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Proper Use Of A Reserve Fund Requires Proper Planning

Springtime and warmer weather can often mean the start of major repair or maintenance projects for an association’s common elements. As unexpected improvements become a priority, associations should look to the reserve accounting for funding. The hope is that a reserve account is properly funded so that a major project can proceed when needed.

This winter’s cold and snowy conditions may have caused many associations to incur expenses beyond what their annual budgets proposed. Extra salt and snow plowing, for example, may not have been properly budgeted for. As associations consider ways to cover those expenses without imposing a special assessment or increasing assessments, the question of whether money from the reserve account can be used or borrowed to cover operating expenses often is posed.

The reserve fund operates as a safeguard and allows associations to repair and replace common elements without having to issue a large special assessment. The reserve fund is not intended to cover the association’s operating expenses; rather, the reserve fund is intended to cover the repair and maintenance of major capital items as needed in the normal course of the association’s operations. The “major capital items” include all of the common elements for which the association has a duty to maintain and repair, such as roofs, foundations, and recreation facilities. Although the reserve fund may be used to pay for minor repairs to the common elements that were not accounted for in the annual budget, the better course of action is to limit use of the reserve fund to major repairs and maintenance to the common elements.

To prevent the need for an association to borrow money from its reserve fund for operating expenses, it requires proper planning and careful crafting of an operating budget. The goal when preparing an annual budget is to cover all expenses that the association may reasonably foresee for the year. To prepare for unusual weather or other unanticipated events, a budget should include a line item for “operating reserves” or “unforeseen expenses” in order to put money aside for such contingencies. This way, when operating budgets are depleted by an unusually high need for salt and snow plowing, for example, the association can use its contingency funds instead of taking from the reserve account.

If an association must use reserve account funds to cover its operating expenses, it must document such expenditures and prepare a plan to restore such funds within a reasonable amount of time. Otherwise, associations may be out of luck with a true need for the reserve hits and the reserve fund has been depleted. How much an association should be contributing to its reserve fund is dependent on each association’s needs. The ideal amount of funding would mean that every time a common element required major repair or maintenance, the association would have that full amount in a reserve account. The challenge for association is how to correctly identify this amount and achieve that funding.

For condominium associations, Ohio law requires that 10% of the annual budget be set aside for reserves. There is the option for this requirement to be waived if a majority of the voting power so approve. However, a waiver is not recommended, especially if the reserve fund is underfunded. Homeowners associations do not have this reserve requirement, but still need to plan for major projects to avoid the use of special assessments.

A reserve study is one tool available to associations to help identify the ideal level of funding. A reserve study is not required for associations, but it can provide a helpful analysis of the projected costs of future repairs and maintenance of common elements. The useful life of common elements is calculated to determine the estimated time a common element will last until repair or replacement is needed. Of course, a reserve study should be updated every few years in order to account for useful life calculates and changing cost estimates. If your association needs help hiring the right reserve planner, we are happy to provide assistance.

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