Starting And Operating An Incorporated Homeowners Association In California
This article provides step-by-step instructions for starting and running an incorporated California homeowners association. It addresses the following frequently asked questions:
- When and how must an incorporated homeowners association register and file forms with governmental agencies?
- What tax returns must an incorporated homeowners association file and what taxes must an HOA pay?
- When should an incorporated homeowners association have its first owner meeting, and what should it do at the meeting?
- How does an incorporated homeowners association call and conduct an owner meeting?
- How does an incorporated homeowners association governing board call and conduct a board meeting?
- How should an incorporated homeowners association create its budget and collect owner dues and assessments?
- What records must an incorporated homeowners association keep and what reports must it make to its members?
- How can an incorporated homeowners association fine and discipline owners and otherwise enforce its rules?
When and how must an incorporated homeowners association register and file forms with governmental agencies?
- Obtaining A Tax ID: A tax identification number (commonly known as an “Employer Identification Number” or “EIN”) is a number that identifies the association for tax purposes. To get an EIN, the developer, an owner, or a manager simply asks the internal revenue service to issue one. The request can be made online, in which case the number is issued instantaneously. In California, every incorporated homeowners association is required to have an EIN.
- Establishing Nonprofit Tax Status: For U.S. federal tax purposes, a homeowners association establishes its nonprofit tax-exempt status by filing a Form 1120H with the IRS by the 15th day of the third month after the end of each tax year (although there is a 12-month grace period). This is required for an incorporated homeowners association. For California tax purposes, an incorporated homeowners association should also obtain California tax-exempt status. To obtain California tax-exempt status, the HOA must file a Form 3500 with the California Franchise Tax Board 90 days before the end of the first year the HOA exists (although FTB can issue the exemption retroactively). Unlike the Federal Form 1120H, the 3500 is a one-time filing and need not be repeated each year.
- Annual Registration: In California, incorporated homeowners associations must file two forms each year to register and perpetuate its existence: (i) it must file a Form SI-CID with the Secretary of State annually within 90 days of the anniversary of the filing of its Articles of Incorporation; and (ii) it must file a Form SI-100 annually with the Secretary of State on the same date.
Incorporated homeowners associations are required to file annual federal tax returns. The best practice is to file as a Section 528 nonprofit homeowners association using a Form 1120H. This filing is due annually by the 15th day of the third month after the end of each tax year. No federal tax will be due so long as the only income the HOA receives is owner dues, and so long as it uses all of this income to pay operating expenses and accumulate reserves.
In California, associations that have not obtained tax-exempt status by filing Form 3500 with the California Franchise Tax Board (see discussion above) must file a Form 100 with the FTB by the 15th day of the third month after the end of each tax year and pay a minimum tax of $800. Associations with California tax-exempt status file a Form 100 only if they receive more than $100 in income from sources other than owner dues and assessments. In addition, associations that have average income (including owner dues) of $25,000 or more must file a Form 199 with the FTB by the 15th day of the fifth month after the end of each tax year. As a practical matter, very few homeowners associations are required to file Form 100 (because they are tax exempt and their only income is owner payments), and only larger homeowners associations are required to file Form 199 (because their average annual collection falls below the $25,000 threshold). Note that the need to file Form 199 does not mean that tax is due, and no tax will be due so long as the only income the homeowners association receives is owner dues, and so long as it uses all of this income to pay operating expenses and accumulate reserves.
When should a homeowners association have its first meeting, and what should it do during that meeting?
A homeowners association should have its first owner meeting as soon as possible after at least two lots or condos are owned by different people. Here is a list of items that should be discussed and resolved at the first homeowners association owner meeting:
Item 1: Electing A Governing Board
The number of board members, qualification of candidates, nomination system, and election procedures, are described in the CC&Rs and bylaws. It is common for association governing documents to provide for election of directors by cumulative voting. This means that each owner is allowed to cast a number of votes equal to the number of directors to be elected, and may choose to cast more than one of such votes for a particular candidate. For example, if three directors are being elected, an owner could choose to cast all three of his/her votes for one person. Cumulative voting is intended to give a dissenting minority of owners the power to elect a director to represent their viewpoint on the board. Another common requirement is that one or more board members be elected by votes cast by the owner or owners other than (and unrelated to) the developer. To understand how this requirement applies, imagine an HOA with a three-person board, where at least one member must be elected by owners other than the developer. The election would take place in two stages. In one stage, every owner, including the developer, would be entitled to cast two votes for each unit he/she owns, and the two candidates receiving the highest number of votes would be elected. In the second stage, each owner other than the developer would cast one vote, and the candidate receiving the highest number of votes would be elected. California has recently enacted extremely complex and burdensome laws regarding election of directors (discussed below) that effectively require advance nomination and a high degree of formality.
