Problem Solved: When a Contribution Becomes an Operating Assessment

The care and feeding of reserve funds is an important part of a co-op or condo’s financial health, but for many boards, the pandemic wreaked havoc on their best-laid plans to keep their reserves healthy. What’s happened out there as a result of COVID?

It’s actually been interesting in different buildings. At some we’ve actually seen cost savings, but at others there have been additional expenses for supplies, cleaning services and extra staffing. We’ve seen payroll costs going up. We’ve also seen certain buildings increasing equipment like fans and UV sterilization lights that go into elevators. All of these weren’t budgeted for, and obviously the biggest thing with a lot of buildings that have commercial space is decreased revenues. We can talk about the increase in expenses, but the decrease in revenues has really hurt them. They’re looking around, saying, “What are we going to do, and where is the money going to come from?” That has put some buildings in the position where they’ve tapped into their reserve accounts, and money that was set aside maybe for something else is now being used for operations. 

So they were borrowing from Peter to pay Paul. Why is that a problem?

In certain situations, it might not be a problem. Some buildings might have a reserve account that is a rainy-day fund, so when they need to borrow $50,000 or $100,000 for something, that’s fine. Unfortunately, not every building is like that. A lot of buildings work really, really hard to build up a reserve account. They may not have a transfer fee or a flip tax that gets collected at the sale of a unit, or the demographic in the building where they could just implement an assessment and someone could cut a check for $20,000. To see that suddenly get wiped out in a year — and not for what it was intended for but for something else — demoralizes the board for all the work they did. So that’s one side of it.

And what’s the other?

The accounting side. You set aside this money telling shareholders and unit-owners it’s going to cover the roof project or boiler replacement or lobby or hallway renovation. And now you’re taking that money and using it to pay for day-to-day operations. If that money was collected from assessments, potentially these owners contributed capital to the building. So that could pose a tax problem. 

How so?

Let’s say you have $100,000 dollars coming in from an assessment, which in certain situations is considered a contribution, and not revenue that would be part of your income bottom line. But if it goes toward operations, it is revenue. Now the question is, will you have to be potentially taxed on that ? The other problem is that you told shareholders or unit-owners that it’s going to be a contribution. If someone sold their apartment that year and they use that contribution to offset their capital gains, they have to potentially amend their tax return. Those are the biggest tax implications.

What can boards do to remedy the situation?

There are three avenues you could take. The first is a payment plan. You decide over how many months you want to pay back the $100,000 — 12, 18 or whatever — and put that money back into the reserve account. The other alternative is an assessment, which no one likes, but is another way to recoup money and replenish your reserves. The third option, which is not my favorite, is that if you have a line of credit, you could borrow on it and make a goal to pay back the principal over a certain amount of time. So these are all manageable little bites to get you back to where you want to go. 

But there’s a trust issue as well. If a board needs to mend its relationship with residents, is there something it should communicate to them about what happened and why it took the actions it did?

You send out a letter or a memo to your shareholders and unit-owners and say, “Hey, we told you that this assessment was going to be for capital, but we had to change course, so it’s not a contribution anymore but an operating assessment.” People might not be happy about it, but you need to communicate very matter-of-factly and directly. 

I want to add that taking money from one pocket and putting it in another for an outstanding item is something that happens all the time, not just because of COVID. Things come up that you didn’t plan for, and you don’t have a crystal ball to figure everything out. But you have to explain to people what’s going on; otherwise light bulbs start going off, and wheels start spinning that something is really wrong. Transparency is always the best policy.

Avi Zanjirian is a partner at the accounting firm Czarnowski & Beer.