Financial Articles

Getting Just Dues
Every hear one of these moral outrages? "Why am I paying more homeowner dues than my neighbor? There are six people living in that unit and I live alone. I only shower once a week and should get a dues reduction." Or, "I’m paying the same amount as Jim in 3B and his unit is twice as big as mine. What’s up with that?" Or, "I don’t see why I have to pay for that expensive pool. I don’t swim and never intend to. Why not knock $25 a month off my dues?"

It's interesting how creative folks can be. But in spite of efforts to get a better deal, the dues structure cannot be changed without 100% approval of all members. And it can only be accomplished by legally amending the governing documents. Since shuffling dues levels means some members will end up paying more, this amendment is virtually assured of defeat. So, the dues structure is what it is.

Rather than fighting over the unchangeable, consider this: The HOA dues structure, as inflexible as it is, opens the door to wonderful opportunities. Group buying power is mighty. From utilities to contract services, owners of HOA property pay wholesale prices on things provided by the HOA. Part of every budget review should include opportunities to take advantage of this concept. For example, by the HOA entering into bulk rate agreements for cable TV and high speed internet service can save end users 30-50% on average. We’re talking thousands of dollars of savings each year. If the HOA is large enough, the newsletter can be funded by advertising revenue which could even turn a profit!

So stop fighting over pennies and concentrate on opportunities that make sense. They’re out there to be had and taking advantage of them confirms the wisdom of HOA living. Get your just dues. BACK

Finding Fee Fairness
After kicking lots of condo tires, comparing benefits and homeowner fees, the buyer makes a choice, closes the deal and moves in. All settled in, he happens to spy the stack of documents (didn’t they call them "CC&Rs, whatever that means?) and decides to riffle through them. Mid riffle, he lands on Schedule B-Assessment Allocation which explains how much each unit owner is supposed to pay. It also shows the square footage of each unit. He notices that his unit at 900 square feet is paying the same fee as units twice the size. WHAT??? How could this be? On top of that, units with a view also pay the same. DOUBLE WHAT???

Welcome to the World of Unfair. Even though most developers understand that fees should be proportional to the benefits received, few states have guidelines or requirements for them. This allows a lot of latitude for developers when they set the fee levels and, guess what?, lowering fees for higher priced units helps them sell faster. This is what’s called your Classic Developer Conflict of Interest. By leveling the homeowner fees, lower priced units end up subsidizing the higher priced units.

Now, here’s a bitter pill. Even though this seems like something that can be corrected after the fact, it can’t. Changing the fee structure after the fact requires 100% approval of all owners. Lowering one unit’s fee means another owner unit will have to pay more. In spite of the best of intentions, few are willing to make that sacrifice and it only takes one to kill the deal.

Even though the fee allocation may not be entirely fair, There are substantial benefits from cost sharing. Virtually every service and utility the HOA pays is substantially cheaper than it would be if members were flying solo. Group buying works. So, rather than viewing the fee allocation as unfair, dwell on the benefits. Besides, life’s rarely fair, mon frere. BACK

Fraudit Standards
Homeowners associations use CPAs to conduct audits of the HOA’s financial statements. Audit procedures have changed dramatically as a result of many highly publicized accounting scandals in the past few years. Although the types of fraud seen in those well-known cases typically do not occur in HOAs, the changes in audit procedures apply to all businesses, large and small.

The biggest changes result from AICPA’s Statement on Auditing Standards No. 99. SAS 99 became effective on December 15, 2002. Its purpose is to improve audit quality and the ability of auditors to respond effectively to the potential for fraud. SAS 99 covers such new topics as:

Characteristics of fraud.
Exercising professional skepticism.
Assessing and responding to fraud
Examining journal entries for fraud.
Evaluating significant unusual transactions.
Communicating fraud to the client.

The effect of SAS 99 is that the auditor will perform procedures to determine unusual relationships between accounts and increase inquiries of management. The auditor will also assess the risks associated with management override of internal controls and journal entries. The auditor will inquire of the board of directors, bookkeepers, property managers, and others to determine if any has knowledge of fraud or suspected fraud. The auditor will also examine programs and controls in place at the HOA or the management company to prevent, detect, and deter fraud. At the conclusion of the audit, the Board, manager and bookkeeper will be asked to sign a letter of representations which vouches for the correctness of the financial statements.

