, a reserve analysis by (1) determining which improvements have a useful life of 3 years or more, then (2) determining what the cost is for maintaining those improvements over the next several years, and (3) then determining what they think the appropriate amount of the reserve fund should be.

The reserve analysis has to be reviewed and, if needed, updated every two years.  The reserve analysis has to be presented to the homeowners at the annual meeting each year where the homeowners at the meeting vote on whether to fund a reserve account and, if so, how to fund it and in what amount.  The results of that vote have to be reflected in the minutes.

The money in the reserve fund has to be kept separate from other funds and may not be used for daily maintenance expenses, unless approved by the owners, or for any other purpose other than the purpose for which the reserve fund was established.  *Action Item: for those who haven’t conducted a reserve analysis since March 1, 2008,  the law requires you to do one by July 1, 2012.

6.  Budgets.  A new law requires a homeowner-elected board to adopt a budget annually and to then present that budget to the homeowners at a meeting.  Since the budget will have already been adopted by the board, there is no requirement that the homeowners vote to approve the budget at the meeting.   The homeowners can, however, call a special meeting within 45 days of the first meeting and vote to disapprove the budget.  The budget will be disapproved if 51% of the total votes in the association vote to disapprove it “at a special meeting specifically called for that purpose by the lot owners.”

7.  Electronic Notice.  A new law states that you can provide notice to homeowners solely by electronic means (e.g., email, website) if authorized by your CC&Rs, bylaws, or rules (unless a homeowner opts out in writing).  *Action Item: adopt a rule authorizing electronic notice instead of notice by mail, at least for certain things.

Curtis G. Kimble

2 Comments | Governance, HOA Finances, Insurance, New HOA Laws, New Non-Condo HOA Laws, Non-Condo HOA, Reserves | Tagged: , , , , , , | Permalink
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How the New Laws Affect You: Condos

May 31, 2011

So, here’s a summary of how the new Utah HOA laws that went into effect on May 10, 2011, affect you most, as well as some recommended “action items.”  Contact us for help with any action item.  Also, see the other posts on this blog for more detail on the new laws.  This blog does not contain a comprehensive list of the new laws, just those that affect your daily operations the most.

If you’re a condo:

1.  Register or No Lien.  Register as an HOA (separate and apart from registering as a nonprofit corporation) with the State of Utah and keep it updated when directors change, or else you can’t enforce any liens against delinquent owners.  *Action item:  subscribe to this blog (on the right side of this page under “Email Subscription”) and we’ll post the info on how to register as soon as we know about it.

2.  Insurance.  A condominium association’s insurance policy that is renewed or issued after July 1, 2011, is required to have liability coverage and 100% replacement cost coverage for all permanent improvements, including fixtures and betterments to a unit made by a unit owner.  The association must set aside an amount equal to the amount of the deductible (or $10,000, whichever is less).  The master policy must be primary, even for unit related losses.  However, the law gives the HOA a method to allocate or transfer some risk and responsibility to the unit owner (or unit owner’s policy) for unit related issues.  For claims against the association’s master policy which are associated with a particular unit, the association can require the owner of that unit to pay the deductible if a notice had already been sent to all unit owners stating they will be responsible for the deductible on the association’s master policy.  *Action item: send notice to all owners regarding payment of the deductible, and make sure your deductible is somewhere in the $2,500 to $10,000 range to reduce minor or frivolous claims against the master policy by unit owners that drive up the premiums.

3.  Payoff Info.  An association is now prohibited from charging a fee for providing payoff information needed for closing on a unit, unless the fee is authorized by the CC&Rs, bylaws or rules, and, no matter what, the fee can’t exceed $50.  Payoff information must be provided by the HOA within five business days from when a closing agent makes a proper request for it (has to be in writing, signed and dated by the owner, etc.), or the lien is not enforceable at closing.

When a unit owner is closing on a unit and the owner needs payoff information because he or she has not been paying their share of the common expenses, providing that payoff information is an administrative burden on the HOA that is appropriately paid for by the offending/delinquent owner, not by the other paying owners.   *Action item:  adopt a rule authorizing a fee for providing payoff information.

4.  Reserves.  Every five years, a homeowner-elected board must perform, or hire someone to perform, a reserve analysis by (1) determining which improvements have a useful life of 3 years or more, then (2) determining what the cost is for maintaining those improvements over the next several years, and (3) then determining what they think the appropriate amount of the reserve fund should be.

