Typically, you'll find a homeowners' association (HOA) in a condominium complex, and sometimes in a subdivision or a planned unit development (PUD). Regardless of the location, HOAs are a fundamental element in such communities because most often they have the job of making sure that property is well maintained.

They do this by making sure that the "common areas," like roads, parking lots, and recreational facilities, are in good repair and condition, and also by making sure that buildings in the community are structurally sound and not "eye sores."

To do all of this, HOAs need money, which they raise in various ways. In addition, almost every state has detailed laws on HOA finances, such as record keeping requirements for financial records. If your condominium or subdivision has a homeowners' association, or if you're thinking of buying a home in an area with an HOA, it's a good idea for you know some of the HOA finance basics.

Initial Finances

Often, a developer takes out a loan from a private bank or mortgage company and uses it to create an HOA or PUD, that is, he or she will build a condo complex or subdivision and create an HOA to manage it. The HOA membership consists of the property owners in the development.

A typical loan is called an "interim loan," and it's not intended to be long-term or "permanent" financing. Rather, it's repaid as "units"-either condos or homes-are sold. So, the units in the HOA or PUD are like "inventory," and the interim loan enables the developer build and sell units until the project is complete and all units are sold.

When a unit is sold, the buyer-owner will be subject to a number of governing documents for the development. This can include the HOA's covenants, conditions and restrictions ("CC&Rs"), which typically restrict and limit how the owner can use the property. Examples of CC&Rs include things like a ban on pets and how many cars you can park in the parking lot.

Typically, anyone who buys a home within the HOA's boundaries automatically becomes a member. Member-owners are then charged fees and assessments, which are usually charged and collected monthly, and are used for things like landscaping, snow removal and road maintenance. Also, there may be special assessments, which are used to pay for emergency repairs or repairs and maintenance costs that were not included in the HOA's budget.

HOA Financials

In almost every state, there are specific, detailed laws that govern HOAs, and particularly their financial records. Although the laws and their requirements vary by state, generally HOAs must perform various tasks with respect to their finances, including:

  • Create and maintain a fund of fees and assessments collected by the HOA from owners/HOA members
  • Make an operating budget, typically for a calendar year, that shows projected income from fees and assessments and itemizes how the HOA plans to use any funds throughout the year, such as paying the costs of landscaping, repairs to common areas, and building maintenance
  • Create and maintain monthly and yearly records on how much money the HOA has received, how any funds have been spent, and the current balance of the HOA's fund
  • Store all receipts for money spent by HOA from the HOA fund
  • Create and maintain a "reserve" fund from fees and assessments collected by the HOA, which can used only for unexpected emergency repairs, such as sudden damage from bad weather or natural catastrophes, or for the future repair, replacement, or maintenance of the major components of the complex or subdivision, such as building surfaces of the condominium buildings, streets and sewers, and heating and cooling equipment
  • Depending on the size of the HOA, it might be required to have a certified public accountant perform a yearly audit

In some states, the HOA must provide these financial documents to the owners/members within a certain period of time and without being asked. Often, they will be posted in a common area, like a recreation room or facility, or it's common for HOAs to have their own Web site where these materials can be posted. In some states, however, the HOA has to provide these financial materials only when an owner makes a written request for them. So, be certain to check the laws in your area if you're trying to obtain financial records from your HOA.

HOAs & Taxes

Another important aspect of HOA finances is tax liability. Generally, HOAs are exempt from state and federal income taxes if:

  • Most of its units are used by individuals as residences
  • It's organized and operated to buy, build, manage, maintain, and care for HOA property
  • At least 60% of its gross income for the taxable year comes from membership dues, fees, or assessments
  • None of the HOA's net earnings or income goes to any individual, except if it's by a rebate of excess membership dues, fees, or assessments, for example

State and federal law require the HOA to make an election to be treated as a tax-exempt organization. Also, even if the HOA is tax exempt, it must file a federal tax return.

The tax exemption excludes from the HOA's gross income all of the membership dues, fees, or assessments collected by the HOA. In addition, the HOA gets an automatic $100 deduction on its gross income. Essentially, then, a tax-exempt HOA is taxed only on its investment income, if it has any, and any other income it might have, such as from renting out a recreational facility to non-member/owners, less the $100 deduction.

Tagged as: Real Estate, Homeowners Association Law, finance basics, real estate lawyer