Body corporates have long used sinking funds as a way to regularly set aside money to cover large future costs, such as major repairs and upgrades. This approach helps ease the financial pressure when those payments are due.
A well-managed sinking fund also allows properties to plan ahead for larger, less frequent expenses, such as major repairs or upgrades, without needing to rely on credit cards or dip into emergency savings.
In certain regions of Australia, maintaining a sinking fund is a legal requirement to avoid significant financial and legal issues.
In this article, our specialists at Duo Tax will explain everything you need to know about sinking funds. You’ll discover what they are, why you need them, how to manage them, and, most importantly, how they can be a game-changer for property management.
What is a Body Corporate Sinking Fund?
A sinking fund is a financial reserve set up by a body corporate to cover major, long-term expenses that aren’t part of the regular day-to-day budget. Instead of relying on special levies or scrambling for last-minute funding, a well-managed sinking fund allows property owners to plan ahead and pay for costly repairs or upgrades when the time comes.
Common uses of a sinking fund include large-scale capital works such as roof replacements, repainting the building exterior, upgrading lifts, or restoring shared facilities like pools and fences. It may also be used for replacing communal area items like carpets or flooring, and in some cases, repaying long-term debts related to the property.
The term “sinking” reflects the fund’s purpose—to gradually ‘sink’ money into a reserve that will eventually cover predictable, often expensive works that go beyond routine maintenance. These funds are usually built through regular contributions from strata levies paid by all property owners in the scheme. If you’re new to strata living, read our guide to what strata is.
Importantly, the sinking fund is separate from other levies like the Administrative Fund, which covers ongoing maintenance and insurance, or Special Levies, which are raised for unexpected, one-off costs.
Having a dedicated sinking fund ensures the owners’ corporation can meet future capital expenses without causing financial strain on owners or delaying essential works.
What the fund is called in each state
- NSW: capital works fund, with a 10-year capital works fund plan.
- Queensland: sinking fund.
- South Australia: sinking fund (community corporations must have one; strata corporations may choose to).
- Western Australia: reserve fund, with a 10-year plan for schemes of 10 or more lots or a replacement value of $5 million or more.
- Victoria: maintenance fund, which tier 1 and tier 2 owners corporations (the largest ones) must set up to pay for their maintenance plan.
- Tasmania: one body corporate fund, which can be split into recurrent and capital parts.
The Step-by-Step Guide on How to Create a Sinking Fund for Your Property
A body corporate generally uses a capital works or sinking fund forecast to estimate future major expenses and determine how much owners need to contribute.
Step 1: Get a Capital Works or Sinking Fund Forecast
The body corporate, usually through its committee or strata manager, prepares a forecast of major works expected over the coming years, often covering 10 years. This may include roof replacement, repainting and lift upgrades, with estimated costs and timing. In some states, this type of plan is required by law.
Step 2: Work Out the Yearly Amount Needed
The forecast shows how much the fund needs each year so enough money is available when planned works are due. This helps reduce the need for unexpected special levies.
Step 3: Set the Levies
The body corporate uses the forecast to set the sinking fund or capital works fund levy in its annual budget. Owners generally approve the budget at the annual general meeting, with each owner contributing their required share.
Step 4: Hold the Money Separately
Levies are held in the sinking fund or capital works fund, separate from the administrative fund used for day-to-day expenses.
Step 5: Review the Forecast Regularly
The forecast should be reviewed as works are completed or costs change. Levies can then be adjusted to help keep the fund on track for future capital expenses.
How Many Sinking Funds Should a Body Corporate Have?
There is no ‘preferred’ number of sinking funds that a body corporate should create. It’s essential that you have at least one fund to cover capital and repayment expenses for the upcoming financial year. On the other hand, too many sinking funds can make managing your monthly budget difficult and saving money required for larger outlays.
Legislation mandates considering major capital spending when planning financial forecasts for both the current year and the following nine years.
Often, the number of sinking funds can depend on the size of the property and the predicted expenses for maintenance, future projects, insurance premium changes, debt repayments, regulatory obligations and so on.