The reserve analysis has to be reviewed and, if needed, updated every two years.  The reserve analysis has to be presented to the homeowners at the annual meeting each year where the homeowners at the meeting vote to determine whether to fund a reserve account and,  if so, how to fund it and in what amount.  The results of that vote have to be reflected in the minutes.

The money in the reserve fund has to be kept separate from other funds and may not be used for daily maintenance expenses, unless approved by the owners, or for any other purpose other than the purpose for which the reserve fund was established.  *Action Item: for those who haven’t conducted a reserve analysis since March 1, 2008,  the law requires you to do one by July 1, 2012.

5.  Electronic Notice.  A new law states that you can provide notice to homeowners solely by electronic means (e.g., email, website) if authorized by your CC&Rs, bylaws, or rules (unless a homeowner opts out in writing).  *Action Item: adopt a rule authorizing electronic notice instead of notice by mail, at least for certain things.

In the next day or two, I’ll post a summary of how the new laws affect non-condo HOAs (all other HOAs).

Curtis G. Kimble

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New Law on Budgets

May 19, 2011

Because of a new Utah law that went into effect on May 10, each homeowner-elected board in a non-condo HOA is required to adopt a budget annually and to then present that budget to the homeowners at a meeting.

Since the budget will have already been adopted by the board, there is no need or requirement for the board to hear input or objections or to conduct a vote of the homeowners on the issue at the meeting.   The homeowners can, however, call a special meeting within 45 days of the first meeting and vote to disapprove the budget.  The budget will be disapproved if 51% of the total votes in the association vote to disapprove it “at a special meeting specifically called for that purpose by the lot owners.”

If a budget is disapproved, the budget that the board last adopted that was not disapproved by members continues as the budget until and unless the board presents another budget to members and that budget is not disapproved.

Note that the vote to disapprove the budget can only take place “at a meeting specifically called for that purpose by the lot owners,” which would not normally be the meeting where the budget is first presented by the board because that first meeting would not normally be called by the lot owners or be called for the specific purpose of having a vote to disapprove the budget.  The reason for requiring a separate subsequent meeting is unclear, but it may be to ensure that adequate notice to all lot owners is provided regarding the purpose of the vote, and also possibly because there should be a degree of difficulty in the process of overturning the decision of the board on this issue, since the board is in the best position to determine the budgetary requirements of the association, rather than the homeowners.

Curtis Kimble

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New Utah Law Versus Fiduciary Duty

March 28, 2011

Because association reserves perhaps play a more important role than any other issue, with the exception of insurance, in the long term viability of a homeowners association, I’m hard pressed to find an issue that triggers the concept of fiduciary duty more than the decision of whether or not to fund an association reserve account and in what amount to fund it.

Every board member is legally bound by a fiduciary duty to his or her association.  It is the duty to act in good faith and in the best interests of the association.  This means a board member cannot put his or her own interests before those of the association.  This duty imposed by law is a very powerful tool.  It is not taken lightly by the courts and breaching this duty subjects a board member to personal liability.

A new law was passed in Utah that is a little disconcerting to me.  It completely circumvents the tool and safeguard of fiduciary duty when it comes to association reserves.  It requires the board to present a reserve study to the homeowners at the annual meeting each year and that a simple majority of those homeowners that show up at the meeting will determine whether to fund a reserve account and the amount of the reserve account, thereby taking the decision completely out of the hands of the board.

If there’s one thing I’ve learned in my years of practice in HOA law, it’s that the individual owners don’t always have the best interests of the association in mind. It’s usually the other way around, they are concerned with their own best interests.  There’s nothing wrong with that, it’s human nature – something the folks on Capitol Hill don’t get, apparently.

As an owner of a home within an HOA myself, I personally have no interest in what the other homeowners in my HOA think about whether to fund a reserve account and in what amount to fund it.  The only individuals who are legally obligated to put the association’s best interests before their own are the members of the board.  The individual homeowners are free to put their own interests first, to be selfish and short sighted, to take the attitude that they may not live here in a few years, so why should they fund expenses ten or fifteen years down the road.  Board members are not.  They are bound by fiduciary duties to the association as a whole.  If board members breach this duty, that’s a different issue and there are remedies for that.  But, as a homeowner, I want that duty to be attached to decisions regarding funding of reserves.

As an attorney who has had to repeatedly deal with the fallout and consequences of inadequate or nonexistent reserve accounts, I hope the collective wisdom of a majority of homeowners at a meeting will allay my above concerns as this new law goes into effect.

Curtis G. Kimble

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