Item 2: Electing an Officer or Officers
Incorporated associations must have at least three officers, including: (i) a president who presides at owner meetings and acts as the primary representative of the HOA; (ii) a secretary who keeps meeting minutes and association records; and (iii) a treasurer, who creates or supervises budgeting, accounting and financial reporting. The board typically elects the officers from among the directors. The number and duties of officers, qualification of candidates, nomination system, and election procedures, will be described in the association governing documents.
Item 3: Establishing Management
Incorporated associations must ensure that the basic duties of the HOA are fulfilled, including: (i) creating the annual budget including a repair/replacement reserve contribution; (ii) collecting and depositing owner dues, paying bills and keeping records; (iii) coordinating common area cleaning and repair; and (iv) complying with the requirements and formalities imposed by California law such as running meetings and reporting to owners. The easiest way to fulfill these responsibilities is to hire a qualified homeowners association manager or management company. At its first meeting, the association should decide whether it will hire a manager and, if so, how the manager will be selected. A specific owner or board member should be charged with the task of obtaining management proposals, along with a deadline for presenting these to the board for decision. If the association chooses not hire a manager, it should carefully delineate exactly who among the officers or directors will be responsible for each of the above-listed tasks, and record its decisions in the minutes.
Item 4: Complying With Filing and Taxation Requirements
An owner or manager should be assigned the task of satisfying association filing and taxation requirements (discussed in detail above) or hiring a professional to do so. Keep in mind that postponing this task can expose the association to monetary penalties. Do not assume that the developer or attorney that created the HOA has complied, or that either will be responsible for penalties resulting for non-compliance.
Item 5: Opening Bank Accounts
California law requires that each homeowners associations have at least two bank accounts: one for its operating expenses (such as insurance, shared utilities, and management costs), and a separate one for its repair/replacement reserves. If either or both accounts do not exist at the time of the meeting, an owner or manager should be assigned the task of opening them. (See the discussion above concerning tax ID numbers.)
Item 6: Adopting the Operating Budget, Maintenance Reserves, and Assessments
California law requires each association to have a budget and repair/replacement reserves. If no budget exists at the time of the first meeting, or if the existing budget is out of date or prepared without a reasonable basis, an owner or manager should be assigned the task of creating a proper one. (For more details, see the discussion of budget preparation and owner dues below.)
Item 7: Confirming Association Insurance
An owner or manager should be assigned the task of verifying the following aspects of the homeowners association insurance policies:
- Expiration dates, to make sure the insurance is in effect and timely renewed;
- Names of the insured party or parties, to make sure the HOA is properly named;
- Items covered on the casualty policy, to make sure that all parts of the building are covered either under the HOA policy or under the individual policies carried by the owners; the HOA should specifically confirm that its casualty policy covers all of the elements that it is responsible to repair and replace;
- Limits of liability coverage to make sure they comply with both the HOA documents and the law; and
- Limits of casualty coverage, particularly those relating to replacement costs and building code upgrades.
Item 8: Establishing Collection Procedures and Fines/Penalties
California law requires every homeowners association to adopt policies regarding assessment collection and owner discipline, and to circulate such information to owners. Some recommendations for policies are discussed below. At its first meeting, the association should discuss and adopt assessment and discipline policies and record its decisions in the minutes. A manager or officer should be appointed to circulate a written statement of the policies to all owners.
The CC&Rs or bylaws will contain requirements for calling and conducting an owner meeting, including:
- The number of days advance notice that must be given;
- The way the notice must be transmitted;
- Whether or not an agenda must be given with the notice;
- Whether matters not included in the agenda can be discussed or decided;
- The level of attendance required to conduct business (also called the “quorum” requirement);
- How owners not able to be physically present at the meeting can participate;
- The number or percentage of votes required to make various types of decisions;
- Whether and how decisions can be made without a formal meeting; and
- How records (or “minutes”) of the meeting must be kept and transmitted to the owners.
California law recognizes two different types of meetings: regular meetings, which are those held on a schedule described in the association documents; and special meetings, which are those convened for a particular purpose. At regular meetings, matters not mentioned in the meeting notice can be voted upon so long as 1/3 of the owner voting power is represented; at special meetings, the owners may only vote on items mentioned in the agenda sent with the meeting notice. Any owner or group of owners with 5% or more of the voting power in the association must be permitted to call a special meeting by sending a written request to the board or an officer who must then send a meeting notice to all owners. If there is no board or officer, the owner or owners calling the special meeting may send the notice and agenda directly to the other owners.
