Definition of Capital improvement.

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1 It is my understanding that an issue has arisen related to capital improvements and whether the Desert Shores Community Association ( Association ) Board of Directors ( Board ) has the authority to make a capital improvement without a vote of the Members. Before commenting on the specifics of this matter, please be advised that this message is intended to supersede and replace any other correspondence and communications related to his matter that may have been previously transmitted. Thus, to the extent that there is a conflict between this correspondence and any others issued by this office, this opinion is intended to govern. As explained to me, the issue in question is related to the installation of lighting in certain common areas. A concern has been expressed by some owners or identified by the Board and management that some areas of the common areas are inadequately lit and, as a result, create a potential safety issue for the owners, residents and guests. This begs the question whether the Board may install the necessary lighting without membership approval. Definition of Capital improvement. The initial issue is to define what constitutes a capital improvement. As you know, the term is not defined in NRS 116 or NAC 116, or in the Declaration. The U.S. Tax Court has held that a capital improvement, as distinguished from a repair, is a modification that constitutes a betterment made to increase the value of the property or appreciably prolong the life of the property or to replace an existing asset such as replacing rather than repairing a fence. Peterson v. C.I.R., No , 2015 WL 64456, at *9 (T.C. Jan. 5, 2015). Therefore, a working definition of a capital improvement may be an improvement to real property that: Creates a new, not previously existing amenity; Adds to, enlarges or expands an existing amenity; Replaces a major component or structural part of the real property; or Adapts the real property to a new or different use. The Nevada Real Estate Division ( NRED ) Ombudsman has stated that upgrading an improvement, such as replacing glass entry doors with a revolving door, is not a capital improvement because it was essentially exchanging a door for a door. However, it is also the Ombudsman s opinion that any addition to the Common Areas would require membership approval. It is our opinion that, in both instances, arriving at a legally supportable conclusion as to whether a vote of the Membership is required prior to undertaking a capital improvement necessitates a careful analysis of the Association s governing documents, NRS 116, and the exact nature of the capital improvement contemplated. In addition to a definition which addresses the type of improvement, it is not unusual for a definition of a capital improvement to include a monetary threshold as well. Again, the statute and regulations provide no guidance. In the case at hand, the installation of new lighting would arguably be a capital improvement. Similarly, if the Association wanted to install a new park bench, it would likely be characterized as a capital improvement. Authorization to Approve a Capital improvement: State Law. The next issue is distinguishing between the authority to approve a capital improvement and the authority to finance a capital improvement. NRS (f) and (g) provide as follows:

2 Except as otherwise provided in this chapter and subject to the provisions of the declaration, the association.... (f) May regulate the use, maintenance, repair, replacement and modification of common elements. (g) May cause additional improvements to be made as a part of the common elements. Based on the foregoing, an association is generally empowered to replace and modify the common elements or construct new, additional improvements subject to other limitations in NRS 116 or the declaration. Thus, the law would allow the Board to approve a capital improvement without membership approval. But such power is subject to the limitations set forth in the Declaration. Authorization to Approve a Capital improvement: Governing Documents. Article III, Section 3.01 of the Declaration provides, in pertinent part, as follows: Every Owner shall have a right of use and enjoyment in, to and over the Association Property which shall be appurtenant to and shall pass with title to every Lot and Condominium, subject to the following provisions: (h) The right of the Master Association (by action of the Board) to reconstruct, replace or refinish any Improvement or portion thereof upon the Association Property, in accordance with the original design, finish or standard of construction of such Improvement, or of the general Improvements within any Phase of Development, as the case may be; and if not in accordance with such original design, finish or standard of construction, only with the vote of Delegates representing at least sixty-seven percent (67%) of the voting power of the Master Association. (i) The right of the Master Association to replace destroyed trees or other vegetation and plant trees, shrubs and ground cover upon any portion of the Association Property. Please note that NRS has effectively repealed delegate voting for those associations, like Desert Shores, which are no longer under declarant control. Therefore, wherever the Declaration refers to the votes of Delegates representing a certain percentage of the voting power of the Association, the requirement is now for a vote of the Members. It should also be noted that the very language of Section 3.01 of the Declaration appears to limit its applicability to existing capital improvements. It is impossible to reconstruct, replace or refinish a new capital improvement. Furthermore, constructing in accordance with the original design, finish or standard cannot apply to a new capital improvement. Thus, this Section allows the Board to reconstruct, replace or refinish any [existing] Improvement... in accordance with the original design, finish or standard of construction of such Improvement. However, one may reasonably and justifiably assert that this provision does not address new capital improvements. Article V, Section 5.01(j) of the Declaration provides, in pertinent part, as follows: The Master Association shall have all of the powers given to such a corporation by law, subject only to such limitations upon the exercise of such powers as are expressly set

