“Capital Improvements vs. Reserve Expenses”

By Robert M. Nordlund, P.E., R.S.

When is an expense a Capital Improvement or a Reserve Expense? Or vice-versa, when is a Reserve project more properly considered a Capital Improvement? This question becomes important to associations as they consider what funds can be used (Reserves or Special Assessment), and what authority is needed to execute the project. Reserve projects are simpler to accomplish than Capital Improvements, because the funds exist and the Board has the authority (responsibility!) to expend the funds to protect, maintain, and enhance the assets of the corporation.

Let’s examine this carefully. We believe the question is pretty clearly answered if the asset previously did not exist. Let’s suppose an association has an older pool area, and in refurbishing this asset they wish to add a spa. We would recommend the Board obtain two proposals, one for refurbishing the pool area and one that also included the added spa. We would counsel our client that the Reserves could pay for the pool portion of the expense and the rest would be a “capital improvement”. Let’s consider another situation where a neighborhood community association wishes to add street entry gates and perimeter fencing to enclose the association. Clearly, that asset did not previously exist, and it should be considered a capital improvement.

Now consider a tougher example. Let’s consider an association with a plaster/gunite pool surface that wishes to upgrade to a fiberglass surface. The fiberglass is more expensive and will last longer, and most would consider it an upgrade. We would argue that since the pool existed, the Board is well within their authority to choose a different quality of material to use in keeping it a Reserve project.

Consider a pool redesign where there exists one simple 10x10 wood shade structure. In the pool refurbish project (pool surface, pool deck, perimeter fence, etc.), the architect proposes two larger shade structures, each 10x20. Capital improvement? We would say no, since the asset existed, there is only a stylistic and size change.

The bottom line is that we believe associations should be free to upgrade in surface, size, aesthetics, and technology as part of Reserve projects. An association with a key-based entry system should be able to expend Reserves to “modernize” to a telephone or card-swipe based system. An association left with an “empty” recreation room by the developer should be able to furnish that room and perhaps add wireless Internet and a cable TV as part of a periodic refurbish project.

As times change, the Board will be faced with many decisions where the repair or replacement of association assets with exactly similar assets would be inappropriate. We are in business to safely, responsibly, and cost-effectively help our association clients protect, maintain, and enhance the assets of the corporation (think home values and quality of life). We believe in many cases this means expending Reserves to replace an old asset with something “better”. Such cases are not capital improvements necessitating homeowner votes and special assessments!

Answers to more Reserve Study Questions