What is a capital improvement certificate?

What is a capital improvement?

According to Investopedia, “A capital improvement is the addition of a permanent structural change or the restoration of some aspect of a property that will either enhance the property's overall value, increase its useful life, or adapt it to a new use. This type of improvement, according to the Internal Revenue Service (IRS), is required to be any addition or improvement to a piece of property that is expected to last for longer than one year.”
 

What is a capital improvement certificate?

A capital improvement certificate is a document a property owner gives a contractor to confirm that a job is a permanent improvement, not a repair, so the contractor can treat the job as exempt from sales tax in states that use that system.

In Rhode Island, a capital improvement certificate is not part of the standard process. Rhode Island generally taxes construction work through contractor rules that treat contractors as the consumer of materials on construction contracts, rather than relying on a homeowner “capital improvement certificate.”
 

Examples of capital improvements

Common examples of capital improvements in Rhode Island communities include:

• Roof replacement: Full replacement of a building roof or major roofing components that have reached the end of their useful life.
   
• Elevator modernization: Significant upgrades to elevator systems to improve safety, reliability, or performance.
   
• Boiler or HVAC replacement: Installation of new heating or cooling systems that support long-term operation.
   
• Pool renovation: Structural resurfacing, new filtration equipment, or large-scale repairs to meet code requirements.
   
• Fire safety upgrades: Replacing sprinkler systems, alarms, or other emergency safety systems.
   
• Common area renovations: Restoring lobbies, hallways, or clubhouses when the work goes beyond cosmetic upkeep.
   
• Paving or resurfacing: Restoring parking lots or private roads once normal patching is no longer sufficient.

So, capital improvements include everything from constructing a playground or spa to replacing your boiler or swimming pool filtration system. Because these projects are required to last longer than one year, these are not inexpensive undertakings. Thankfully, there are several options to pay for them.
 

How to pay for capital improvements

1. Reserve funds

   Your reserve fund should be your first line of defense when it comes to funding repairs and replacement of your existing assets.
   
   Before drawing from reserves, boards should confirm that the project is identified in the reserve study or permitted under Rhode Island HOA laws and their governing documents. Legal counsel can help interpret these requirements, especially since some projects that feel like capital improvements may fall outside the items listed in the reserve study.
   
   Unfortunately, up to 72 percent of reserves are “under-funded,” meaning they are not funded sufficiently to pay for the things they are supposed to cover when they reach the end of their useful lives, according to FirstService Financial, which provides best-in-class financial services and insurance programs for FirstService Residential-managed communities.
   
   It’s important to confirm that your reserves are funded properly, or your association risks not being able to meet its obligations for maintenance of the community assets.
    

2. Special assessments

   Special assessments are extra charges collected from homeowners when a community needs to complete a capital improvement and does not have enough reserve funds available. They can help a project move forward without taking on debt, but they must be approached carefully because the financial impact on residents can be significant.
   
   Large, unplanned charges may create concern among homeowners and can lead to questions about how the need for the project developed. If some residents cannot pay the full amount at once and request extended payment plans, the association may face delays in collecting enough funds to begin the work.
   
   Because of these risks, a special assessment should never be adopted without a close review of the governing documents and early involvement from the association’s attorney. Many Rhode Island communities have specific requirements for notice and approval thresholds. A property manager can organize informational meetings and communicate with residents on behalf of the board so the community can move forward with clarity.
   
   Learn more in our guide to board vs. management duties.
    

3. Loans

   Borrowing money for capital projects has become common practice among communities. Unlike a special assessment, a bank loan allows unit owners to pay for the project over an extended period and potentially spread the cost of an improvement over generations of homeowners. Of course, loans do come with interest and fees, but they can be a viable option for communities or buildings taking on a large and costly project.
   
   There are three benefits of using a loan to fund capital improvements:
    
   • First, there are typically no prepayment penalties for making additional principal payments or paying off the loan. In most cases, a prepayment penalty only applies if the loan is refinanced with another lender.
      
   • Second, most banks will lend for up to 10 years, but increasingly banks are extending amortization to 15 or 20 years. This reduces the monthly payment and makes financing more affordable for unit owners.
      
   • Third, closing costs are minimal for community loans. Since there is no physical collateral, the title and attorney fees are much lower than if real property was involved.
   
   Like all critical decisions, communities must consult with their legal counsel and governing documents before applying for a loan to maintain compliance with the community’s bylaws.

How does that play out in the real world?

The Gibson, an 80-unit condominium located in the heart of Washington, D.C., was constructed in 1981. As could be expected with a building of this age, the glass and windows were due for replacement, and the association board was tasked with sourcing a loan to cover the expense. Not only would this project serve to fix issues with the existing windows and doors, it would also protect and enhance the value of the owners’ investments in their units.

FirstService Financial was engaged to assist in the loan process, and ultimately the association and financial institution were able to agree to the following terms: $1,500,000 loan, 12-month non-revolving line of credit (draw period) followed by a 10-year term at 4.06%, fixed at closing.

Capital improvements, and the costs of them, are inevitable. When your association has to invest in its property, whether for repairs or a new construction project, the financing for that work must be considered as carefully as the work itself.

Whether you choose to use your reserve fund, levy a special assessment, or take out a loan, it will affect the well-being of your association in a variety of ways. A financial management expert can provide advice on the risks of each and help you decide which is the best option for your community.

To learn more about how to keep your community association financially healthy, contact FirstService Residential today.

This information is provided for general informational purposes only and is not intended to constitute, and should not be relied upon as, legal, regulatory, financial, or operational advice, or as a representation or guarantee of any specific services, capabilities, or outcomes. Property management needs, regulatory requirements, market conditions, and available services vary by jurisdiction, property type, and community. FirstService Residential provides services through locally based affiliates and associates, and services and results may vary by community, region, contractual terms, and applicable law.