One of the most crucial responsibilities of an HOA board is safeguarding the association’s assets. This requires careful financial planning and revenue generation, but also understanding insurance and tax implications.
Without adequate insurance coverage, associations are vulnerable to lawsuits, property damage claims, and liability issues. Misunderstanding tax implications can also put the association at risk for unexpected penalties and fines. Both scenarios jeopardize the community’s financial health.
In this blog, we delve into HOA insurance needs as well as tax considerations. Our hope is to equip your board with the knowledge needed to make informed decisions that protect your community’s financial future.
Contents
- Essential Insurance Policies for HOAs
- Master Policies vs. Individual Policies
- Additional Insurance Considerations
- How to Purchase HOA Insurance
- HOA Tax Implications to Keep in Mind
- Understanding Capital Contributions for HOAs
Essential Insurance Policies for HOAs
The primary goal of insurance is to mitigate risk. For HOAs, this means safeguarding the community’s assets and protecting against potential liabilities. Different types of insurance policies play crucial roles in achieving this goal.
Common policies include:
Liability Insurance
Liability insurance protects the association against claims resulting from injuries or damages occurring on common property. This insurance typically covers legal fees, settlements, and medical expenses related to incidents such as slip-and-fall accidents, property damage, or any other situation where the HOA may be held responsible.
Matters generally excluded from liability coverage include:
- Injuries from automobiles, boats, or aircraft
- Injury to employees arising out of employment
- Injuries arising from discharge of smoke, fumes, or chemicals
- Damages for false arrest, malicious prosecution, wrongful entry, eviction, libel, or slander
- Contractual liability
- Host liquor liability
- Non-owner automobiles
Most of these exceptions can be covered under separate policies or additional riders.
Comprehensive Coverage
Also known as “all-risk” or “casualty” coverage, this policy insures the HOA for “all forms of physical loss” except for specific exclusions noted in the policy.
Flood Insurance
Flood insurance may or may not be available, depending on the community’s location. In designated flood hazard areas, flood insurance may be required by lenders or secondary lending agencies.
Worker’s Compensation
If the HOA has any employees, such as maintenance personnel or resident managers, it must carry worker’s compensation. In some states, laws require worker’s compensation be carried for contractors who work on the premises, even though they aren’t employees of the association.
Automobile Insurance
If the HOA owns any vehicles, it should carry adequate automobile insurance, including personal injury, liability, property damage, medical, and comprehensive.
Non-Owned Automobiles
If the association only has basic liability coverage, that policy might not cover any damages or liability related to the use of non-owned vehicles. In other words, if a board member or employee uses their personal car for HOA business and gets into an accident, the association may not be protected. To ensure adequate coverage, the association should obtain a “non-owned automobiles” endorsement.
Directors and Officers Insurance
Directors and officers (D&O) insurance is a liability policy that protects HOA board members from personal losses resulting from legal actions or claims made against them in their capacity as directors or officers. This coverage typically includes protection against claims of negligence, mismanagement, breach of fiduciary duty, or errors in judgment.
Rain Damage
Rain damage insurance protects property from losses caused by water infiltration due to rain. This insurance typically falls under broader property insurance policies, covering damages resulting from events like roof leaks, flooding, or water intrusion in basements and walls.
Auxiliary Structures
Auxiliary structures such as fences, signs, pools, and carports may not be covered under a standard comprehensive policy unless they are specified.
Glass Coverage
Glass coverage protects against damage to windows, doors, and other glass structures in the event of accidents, vandalism, or severe weather.
Dram Shop Coverage
If the association operates a bar or at any time dispenses alcoholic beverages, the HOA must add a dram shop coverage rider to its liability policy.
Association Personal Property
If the association owns personal property, such as recreation room furniture or pool cleaning equipment, that personal property should be insured to full actual cash or replacement value.
Boiler and Machinery
In a community with a steam boiler, a boiler and machinery policy covers sudden and accidental breakdowns of pumps, compressors, boilers, and motors. This policy also covers damage caused by a boiler explosion.
Umbrella Coverage
An association should have liability coverage of at least $1 million. One way of obtaining higher coverage limits is to purchase an umbrella policy, which provides additional liability protection beyond the limits of existing policies.
Title Insurance
Title insurance protects the association from potential financial losses related to defects in the title of the properties within the community. Typically, the community’s developer will purchase title insurance and then deed that insurance over to the association.
Property Damage Insurance
Property damage insurance protects the association’s property from hazards such as fire, windstorms, and building collapse. The coverage is generally included in comprehensive policies.
Product Liability Insurance
Product liability insurance protects businesses and organizations from claims related to injuries or damages caused by products they manufacture, sell, or distribute. An HOA may consider this coverage if it provides amenities such as playground equipment, fitness facilities, or community events that involve food.
Cross-Liability Endorsement
A cross-liability endorsement provides coverage when one unit owner sues another owner or the association for injuries resulting from an accident in a common area.
Master Policies vs. Individual Policies
Master policies are comprehensive insurance plans that cover common areas and shared liabilities within the community. These policies protect the association as a whole.
Comparatively, individual unit owners can obtain a special policy that offers personal property coverage as well as personal liability coverage. This is usually referred to as an “H0-6” policy and helps ensure individual homeowners are adequately protected against potential risks.
Most HOAs carry a master policy but also require that unit owners carry their own liability and personal property insurance. This dual approach helps safeguard both the community and its residents.