California law requires written notice for all owner meetings. The notice must include the place, time and date of the meeting, an agenda of the matters to be discussed and, in cases where directors are to be elected, the name of those who have been nominated. The notice may be mailed or hand-delivered, but posting the notice in the common area is not sufficient. Notices that are hand-delivered or sent by registered mail must be given between 10 and 90 days before the meeting. Notices mailed by any other method must be given between 20 and 90 days in advance. Notice is not required when the meeting is a continuation of another meeting that was adjourned within the previous 45 days as long as the time and place of the continuation meeting was announced at the original meaning. If an owner meeting is held without proper notice, any decision made is invalid unless every owner who did not attend the meeting signs either a written waiver of notice or an approval of the meeting minutes.
California law does not impose a quorum requirement, but does provide that if less than 1/3 of the voting power is represented, the only matters that can be voted upon by those mentioned in the meeting notice. (This agenda-only restriction applies to all special meetings, regardless of attendance level, but only applies to regular meetings if less than 1/3 of the voting power is represented.) Owners unable to attend the meeting in person may participate in meetings through electronic means, delegate their voting power to others, or vote by written ballot. Decisions may be made without meetings if a written ballot is distributed that describes each matter to be voted upon, the manner of indicating approval or disapproval, the response deadline, the number of ballots to needed to satisfy the associations quorum requirements, and the number of votes required for approval. The association must prepare and maintain minutes of all owner meetings, and make these available for owner inspection.
California has recently enacted extremely complex and burdensome requirements for meetings at which directors will be elected, governing documents will be amended, or exclusive usage rights to common area will be granted to a particular owner or owners. The Association must designate either one or three election inspectors to supervise the vote. These inspectors may be owners provided they are not on the board. Voting must be by secret written ballot sent 30 days before the voting deadline. The ballot may not identify the owner by name, unit number, or otherwise. It must be sent with two pre-addressed envelopes and instructions. The ballot must be inserted into one envelope that is then sealed and inserted into the second envelope. On the second envelope, the voter prints and signs his/her name, and provides his/her address and unit number. The voter then mails or hand delivers the second envelope to the election inspector(s), who must count them in an open meeting of the board or owners. The ballots must be retained for one year and available for review by owners. There is no exemption from these requirements for smaller associations, and failure to follow them allows a court to void the election results and impose monetary penalty on the association.
Every homeowners association must satisfy the minimum meeting and voting formality requirements imposed by California law regardless of how few condominiums the property contains and regardless of what its governing documents state; and if the documents impose requirements that are more stringent than those imposed by law, the HOA must comply with the requirements in its documents.
The CC&Rs or bylaws will contain requirements for calling and conducting a board meeting, and these will typically cover the issues listed at the beginning of the preceding section. California has recently enacted the “Common Interest Development Open Meeting Act”, which imposes a series of requirements relating to board meetings and decisions; however, the new law contains a variety of inconsistencies and ambiguities, making its mandates unclear. In order to ensure that it is complying with California law, homeowners associations should adhere to the following “best practices” regarding board meetings:
- Board members should avoid informal, private discussions about association matters; all such discussions should take place at board meeting where proper notice is given and all required formalities are observed;
- Notice of board meetings, and an agenda, should be given to all owners at least four days in advance of the meeting (unless the association documents require more notice);
- The notice and agenda should be delivered personally or by mail to each owner, or posted in the common area (with a copy mailed to any owner who has requested mailing in advance;
- Matters not described on the meeting agenda should not be discussed at the meeting;
- Owners should be allowed to speak (but not vote) at board meetings; and
- Minutes of each board meeting should be circulated to each owner within 30 days of the meeting.
Many of the above requirements do not apply in “Emergency Situations” and “Executive Sessions”. Emergency Situations are circumstances that could not have been reasonably foreseen and that require immediate attention and possible action. Executive Sessions are meetings in which the board considers litigation, formation of contracts with third parties, owner discipline, personnel matters, or to an owner’s payment of assessments. Special board meeting requirements apply to Emergency Situations and Executive Sessions, and boards should consult an attorney if these circumstances arise.
A homeowners association operating budget consists of two components: the operating expenses, including annually recurring costs such as insurance, management, common area utilities, janitorial costs etc.; and the repair/replacement reserves, which is money collected in advance for eventual repair, refurbishment and replacement of the portions of the property that the HOA is responsible to maintain. Both budget components must be based on facts about the specific property for which the budget is prepared rather than on industry statistics or generalized averages or, worse, “educated guessing”. The best practice for establishing the repair/replacement reserve component of the budget is:
- List all association-maintained components for which refurbishment or replacement will be needed in 30 years or less;
- List the estimated cost of refurbishment or replacement for each component;
- List the number of years before the item is expected to need refurbishment or replacement;
- Divide each component’s estimated refurbishment/replacement cost by the number of years, which will tell you how much to collect for the item each year; and
- Add the annual collection for each item to determine the total annual reserve collection.
