How to Deal With Budget Surpluses

Avi Zanjirian, Audit Manager
Czarnowski & Beer

The Lay of the Land

In the past, if a co-op showed a profit in a given year, it would be able to offset that with depreciation. But we’re reaching the point in 2018 where a lot of these cooperatives that were being depreciated over the past 30 or 40 years are going to lose that tax shield.

An example of this is a co-op we represent that stopped using depreciation this year. But it was also switching from fuel oil to natural gas and had refinanced its mortgage. The result was that the co-op saved a lot because of lower utility bills and lower interest. It was going to have an extra $100,000. We suggested that the board set aside in the operating budget that money for the capital reserves – offer it to the shareholders as a capital contribution. Doing that allows the building and the shareholders to add that to their basis. The board is also taking this money, and saying, “We’re allocating this in our budget for the reserves as if it were a capital assessment.”

In such a scenario, the co-op wins because it doesn’t have to give the money back, and it gets to add it to the reserve fund and also have a balanced budget. The shareholders win because now they get additional basis to their apartments that they bought 20 years ago. When they look at their financial statements, they don’t see this surplus because the money has been allocated to the reserves.

Now What?

This surplus is not taxable revenue as long as three conditions are met: the board tells the shareholders, either by putting out the budget or by sending out a letter; the money is placed in a restricted reserve account; and the money is used for capital improvements only. If the board does those three things, that money will be considered a capital contribution and will not be added to the operating revenue of the building.

Condominiums don’t have depreciation. What if they have a surplus? As with co-ops, they should allocate that to the reserves, with the same three conditions. If it’s done that way, it’s hard for the unit-owners to say: “Oh, no. We want the money back.” You say to them: “Do you want to get assessed in three years for $1 million, or do you want us to build up a reserve fund?” When you put it like that, there’s no argument.