A.5.7.4.1 Capital Costs vs. Operating Expense

A. A key principle of both financial accounting and planning for future capital costs is a clear, and consistently applied distinction between items that are operating expense, and those that are capital costs. While most work on building or site components is clearly one or the other, many work items may be classified as either expense or capital depending on the Borrower’s policy. This policy should be in writing and remain constant until amended in writing. Thus, for example, replacement of roofs, windows, siding, and similar items on a building is always a capital cost and should be included in planning for future capital needs. Meanwhile cleaning windows, changing air filters, cleaning or repairing carpets, and similar tasks are always operating and maintenance costs. By contrast, repainting, re-carpeting, and similar renovation of unit interiors at turnover or at standard time intervals may be treated as either operating expenses or capital costs at the Borrower’s discretion.

B. The Lender must determine that the Borrower’s written policy defining capital costs and operating expense is consistent with HUD’s Asset Management Handbook 4350.1, Chapter 4, Section 4.1 through Section 4.3 and that all repair or replacement of components defined as capital costs are included in the CNA by identifying them as components and recommending an alternative. The Lender must ensure that any items (e.g., carpet, interior painting) not identified as components (i.e., not listed among components on the components tab) in the CNA e-Tool are accounted for in operating expenses (i.e. if carpets exist and are not listed among components, then carpet repair and replacement must be budgeted as an operating expense). The Lender must compare the maintenance costs reported in the prior three years of project operating history to the repairs and replacements described as future costs in the reserve for replacement schedule. Costs omitted from the schedule should appear in the maintenance history.