Each California homeowners association must conduct a detailed reserve study at least once every three years that includes all of the elements described above along with a plan for funding the reserves, and must review the most recent study and funding plan annually to determine if changed circumstances or new information require revisions. California law requires homeowners associations to send each owner a copy of the operating budget and dues calculation, along with a disclosure relating to the reserves, between 30 and 90 days before the beginning of the HOA’s fiscal year. California recently developed a fill-in form for this disclosure that can be found in California Civil Code Section 1365.2.5. Replacement /reserve funds must be kept in a separate bank account, and cannot be used to pay for operating expenses except in very limited circumstances.
California law allows adjustments to the operating budget and owner dues to be made by the board, but non-emergency dues increases greater than 20% must be approved by a majority of owners. Similarly, special assessments (which are extra payments required because the budget turns out to be inadequate) can be approved by the governing board unless the amount exceeds 5% of the total operating budget. The association documents can (and often do) impose additional assessment restrictions and voting requirements.
California law requires every homeowners association to have a written policy for collecting delinquent dues and assessments, and to send a copy of its policy to each owner every year. California law prohibits an owner from withholding a dues or assessment payment on the grounds that the owner is entitled to recover money or damages from the homeowner association, but permits an owner to dispute an assessment on other bases either in small claims court or by demanding a meeting with the board (or with all owners if there is no board).
California law allows the homeowners association to record a “lien” against the non-paying owner’s lot or condominium, an inexpensive and quick procedure that ensures that the association will automatically receive its money when the property is sold, and gives the HOA preferred repayment status if the defaulting owner files bankruptcy. A decision to record a lien must be made at a meeting open to all owners. At least 30 days before recording a lien against a delinquent owner’s property, the association must send a notice by certified mail that includes a variety of specific information and language. Recording a lien is a particularly useful homeowners association remedy when the defaulting homeowner is “under water”, meaning that the value of his/her unit is less than the balance owed on the mortgage. While filing the lien will not trigger immediate payment, it will increase the likelihood that the HOA will be paid eventually, while avoiding the need for the HOA to take over the defaulting owner’s mortgage. Keep in mind, however, that if the owner defaults on the mortgage and the bank forecloses, the homeowners association’s lien will be wiped out, and it will not be legally entitled to recover the defaulting owner’s debt from the lender or from the new owner.
California law also allows the homeowners association to trigger a process under which the non-paying owner’s property is sold on the open market, provided that the defaulting owner gets to keep any amount of the sale price left after paying costs of sale, mortgages, legal fees, and debts and penalties to the HOA. This forced sale process, called a “foreclosure”, is non-judicial, meaning that the homeowners association does not need to go to court at any point during the sale process. A homeowners association that wants to collect unpaid dues or assessments through non-judicial foreclosure typically hires a trustee or foreclosure service to handle the sale and collection process. A decision to foreclose must be made in an executive session board meeting (i.e. one that is closed to owners). Note that a foreclosure is only useful if the value of the defaulting owner’s lot or condominium is significantly greater than the amount of the mortgage; otherwise, the proceeds from the forced sale, after payment of costs and mortgage, may not be sufficient to repay the owner’s debt to the HOA. Also note that liens and non-judicial sales are allowed for delinquent assessments, interest, late fees, collection costs (including attorney fees), and interest, but are not allowed on for fines and penalties imposed for rule violations.
California law imposes a variety of requirements for homeowners association recordkeeping and reporting, including:
- Annual budget and repair/replacement calculation
- Bank records including reconciliations
- Tax returns and regulatory filings
- Meeting notices and minutes
- Member list, including the names, addresses and contact information of each owner
- Insurance policies
- Agreements with service providers including any association manager
- Annually: Budget including repair/replacement calculation, and statement of dues
- Annually or more frequently: Report of income and expenses
- Annually: Summary of insurance coverage and/or copies of policies
- Annually: Copy of HOA dispute resolution procedures
- Annually: Copy of HOA assessment collection policy
- Annually: Copy of HOA alteration approval procedure
- Annually: Schedule of HOA fines and penalties
- Regularly: Meeting minutes
Homeowners association documents may supplement these requirements, but may not diminish or eliminate them.
California law permits homeowners associations to impose fines and penalties, but only provided the HOA adopts a schedule in advance, and sends a copy to each owner each time a fine or penalty is established or adjusted. Fines or penalties cannot be the basis for a lien or non-judicial foreclosure, but can be collected through legal action, including a forced sale supervised by a court.
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About The Author
SirkinLaw APC has been creating homeowner association documents, advising owners, and mediating association disputes, for more than twenty years. Andy Sirkin was co-author of 10 editions of The Condominium Bluebook, and his expertise in preparing governing documents is recognized throughout California. SirkinLaw APC governing documents continue to be the ones other firms emulate, and Realtors, lenders and buyers strongly prefer. This leadership results from constant improvement and innovation that makes our documents easier to read and understand, as well as more efficient and less expensive to enforce.