CAPITAL IMPROVEMENTS

QUESTION: We need to replace our roof. We have money in reserves for that purpose but one of our owners, a CPA, insists that replacing the roof is a capital improvement requiring membership approval. That can't be right. Do we need approval?

ANSWER: CC&Rs often require membership approval for improvements costing over 5% of the annual budget. In my opinion, the general definition of capital improvement is for tax purposes and does not apply to community associations.

Tax Definition. In the business community, a capital improvement is anything that (i) enhances the value of a property, (ii) extends the useful life of an asset, or (iii) adds to its value. Using this definition, virtually every reserve expenditure is a capital improvement requiring membership approval. This broad definition was created for tax purposes and has no practical application in the community association industry.

Community Associations. For community associations, a different definition is required. You should use the following: "A capital improvement is any (i) substantial discretionary addition to the common areas, (ii) voluntary significant upgrade to common area materials, or (iii) discretionary material alterations to the appearance of the development."

Discretionary Additions. The discretionary addition of new facilities which were not previously part of the development's original construction, which exceeds 5% of the budget, requires membership approval. Examples include the construction of a clubhouse, tennis court, swimming pool, or gym.

Exceptions. Capital improvements that do not require membership approval are (i) those required for safety purposes, and (ii) governmentally mandated improvements. The voluntary addition of a retaining wall to stabilize a slope for safety purposes should not require membership approval. The installation of a fire control system ordered by local fire authorities does not require membership approval.

Significant Upgrades. Boards should take advantage of improved building materials and designs whenever possible. However, discretionary upgrades that are appreciably more expensive need membership approval. For example, replacing chain link fences costing $25,000 with slumpstone costing $100,000 requires membership approval. Replacing lobby carpet that costs $62,000 with tile at $120,000 requires membership approval. Upgrading carpet from $62,000 to a higher quality at $70,000 does not require membership approval if it falls within 5% of the annual operating budget.

Exception. An exception is a mandated upgrade. If an association repairs its 30-year old elevators and the city orders a substantial upgrade to integrate the elevators with the building's fire alarm system, this capital improvement does not require membership approval. The upgrade is required regardless of the membership's approval or disapproval.

Material Alteration in Appearance. Any repair or replacement that constitutes a substantial alteration in the appearance of the development should require membership approval even if the cost does not exceed the 5% restriction. For example, replacing a decorative fountain with a statue is a material alteration to the appearance. Failure to get membership approval could have significant consequences.

Exception. Replacing wood shingles with fireproof shingles to satisfy fire codes does not require membership approval. Even though the new shingles exceed the 5% restriction, the membership cannot veto the change. However, the membership should vote on any discretionary change in the appearance, such using red clay tile over gray slate.

RECOMMENDATION. Because of the uncertainty created by the 5% capital improvement restriction, associations should define "capital improvement" whenever they amend or restate their CC&Rs. If your association needs assistance amending its documents, contact us for more information.

Updated 8/9/2008