HOA are corporate entities which should maintain professional and honest books. SAS 99 will help auditors ferret out those that have ill motives.

For more information, see www.AICPA.org. BACK

Taxman Returns
In spite of the fact that most HOAs are nonprofit corporations, tax filing is still required. A few HOAs qualify under Internal Revenue Code 501(c)(4) as tax exempt if use of common property is extended to the general public. Otherwise, the HOA must file a federal tax return using either Form 1120 (regular corporation) or a Form 1120-H (for HOAs).

To qualify for Form 1120-H, the HOA must meet three criteria:

1. At least 60% of the revenue must be exempt income;
2. At least 90% of expenditures must be for exempt activities; and
3. The HOA must be substantially residential.

Exempt income is fees levied to maintain the common property. Non-exempt income is derived from things like investment interest, laundry or vending equipment; unit rental and special user fees for HOA facilities.

The advantages of the Form 1120-H include its simplicity, taxes are owed only on non-exempt income and that there is an automatic $100 deduction. The tax rate on non-exempt income is 30%.

Tax advantages of the Form 1120 are a lower tax rate of 15% for the first $50,000 of taxable income. However, the return is more complex and requires adherence to a variety of tax code sections and rulings. Under the Form 1120, if there is excess exempt income over expenses it is taxed unless the association refunds the excess or transfers it to capital reserves through a vote of the members. The options are set forth in IRS Revenue Ruling 70-604 and must be included in a resolution submitted to a vote of the members.

If your HOA hasn’t been filing taxes, get on the stick and discuss your options with a knowledgeable CPA. "Cuz I’m the taxman...and you’re working for no one but me".

Information provided by Orten & Hindman. BACK

Money, Money, Money
It’s said that the love of money is the root of all evil. Others say it makes the world go around. But in an HOA, love it or hate it, it’s needed to keep the boat afloat. Unlike the federal government which can print more money when necessary, it’s up to all HOA members to pay their fees or else the rest will have to do it for them.

While the governing documents give the authority to collect money from members, there is often little direction on the details of how to do it. Enacting a formal Collection Policy is one of the most urgent and necessary of all policies. Some of the nuts and bolts:

Due Date. While it seems obvious, stating that payment is due by a certain date is necessary. Make it due when it’s due. "Due on the 1^st and late on the 5^th" means due on the 5^th (and the post office or dog gets blamed when it doesn’t arrive until the 10^th).

Late Fees. Late fees work best when they accumulate daily. A one time late fee doesn’t urge payment once incurred. Late fees growing by the day do.

Finance Charges. The credit card companies charge them. Merchants charge them. So should the HOA. 1-1½ % per month is fair.

Bad Checks. Merchants charge at least $25 for returned checks and so should the HOA. Checks are a privilege not a right. If a member continues to bounce checks, terminate check privileges.

Application of Payment. Unless balance is paid in full, payment should apply to oldest balance which means late fees and/or finance charges continue until balance is paid in full.

Late Notice. Should be mailed within 10 days of the due date.

First Ten Day Demand Letter. Should be mailed when balance is 30 days late.

Second Ten Day Demand Letter. Should be mailed when balance is 60 days late. After 10 days, matter is turned over to an attorney for collection which can include filing a personal judgment, lien on the property, garnishment of wages and foreclosure of property.

The goal of a good Collection Policy is to bring money in promptly and in full. Penalties should be severe enough to get attention but not so severe as to create animosity or resistance. Be consistent and timely in the Policy application. Be very careful about exempting friends. Collections is one of the main reasons that HOAs should be professionally managed. No one should have to collect money from a neighbor. If you are having payment problems, engage a professional HOA manager soon to help put finances back on track.

Money, money, money makes the HOA world go around. Make sure you have a good collection policy to keep the coffers full and the world spinning.

