How should rental income from association foreclosed properties be applied?

By May 20, 2012Articles, News

Q. My condo association has foreclosed on a couple of units and is renting them while the banks continue to stall their foreclosures. There has been a question at board meetings on how to treat the rental income. Our attorney said that the rental payments should be applied only to the delinquent balance owed on the rented unit. Our accountant said that this revenue is regular income to the association and need not be applied to “pay down” the delinquent assessment balance for the rented unit. Who is correct? — S.B.

A. We believe your accountant is correct. There is nothing in Chapter 718, The Florida Condominium Act, that requires the association to apply the rent payments to the delinquent assessments and other charges owed on the rented unit. The association now owns the unit, and the unit is an asset of the association just like the clubhouse, tennis courts or other association property. The rental payments are not assessments being paid by the unit owner. The funds are received from a third party, who has no obligation to pay assessments. Further, paying down the balance only on the rented unit will harm the association down the road when a new owner ultimately takes title and the association’s ledger for that unit artificially reflects a lower or negative balance because of the rents received.

According to John Stroemer, of Stroemer & Company, CPAs, the rental activity creates tax consequences for the association. The rent is taxable income, and further, there is sales tax if the lease term is less than six months and one day. We recommend that you seek a second opinion from an attorney and CPA on this important issue.

Q. I am on the board of our homeowners association, and we are considering foreclosing on a couple of homes that have serious arrearages. If we end up with title to the homes, what is the risk to the association? Are we obligated to pay the dues on the home while we own it? Do you have any suggestions? — J.F.

A. The risk to the association is small, but there are some things to consider. First, the association should check with its insurance agent to ensure that there is adequate liability coverage in place for owning and renting the home. If insurance coverage is questionable, the board can minimize liability by taking title in a different entity, such as an LLC. Regarding dues owed for the property, the association cannot pay itself and would merely be absorbing the operating costs for that property. Banks and other purchasers have taken the position that the association cannot recover delinquent fees that became due while the association owned the property, but we have generally been successful defeating that claim. Owning the property in a different entity further helps defend against that claim because technically the association never owns the property. It is also advisable to have an exit strategy. Many associations take title without being advised of all available options or how to ultimately dispose of the property. Your association is not in the business of owning property, and this should be a short term solution. If the association can generate some rental income in the short term, that is a positive and it can be done safely as discussed above. However, the ultimate goal is to put a new owner in the property who pays maintenance fees. Your association counsel should be able to help your board achieve that goal.

Q. My HOA has a master irrigation system. Our community documents require the owners to use the master system and prohibit the installation of wells that serve individual lots. The irrigation controls, however, are on each privately-owned lot. This requires the HOA to set the controls to the proper settings. Some owners tamper with the settings, resulting in excess water usage in violation of the HOA’s mandated watering schedule. Can my HOA enter a homeowners’ property to restore the irrigation controls to the property settings? If so, what are the risks and alternatives? — M.W.

A. The rights of your HOA to correct this problem largely depend on your community documents. This is an issue that should be closely monitored, particularly if the owners share equally in the irrigation budget and if excess usage will result in violations of the HOA’s water use permit(s). Many community documents for HOA’s contain “self help” provisions. These provisions allow the association to enter a homeowner’s lot to correct a violation after reasonable written notice of the violation. Some typical violations involving “self help” involve landscape maintenance, roof cleaning and unapproved exterior alterations. If your documents give the association the necessary easements or entry rights to correct an individual owner’s water usage, then the association probably has the right to enter the lot and reset the irrigation controls. If the documents are silent on notice, we suggest that the owner be given at least 14 days written notice before the association considers this option. The association should also consider the homeowner’s likely reaction. If the homeowner is in residency and is known to be aggressive toward the association, the association should do what is reasonably necessary to prevent any confrontation with association personnel. Alternatively, the association can impose fines of up to $100 per day until the owner corrects the problem, if the governing documents so provide.

Q. My board is getting conflicting opinions on how to budget for bad debt related to delinquent maintenance fees. We do not want to raise our dues by being ultra conservative, but we also want to avoid financial problems and/or special assessments that might result from poor forecasting. Do you have any suggestions? — J.C.

A. Properly budgeting for “bad debt” depends on multiple factors, such as total receivables, the age of certain receivables, historical data and the level of operating cash reserves. Since each community has its own special circumstances and historical data, there is no single budgeting solution that applies across the board. We do have some suggestions, however. When setting out to approve the budget for the upcoming year, the board should look at history for delinquencies in prior years and forecast for a similar number of new delinquencies. At yearend, the board should look at the delinquent assessments that are older than 12 months and consider a write-off. The reason for the write-off is the reduced liability given to foreclosing banks under Florida law. If a qualifying bank forecloses, its liability for delinquent assessments is the lesser of 12 months of past assessments or 1 percent of the mortgage debt. If your association ultimately recovers more than this limited amount, that is obviously a positive boost to your cash flows. The problem with keeping those older receivables as an asset on your books is the uncertainty of recovery. It could take years to recover those assessments, and if a bank forecloses, the potential for some sort of write-off is high. Also, your association might include interest and late fees on delinquent assessments as part of its projected revenue. This is fine if backed by historical data, but the association should still consider writing off those projected revenues when the delinquency exceeds 12 months. These are conservative strategies, but depending on your cash operating reserves, these suggestions should help your association avoid an operating deficit because of delinquencies.