Many community associations struggle with how much money to reserve for the future replacement of components. An association establishes an annual budget using the estimated expenses required to operate over the coming year. If the association is responsible to replace a component, e.g., roofs, siding, etc., then a replacement reserve account sets aside money to fund replacement of the component in the future. Having a funded replacement reserve avoids finding alternative funding at the time of replacement, which can create hardships for owners. Further, Minn. Stat. §515B.4-107 requires that members disclose to potential buyers how much money is in the association’s replacement reserve account and what components the association is required to replace. Certain federally insured loans applied for by buyers require certain reserve practices by the association to be approved. Therefore, an underfunded reserve account can discourage potential buyers and limit members’ ability to sell their units.
The Reserve Requirement. So how much is an association legally required to reserve? Under Minn. Stat. §515B.3-1141, the association is legally required to include in its annual operating budget an allocation to replacement reserves that is projected by the board to be adequate to fund the replacement of those components of the community that the association is obligated to replace.
How does the board determine the amount that is ‘adequate?’ The board should fund the reserve based upon estimates of what it will cost to replace the components at the time of replacement. The board should consider obtaining such estimates from professionals. The board is not required to, but should consider retaining the services of a professional Reserve Analyst in determining a reserve funding amount and plan. The board should avoid establishing reserves solely as a fixed percentage of the operating budget without relation to the actual cost of replacement.
Periodic Review of Reserving Requirement. The association must re-evaluate the adequacy of its reserve funding plan at least once every three years. The re-evaluation method is within the association’s discretion. The board should consider having a competent party – the Board itself, a management agent, etc., review the funding plan to confirm whether the current level of reserves is adequate for the association’s needs. The records of the association should reflect the actions taken to satisfy the periodic review requirement, and whether the board determined if an adjustment to the funding plan was necessary.
Exceptions to Reserve Requirement. Unless required by the association’s declaration, the association need not reserve for the replacement of components that have a useful life of greater than 30 years. Further, even though the association may be the party responsible to replace a limited common element (e.g., deck, porch, patio, etc.), the association need not reserve money to replace that limited common element if the association has the authority to assess the cost of replacement exclusively to the owner of the unit to which the limited common element is allocated.
Further, unless prohibited by the declaration, the association can choose NOT to place any money in reserves and can elect instead to fund replacement of components through special assessments. However, to establish this funding plan requires approval by both the board and the membership, and re-approved upon each periodic review of the funding plan.
Segregating Reserve Funds. The association must keep replacement reserve funds in an account separate from operating funds. The association cannot use or borrow from replacement reserves to fund operating expenses; however, the association can pledge the reserves as security for a loan.
Although this article is intended to provide a general overview of the reserve requirements that apply to all associations, each community is subject to its unique governing documents, requirements, and circumstances. Every association board should consult with its advisors regularly before adopting or amending a reserve funding policy, to ensure that the association is conforming to the particular requirements of the association.