For a sample Collection Policy, see Regenesis.net Policy Samples. BACK

Passing the Baton
Every time a condo sells, an angel gets its wings (Oops! Wrong story.). Every time a condo sells, the new owner inherits obligations passed on by the former owner or required by the HOA. There are the obligations to obey the rules, pay the homeowner fees and to volunteer for HOA service.

But now and again, someone gets the bright idea that new owners should pay a special fee at closing as a contribution to working capital or reserves. This idea appeals to current members because they are exempt from paying it, like a hotel tax foisted on tourists. It also seems fair since new members haven’t contributed to reserves. A newcomer contribution seems to level the playing field.

There are several fatal flaws with these rationales. Requiring new members to pay a special fee redefines the homeowner fee allocation. Redefining the fee allocation requires 100% approval by all members, not simply a majority vote. And even if you could get 100% agreement, unless the fee applies to one and all, present and future, it is neither fair nor legal.

Secondly, while new members have not paid into reserves is true, they don’t owe the money. New members are not responsible for reserves which should have been collected in the past. Reserves should be paid by those that are receiving the benefit. Reserve money is typically set aside each month to pay for repair or replacement of assets like roofs, paint and siding as they deteriorate. The reserve contribution should equal a month’s worth of that deterioration. In other words, current owners should pay for the portion of those deteriorating assets they just got the benefit from. New owners have received no benefit so owe nothing. If there is a current shortfall in reserves, it’s because past owners did not pay enough.

If your operating budget or reserve plan is inadequate, fix it and have current owners pay the freight. If you haven’t hired a Professional Reserve Analyst™ to perform a reserve study, do so as soon as possible. A Reserve Study is an indispensable planning tool that every HOA needs. It will provide a maintenance and funding schedule for the Board that fairly divides costs among all owners along the time line.

New owners should be asked to pick up the baton passed by the outgoing owner. There are obligations that go with that baton, to be sure, but one of them is not paying for the HOA’s past mistakes. Pass the baton. Don’t beat the newcomers with it. BACK

Carpe Aurum
Homeowner association members are moving targets. They buy, they sell. They come, they go. The buying and selling process involves what’s called "closing". At closing, money is exchanged between buyer and seller, legal documents are signed, title insurance is bound and a myriad of other details are handled. Among these details should be applicable HOA business which includes money, rule violations and architectural design requirements. Yet, it’s not uncommon for a seller to try to scoot away without paying a past due HOA balance or rectifying an architectural violation or two. Whether by innocent omission, ignorance or purposeful deceit, buyers, sellers, title companies, lenders and real estate agents often close sales without settling HOA accounts.

In defense of this shabby business is the fact that many HOAs are hard to find...not by geographic location but by the identity of those in charge. Many HOAs fail to publish or withhold contact information for the Board and management. Posting an entry sign with this information solves this problem. Having an HOA website is even better because the website can and should contain much of the information required to have an informed closing.

Yet, often a closing takes place, a seller collects the proceeds and blows town without having paid a balance owing to the HOA. If the HOA has failed to file a lien on the owner’s HOA property, the HOA can still pursue collection alternatives but they tend to be less likely to succeed and the collection agents like to take a big cut of the proceeds. With a properly filed lien, the HOA’s debt will usually be caught by the title insurance company and get paid at closing.

There are, however, sales that may not include title insurance. Sales involving cash, tax sales by the IRS and those where the seller carries a contract and note are examples. While informed buyers always insist on title insurance, some don’t know any better (or don’t think it’s important) and close the sale without it. These buyers purchase the property subject to existing liens which include any filed by the HOA for a balance due or architectural violations. In those cases, the buyer is on the hook to satisfy them.

In some states, like Oregon, the HOA has an automatic lien by virtue of authority found in the recorded governing documents and state statute which recognizes that authority. In those states, even if there is no specific lien filed against a home or unit, the HOA still has one and can enforce satisfaction.

Since money is what fuels the HOA’s ability to function, collecting all that is due is critical. Much of the sale closing confusion can be avoided by aggressive collection when the debt is initially incurred and long before a sale takes place. The HOA’s money collection motto should be "Carpe Aurum" (Seize the Gold). The sooner seized, the lesser missed.

For a sample Collection Policy, see the Policy Samples section. BACK