Additional Insurance Considerations
When exploring insurance coverage options, HOAs should also keep in mind:
Claims Made vs. Occurrence Coverage
When purchasing liability insurance, particularly D&O policies, it’s important to distinguish between claims made and occurrence coverage.
Claims made policies provide coverage for claims made during the policy period, regardless of when the incident occurred. That means if a claim arises after the policy has expired, it will not be covered. Comparatively, occurrence policies cover any incidents that occur during the policy period, regardless of when the claim is filed.
Replacement Cost
Policies may be written to provide coverage based on replacement value rather than depreciated value. So, in the event of a loss, the insurer will pay the cost to replace or repair the damaged property with new materials without deducting for depreciation.
Inflation Guard Endorsement
An inflation guard endorsement automatically increases the coverage limits over time to keep pace with inflation. This helps prevent underinsurance in the event of a loss.
Building Ordinance Endorsement
Most building codes require that if a building suffers more than 50 percent damage, it be rebuilt in compliance with current codes. A building ordinance endorsement covers the additional costs associated with these repairs.
Waiver of Subrogation
Under a standard insurance policy, insurance companies have a legal right to recover losses from the parties who caused the damage. A waiver of subrogation is a provision in an insurance policy that prevents the insurer from seeking recovery of costs. Every HOA’s master policy should include this provision so that individual owners aren’t potentially at risk.
Co-Insurance
Co-insurance is a provision in an insurance policy that requires the policyholder to insure their property for a specified percentage of its total value. If the property is underinsured at the time of a loss, the insurance company may apply a co-insurance penalty, reducing the payout based on the ratio of the actual coverage to the required coverage.
For example, if a property is valued at $1 million and the policy requires an 80 percent co-insurance limit, the owner must maintain coverage of at least $800,000. If they only insure it for $600,000, they could face a penalty during a claim.
How to Purchase HOA Insurance
Appropriate insurance coverage is one of the best ways an HOA can protect its community’s assets. However, with numerous policies, options, and brokers available, the process can feel overwhelming.
To help streamline this journey, the board should:
Step 1: Appoint an Insurance Committee
Your board should form an insurance committee that will be responsible for investigating options and making informed recommendations.
Step 2: Choose a Specialized Insurance Broker
Next, the committee should select an insurance broker who specializes in HOA insurance.
Step 3: Gather Insurance Specifications
The committee should then provide the broker with a comprehensive list of the coverage needs specific to the HOA.
Step 4: Solicit Multiple Bids
The committee should reach out to two or three different insurance providers to request proposals.
Step 5: Make an Informed Decision
After thoroughly reviewing the proposals, the insurance committee should make a recommendation to the board.
HOA Tax Implications to Keep in Mind
Just like insurance coverage, taxes can affect the association’s overall financial stability. Missteps in this area can lead to unexpected liabilities, fines, and even bankruptcy.
To avoid these pitfalls, HOA boards should be aware of the following tax implications:
Classification of Income
Understand whether your HOA is classified as a nonprofit or a for-profit entity. Nonprofits may have different tax obligations and potential exemptions.
Reserve Fund Contributions
Reserve fund contributions can be classified as capital contributions if certain criteria are met, which can impact tax treatment.
Investment Income Taxation
Any income earned from investments is typically taxable. However, income from municipal bonds may be exempt.
Capital Gains Tax
If your HOA sells property or assets, be aware of potential capital gains taxes.
Deductibility of Expenses
Understand which expenses can be deducted for tax purposes, such as maintenance costs and repairs. This can lower the overall taxable income of the association.
Sales Tax
Depending on your state, certain services or materials purchased by the HOA may be subject to sales tax.
Employment Taxes
If the HOA employs staff, it must comply with employment tax obligations, including payroll taxes.
IRS Form Filing
Most HOAs must file annual tax returns with the IRS, often using Form 1120-H for homeowners associations. Failure to file can result in penalties.
Assessment Income: Understanding Capital Contributions for HOAs
How HOAs manage and classify assessment income can significantly affect the association’s tax obligations. For assessment income to be treated as capital contributions, which have specific tax advantages, the HOA must:
Notify Unit Owners in Advance
To classify a portion of the assessments as capital contributions, the HOA must inform unit owners that specific amounts are being contributed to the reserve fund.
Designate Funds for Future Capital Expenditures
It’s essential for the HOA to set aside reserve fund contributions specifically for future capital expenditures, like roof replacements and major landscaping.
Use Funds Appropriately
The funds that are earmarked for reserves should only be used for significant repairs and replacements, not for everyday maintenance. Misusing these funds could jeopardize the capital contributions classification and expose the HOA to increased tax liabilities.
Segregate Funds
HOAs must maintain separate bank accounts for reserve funds and operating funds. This can protect the association from potential audits or tax implications.
Given the complexity of tax law, it’s recommended that HOAs seek the assistance of a certified public accountant. These professionals can help your board create a financial plan that aligns with the association’s goals.
Let Us Help Protect Your Community’s Assets
Money isn’t everything. But in the world of HOA management, financial solvency can make or break a community. That’s why it’s important for your board to understand the different types of insurance policies available and to also stay informed about tax obligations.
Luckily, you don’t have to navigate insurance and taxes alone. As a leading provider of HOA management services in North and South Carolina, Community Association Management empowers association boards with expert-backed resources and solutions. From a suite of customizable community management solutions to cutting-edge HOA accounting services, we are here to help your community thrive.
To learn more about our HOA management services, contact us online or give us a call at 888-565-1226.