What are the Types of Sinking Fund Accounts?
Body corporates usually keep the sinking fund in a bank account held in the body corporate’s name, separate from the administrative fund. Many choose an account that earns interest but still lets them withdraw money when works fall due, such as a high-interest savings account.
The Advantages of Sinking Funds
Let’s discuss the upside of sinking funds for property owners and body corporates.
Financial Buffer for Unexpected Expenses
A sinking fund can act as a financial buffer for unexpected costs, such as insurance premiums, abrupt repairs, or unexpected repairs. Instead of being caught off guard by these expenses, you can plan ahead, and set aside a small sum over time, mitigating the financial impact when these costs do arise.
Spread Out Expenses Over Time
Furthermore, a sinking fund helps to spread out substantial purchases and long-term expenses over a given period. By regularly contributing a certain amount to your sinking fund, you can accumulate the needed sum without bearing the burden of a hefty one-time payment.
Avoiding Credit & Loans
A sinking fund also serves as an alternative to credit card usage or loans, which are often the first choice for sudden, large expenses. With a well-managed sinking fund in place, you can ensure you have enough money to avoid potential debts and the accompanying interest payments.
Generating Interest
Placing your sinking fund into a traditional or high-yield savings account can also generate a return on your savings. As your fund grows, the accruing interest can help you achieve your monetary goals faster.
Prevent Impulsive Outlays
Finally, having a set plan and purpose for your funds can reduce impulsive spending. When large expenses are expected, and savings are set aside for these costs, it prompts mindful spending habits, saving you from unnecessary and costly purchases.
The Potential Drawbacks of Sinking Funds
Managing sinking funds isn’t always plain sailing. Although they offer many benefits, a community management company or owners’ corporation needs to be mindful of potential stumbling blocks.
Let’s look into some of the drawbacks:
Strata levies spent on debts
While sinking funds are designed for capital expenditures and improvements, they can sometimes be diverted to cover body corporate expenses, such as debts, which can detract from the overall quality and value of the property.
Legal action to recover unpaid levies
If strata levies aren’t paid on time, the body corporate committee may need to pursue legal action to recover the unpaid levy, which can result in the sinking fund falling short. This can create tension and potential conflict within the corporation.
Budgeting complexities
Forecasting future outgoings accurately is challenging, especially when predicting maintenance expenses. There’s the challenge of predicting maintenance requirements, planned projects, changes in insurance premiums, and regulatory obligations. Misjudgments can lead to financial shortfalls.
Underestimation of maintenance costs
Substantial expenses like air conditioning, elevators, interior lighting, and hydraulic pumps can easily be underestimated or overlooked, skewing the sinking fund’s budget.
Chances to increase costs
If maintenance activities are left to luck rather than planned systematically, it could lead to substantial cost increases and higher levies.
Are sinking fund levies tax deductible?
If you rent out your property, regular levies you pay to the body corporate’s administrative fund or general sinking fund are tax deductible. A special levy raised to pay for a particular capital improvement isn’t deductible, but you may be able to claim a capital works deduction once the work is finished. For more detail, read our article on the tax deduction potential of strata rates.
Key Takeaways
As a property owner or member of a body corporate in Australia, managing your financial resources effectively is crucial for your property’s maintenance and overall state.
- A sinking fund is a financial safety net predominantly used by body corporates to tackle significant or unplanned property expenses.
- Creating a sinking fund requires careful planning, from the determination of its purpose to choosing the right financial institution to host it.
- Body corporates usually only need one sinking fund, although multiple could be beneficial for larger complexes.
- Sinking funds can be held in various types of savings accounts, each with their own benefits and drawbacks.
- The benefits of a sinking fund include serving as a financial buffer, avoiding credit, generating interest, and preventing impulsive spending.
- Drawbacks can include overspending, the risk of legal action, complex budgeting, underestimating maintenance costs, and increased costs.
A well-managed sinking fund is crucial for maintaining the financial stability of a body corporate. Organising sinking funds can be difficult, which is why seeking professional advice can help make the process flow much smoother.
