Are Reserve Contributions in Excess of “Actual Costs”?

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A California client asked a very interesting question. California law (Civil Code 1366.1) specifically limits associations from collecting assessments in excess of the actual costs for which the funds are being collected. Nationwide, this supports the principle that associations are “not for profit” entities, designed to collect only the funds necessary to run the association, and no more.

The boardmember suggested that often Reserve contributions are unsubstantiated (just guesses about the future), so therefore there are no “actual costs” to be offset. Following that theory that the “costs for which the Reserve contributions are levied” do not exist, there is no basis for an association to collect Reserve contributions by law in California (or by common practice in all other states). This is key, because adequate Reserve contributions represent a large fraction of an association’s budget, typically in the range of 15-40%!

Interesting point. But there is a logical flaw to this theory. Reserves are in truth not collected for unsubstantiated “future costs”. Reserves are collected to offset the daily, weekly, monthly, yearly deterioration of the association’s current common area components. Ideally, Reserve contributions exactly offset the ongoing deterioration, so by the time the asset fails, its entire replacement cost has been contributed by the owners over the years who enjoyed the use of that asset. Reserve contributions pay the monthly “bill” of the ongoing deterioration of the major common area assets the association is responsible to maintain.

The Reserve components should all be clearly listed in the Reserve Study… including their Useful Life, Remaining Useful Life, and Current Replacement Cost. This is the table of information where the size and frequency of Reserve expenses are listed, from which we can calculate the $ deterioration of these assets and anticipate the actual Reserve cash needs of the association.

Bottom line – Reserve contributions are substantiated. Everything changes each year (the condition of the components, the anticipated replacement cost of the components, and the strength of the Reserve Fund), so annual Reserve Study updates are a good idea (they’re required in California according to Civil Code 1365.5.e). With regular (annual) Reserve Study updates, boardmembers get the budget guidance they need, and owners get the disclosures they deserve so they can see that the Reserve contributions are indeed substantiated.

Great question!