3 forth in the Restrictions. The Master Association shall have the power to perform any and all lawful acts which may be necessary or proper for or incidental to the exercise of any of the express powers of the Master Association. Without in any way limiting the generality of the foregoing provisions, the Master Association, acting through the Board, shall have: (j) The power but not the duty, by action of the Board, to construct new Improvements or additions to the Association Property, or demolish existing Improvements (other than maintenance or repairs to existing Improvements), in accordance with the provisions of Article VI, Section 6.08 of this Master Declaration. As you can see, Section 5.01 (j) of the Declaration grants to the Board the power to construct new Improvements or additions to the Association Property.... The only condition or limitation placed on the exercise of this power is compliance with Section 6.08 of the Declaration. Article VI, Section 6.08 of the Declaration provides as follows: The Board, with the vote of Delegates representing at least fifty-one percent (51%) of the voting power of the Master Association, may levy, in any fiscal year, a Capital Improvement Assessment applicable to that year only for the purpose of defraying, in whole or in part, the cost of any construction, reconstruction, repair or replacement of a Capital Improvement upon the Association Property, including fixtures and personal property related thereto. All Capital Improvement Assessments shall be levied among the Owners based upon the number of assessments units (determined pursuant to Section 6.05) chargeable to each Owner. Section 6.08 of the Declaration requires 51% of the Members to approve a Capital Improvement Assessment. However, there is no reference to a membership approval requirement if there is no need to impose a Capital Improvement Assessment. In summary, the Board has the authority to approve, without a vote of the Members, any capital improvement to reconstruct, replace or refinish an existing Improvement or portion of the Common Areas if it plans to do so in accordance with the original design, finish, or standard of construction. However, if the Board wants to approve a repair, reconstruction or renovation plan for an existing capital improvement that deviates from the original design, finish or standard, then it must obtain the approval of Members representing at least sixty-seven percent (67%) of the voting power of the Master Association. This is an ambiguous standard at best and thus the issue will have to be addressed on a case-by-case basis. With regard to new capital improvement the Declaration allows the Board to make the improvements without membership approval, subject to NRS (3). If the Board is considering constructing, situating or expanding a new building or structure, then it must also consider the additional requirements of NRS (3) to obtain the consent of nearby residents: An association may not expand, construct or situate a building or structure that is not part of any plat of the planned community if the expansion, construction or situation of the building or structure was not previously disclosed to the units owners of the planned community unless the association obtains the written consent of a majority of

4 the units owners and residents of the planned community who own property or reside within 500 feet of the proposed location of the building or structure. On October 22, 2015 the NRED issued Advisory Opinion 16-01, which replaced Advisory Opinion With respect to the requirement of obtaining membership approval for a capital improvement, the Division concluded that the board may initiate capital improvements only if authorized by the governing documents. In such case, homeowners approval is only required if NRS (3) applies. The NRED also addressed the issue of ratification of a budget which contains a capital improvement expense equate[s] to homeowners approval of the expense. The NRED concluded that [t]he board may not put a capital improvement expense in the budget unless the Board is authorized by the governing documents to take action regarding the improvement.... Ratification of a budget which includes a capital improvement expense does not satisfy the requirement for owners to approve a capital improvement through amending the governing documents; and it does not constitute compliance with NRS (3). In the case at hand, the Declaration allows the Board to construct new Improvements or additions to the Association Property, in accordance with the provisions of Article VI, Section 6.08 of the Master Declaration. As noted above this provision only requires membership approval to approve a Capital Improvement Assessment but not the capital improvement itself. Thus, the Board is authorized by the governing documents to make new capital improvements and, therefore, the Board may include the expenditure in the budget as provided in Advisory Opinion Authorization to Finance a Capital improvement. As noted above, Section 6.08 of the Declaration requires 51% of the voting power of the Membership to approve a Capital Improvement Assessment. But no such Assessment is required in this instance. If a Capital Improvement Assessment must be imposed then the Board must give written notice to each Owner of the meeting at which the Capital Improvement Assessment is to be considered or acted upon at least 21 days before the scheduled meeting. See NRS (9). The Board also has the option of borrowing money for the purpose of improving, repairing or adding to Association Property and facilities. However, borrowing money requires the approval of at least 67% of the voting power of the Members and the approval of Mortgagees. See Declaration Article III, Section 3.01(d). However, if the Board has surplus operating funds which would pay for the Improvement, it would not need a special vote of the Members on the financing, other than the budget ratification vote. Article VI, Section 6.06 of the Declaration provides that the Board may retain any surplus operating funds and apply these funds to reduce the following year s Common Assessment. See also NRS In Advisory Opinion the NRED addressed the following: Can surplus funds be used to pay for capital improvements? Its response was as follows: Yes. Although surplus funds must be distributed as set forth in NRS , to the extent the governing documents authorize a capital improvement and the association has satisfied the provisions of NRS (3), if applicable and NRS (9), they can use surplus funds to pay for an authorized capital improvement.

5 It is our opinion that surplus finds may be used for a capital improvement can be used by the Board if approved by the Board and the Board complies with NRS (9) and NRS (3), if applicable. John E. Leach Conclusion. Based on the foregoing, the Board has the authority to approve, without a vote of the Members, any capital improvement to reconstruct, replace or refinish an existing Improvement or portion of the Common Areas if it does so in accordance with the original design, finish, or standard of construction. The funds for reconstructing, replacing or refinishing will usually come from the Association s reserves. However, if the Board wants to approve a repair, reconstruction or renovation plan for an existing capital improvement that deviates from the original design, finish or standard, then it must obtain the approval of Members representing at least sixty-seven percent (67%) of the voting power of the Master Association. The need for membership approve in these instances should be addressed on a case-by-case basis. With regard to new capital improvements the Declaration allows the Board to make the improvements without membership approval, subject to NRS (3). Thus, if the proposed improvement is characterized as a building or structure then the Association must obtain the written consent of a majority of the Owners and residents of the planned community who own property or reside within 500 feet of the proposed location of the building or structure. However, if a Capital Improvement Assessment is required to finance the capital improvement then membership approval is required to impose the Capital Improvement Assessment.