As a Certified Public Accountant, I am often asked to explain the difference between capital and non-capital expenses. Capital expenses are also sometimes referred to as fixed assets. Therefore, in this article and in the context of Condominium and Homeowner Associations (CIRAs), capital assets will be equivalent to fixed assets. Homeowner Associations are differentiated from Condominium Associations in that Homeowner Associations have a different legal framework and usually consist of single-family homes.

Fixed assets are non-liquid assets (not purchased to sell in the ordinary course of business and that have a long-term use, longer than a year). Examples of fixed assets include land, buildings, machinery and equipment and furnishings such as clubhouse furniture.

Non-capital expenditures include expensed amounts typically found in the operating budget such as general maintenance, utilities, management fees and insurance. These types of expenditures are also called period expenses because they generally benefit periods on a monthly basis or less than a year. Painting and minor repairs to property are considered to be non-capital expenses required to be expensed when incurred. A capital improvement is a major expenditure that enhances a fixed asset to such an extent that the improvement can be recorded as a fixed asset. To be capitalized as a fixed asset, the improvement must be expected to last for at least one year. The enhancement must fall into one of the following categories:

• It extends the life of the asset
• It enhances the overall value of the asset
• It adapts the fixed asset to be used in a new way

If an expenditure does not meet any of these criteria, then it is classified as a repair or maintenance expense.

Knowing the definition of fixed assets is important because it can have a material impact on the balance sheet, income statement and statement of cash flows presented on the accrual basis of accounting. Understanding these concepts can help with presenting economic activity to the Board and membership as well as other stakeholders accurately and in accordance with Generally Accepted Accounting Principles (GAAP).

Condominium and homeowner associations (CIRAs) have unique requirements for reporting and presenting fixed assets. CIRAs generally do not record, depreciate, and present fixed asset purchases unless they have title to the property and can perform either of the following:

• The CIRA can dispose of the property and retain the proceeds of the disposal.

OR

• The CIRA has the ability to generate significant cash flows from members or non-members (for example renting out the clubhouse).

Condominium Associations most often do not have title to common area property. The reason is because the legal framework of Condominium Associations is such that the members of the Association own a pro-rata interest in the common area property such as the clubhouse, tennis courts, walkways, entry gate etc.

Homeowner Associations generally do have title to common area property. Although Homeowner Associations do have title in the common property, the assets are not recorded because they either are not used to generate significant cash flows or will not be disposed of in the ordinary course of business.

Capital improvements to common area property are also not capitalized if they do not meet the aforementioned qualifications. These types of improvements would include replacing the roof, replacing siding and other capital improvements generally funded via reserve funds.

Personal Property and Acquired Real Property

Associations are potentially required to capitalize acquisitions of personal property.

Personal property is most often purchased by the CIRA. Some examples of personal property that may need to be capitalized include but are not limited to recreation equipment, work vehicles, and furnishings and fixtures. These types of assets are often purchased by the Association subsequent to inception of the CIRA and can be disposed of in the ordinary course of business. CIRAs can also purchase real property such as a unit or raw land. These assets would be capitalized since the CIRA has title and can usually dispose of the property. Personal property and qualified real property acquired by the CIRA should be capitalized and depreciated if applicable over the estimated useful lives of the asset. Accumulated depreciation will show how much of the asset has been depreciated (expensed) so far.

Capitalization of Personal Property

Many CIRAs make minor purchases of personal property such as clubhouse furnishings, pool patio furniture, office equipment etc. These types of expenditures are most often included in the operating budget or funded via the reserve study. Many CIRAs do not believe there is a cost benefit of recording and depreciating these relatively minor expenses in the financial statements. From an auditor’s viewpoint, the inclusion of such assets as fixed assets and related depreciation expense would generally not affect a user’s economic decisions on the financial affairs of the CIRA.

To avoid capitalizing and depreciating minor purchases of personal property fixed assets, CIRAs can elect to adopt a “Capitalization Policy” that states that all asset purchases under a certain threshold shall be expensed when purchased rather than recorded as an asset and depreciated. Such a policy should be approved by the Board of Directors via a resolution and consistently followed.

The threshold of such a policy generally ranges from $500 to $5,000 or more depending on the size of the CIRA. The determination of such a threshold and the wording of such a resolution should be discussed with your CIRA’s CPA and if applicable, legal counsel. It should be noted that there are IRS safe harbor capitalization thresholds that may affect tax deductions.

Income tax considerations of Capital Assets

Generally, there are few income tax benefits to CIRAs relating to capitalizing and depreciating fixed assets unless the CIRA has title, tax basis (they purchased the asset subsequent to inception) and they have depreciable property that generates related significant non-member taxable income. Fixed assets acquired from the developer/declarant generally have no tax basis because this property was most likely expensed by the developer during the sales phase and then the property was subsequently declared to the CIRA with no tax basis.

As mentioned previously, assets purchased by the CIRA would have tax basis giving rise to tax deductible depreciation against non-member taxable income strictly related to and not exceeding the taxable income of each activity. In the case of an CIRA filing a tax return under code section 277 as a regular corporation, depreciation expense can reduce member income and may allow the CIRA to avoid paying tax on excess member operating income.

One area of benefit to the member of a Condominium Association relating to expenditures for capital assets whether recorded and depreciated or not relates to the tax basis of individually owned condominium units. When a member buys his/her condominium, the tax basis of the condominium used for computing taxable gain or loss is generally the purchase price plus other capitalizable expenses.

The member then can add to the tax basis of their unit any capital improvements made to the interior of the unit such as a complete kitchen remodel. In this era (until recently) of increasing prices, it is possible that members may be faced with taxable income on the sale of their unit in excess of the IRS allowed exclusion of the sale of a personal residence of $250,000/$500,000 for single or married filing jointly, respectively.

For investment property, there is no exclusion so there could very well be a tax impact on the sale of a unit. In the case of a kitchen remodel, the tax implication is fairly straightforward. However, what about the assessments paid by the members of condominium units that relate to a reserve funded qualified capital improvement to common area property? These improvements would include a new roof, new siding, new decks, etc. Members are allowed to add to the tax basis of their unit their pro-rata portion of the monthly or special – assessment that relates to the funding for qualified capital improvements.

This article has presented a lot of information on a detailed subject in a limited amount of space. Should you have any questions on your association and its facts and circumstances, please reach out to your accounting/tax professional for guidance.