Maintenance vs Capital: Where Painting Fits in a Condo Association
Weighing Your Options
Aesthetic appeal is a major factor in determining the value of a property. As a construction manager or the manager of a condo association, you have to determine when it is time to repaint condo buildings. However, the cost of maintenance must be weighed against the expectations of the resulting increase and the property value of condo buildings.
Embarking on repainting and other major maintenance work based on the apartment maintenance timeline is a costly undertaking. The difference in how the IRS and home owners/condo associations treat the amounts used in exterior painting and other maintenance projects like roofing as well as wood and siding replacement can lead to taxation problems. It’s thus important for you to understand the nuances of financing such maintenance activities to avoid any problems.
Home owners and condo associations consider exterior painting in the same category as the other main maintenance and construction projects like concrete repairs and roof repairs. These associations typically consider such expenses as either operating expenses or reserve expenses and classify these projects as repainting under reserve expenditure. This makes sense given that these expenditures are capital assessments and thus should be taxed.
The IRS differs with the associations in two significant ways in relation to these expenditures. First, the IRS classifies expenses as either capital expenditure or non-capital expenditure. The second difference is the fact that the IRS stipulates that an assessment can be capital in nature only if the expense’s nature must be capital. The problem arises because many tax court cases and judicial rulings categorically classify repainting and the other main maintenance tasks that are not undertaken annually as being non-capital expenses.
This leads to reserve contributions being taxable. Due to this, a condo association will most likely incur heavy penalties when amassing the necessary funds to undertake exterior painting, roofing, concrete repairs or other maintenance work on the condo buildings. The easiest ways that you can fund such projects without incurring high taxes is by using Form 1120-H as opposed to Form 1120 when filing returns.
Form 1120, while it has a lower tax rate, has several drawbacks you should consider as compared to Form 1120-H. It is harder to complete and due to the differentiation of income expenditure into non-membership activities which are taxed and membership activities that are not taxed. It also exposes the association to a tax audit given it is more complicated and harder to comply with. In most cases, condo associations filing returns using Form 1120 end up paying more in taxes. Form 1120-H is simpler to complete and categorizes the income into two categories, non-exempt function expense (taxable) and exempt function income (not taxed). A $100 deduction where applicable further reduces the taxes paid.
Properly managing the financing of projects is indispensable in the proper management of condo associations. Knowing the best way to accumulate the required funds helps in reducing the taxes you have to pay ultimately and can result in major savings.