In order to own and manage rental property, real estate accounting is crucial. Although most investors certainly don’t enjoy doing accounting, excellent accounting helps keep property profits higher by precisely tracking income, costs, and tax deductions.
If you manage or own a rental property, you must ensure that you are proficient in real estate accounting because it is crucial to the operation of the company. Although accounting is typically the least favored duty of most people and might seem intimidating, you still need to have the necessary knowledge to ensure the success of your company.
You can make sure you keep track of all your income, expenses, and tax deductions if you have the correct accounting abilities.
While the majority of people believe that real estate brokers only interact with individuals and show houses, the work involves much more. In addition to being able to perform administrative duties, real estate brokers also need to be completely knowledgeable about the buying and selling process.
You’ll discover the foundations for taking charge of the accounting side of your real estate firm in this article. This article should have equipped you with the knowledge necessary to decide how to handle accounting in your real estate company. Utilize this information to your advantage and set your small business up for success.
How can I Learn Real Estate Accounting?
The financial duties a business owner must complete on a monthly and annual basis to keep things operating smoothly are referred to as real estate accounting. Real estate accounting is more precisely concerned with taxation issues and possible revenue generated by properties.
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To get a detailed picture of each property’s cash flow, real estate accounting entails recording income and expenses, just like any other accounting procedure. This data can be used to file tax returns, pay taxes, and get the business owner ready for an audit.
People frequently become distracted and try to change the discussion when they hear the word “accounting.” Although though accounting may not be the most fascinating subject, it has a number of significant advantages.
Improve cash flow
Real estate investors can increase cash flow by sending out rent statements as soon as feasible, encouraging renters to pay on time, and delaying paying vendors until the due date.
A solid real estate accounting system makes it easier to keep track of payables, ensuring that vendors are paid on time or ahead of schedule in order to benefit from an early payment discount. (Internet rent payment platforms like RentTrack incentivize tenants to pay the rent on time by reporting rent payments to all three credit agencies.)
Control income and expenses
Real estate investors can increase revenue with the help of individualized advice from a rental property accounting system like Stessa, which automatically tracks income and expenses.
Stessa is free and simple to use. Sign up for a free account, enter the address of your rental property, securely link your bank accounts, and see your real estate portfolio statistics come to life.
Stessa updates your income statement once a renter rent payment clears your bank account. Simply download the iOS or Android mobile app, scan a receipt, and Stessa will parse the receipt data to create a new expenditure entry that is automatically categorized for you. This will allow you to track spending while on the go.
Reduce outside expenses
While your accountant may never be totally replaced by an automated real estate accounting system, it can assist cut down on the amount you have to pay a bookkeeper or CPA in fees.
When tax season starts on January 1st, a CPA will tell you that they start working seven days a week to prepare tax returns. You can greatly simplify your tax professional’s job and cut down on the amount of billable hours they charge you by giving them financial statements that are prepared for tax purposes.
Backup for a tax audit
Even while there’s a chance a real estate investor won’t ever be audited, it’s always better to be safe than sorry. There are three different kinds of IRS tax audits that a landlord could experience:
- Correspondence audit with an IRS request for additional documentation.
- Field audits are conducted face-to-face, typically in a taxpayer’s home or business.
- Office examinations are conducted in IRS offices.
An effective real estate accounting system automatically generates a paper trail to support each claimed source of income and expense. If you are ever audited, your records will be organized neatly so you won’t have to search for the information the IRS asks. You can keep track of supporting documentation, such as invoices and receipts, by using an accounting system for real estate.
Monitor property and portfolio performance
Maintaining thorough records might also make it simpler to keep tabs on the portfolio’s and individual properties’ financial performance. Investors can develop plans to enhance revenues and boost net cash flow by comparing historical rental property performance to the present year:
- Spotlight rental properties that are performing well.
- Identify underperforming properties to help decide to hold or sell.
- Compare year-over-year financial metrics such as cash on cash return.
- Create historical property performance data to help make refinancing a rental property easier.
How do you get started with real estate accounting?
While establishing a real estate accounting system, there are seven essential stages to learn real estate accounting:
1. Choose an accounting method
Cash and accrual accounting methods are the two most used forms. Depending on the accounting style you choose, transactions are recorded differently. The cash method allows for the reporting of revenue in the tax year it is received and the deduction of costs in the tax year they are incurred.
Regardless of when the payment is received, income is typically reported under the accrual method of accounting in the tax year it is earned. For instance, money is credited in December and recorded as being due from the tenant if you give the tenant an invoice for the January rent in December.
The accrual accounting system operates similarly when it comes to expenses. Even if the cost is not paid until January, if you receive a charge for landscaping services in December, the bill is recorded as an expense in December.
Every approach has advantages and disadvantages. According to IRS Publication 538, the majority of people and many small firms employ the cash method of accounting.
2. Separate business and personal funds
Income and spending from a person’s business and personal life shouldn’t be combined. Because of this, the majority of real estate investors open a business checking account for payments and deposits as well as a debit or credit card.
It is considerably simpler to analyze your business bank statement and find a transaction because all of the funds are held in one location. Also, having a business account for a rental property can:
- Keep books organized
- Avoid inaccurate tax returns
- Improve cash flow management
- Identify opportunities to increase income and reduce expenses
A landlord might also be obliged to keep tenant security deposits in a different bank trust account, depending on your state’s landlord-tenant rules.
3. Create a chart of accounts
Income and costs are separated using a chart of accounts. Assets, liabilities, equity, revenue, and expenses are typically broken down into several divisions in a chart of accounts for a rental property.
For each category, accounts are made for various transactions. For instance, a landlord might have separate accounts for rental income, late fees, and other rent in the revenue category (such as pet or roommate rent).
Depending on the type of property and the demands of the investor, the chart of accounts for a rental property might be altered. Schedule E is a popular model for real estate investors’ charts of accounts (Form 1040).
4. Track and itemize income and expenses
You must classify and post to the property account any money that comes into or leaves your real estate business. Software for managing the finances of rental properties, like Stessa, automatically tracks revenues and expenditures and classifies them for simple reporting.
The relevant category and account are used to record the income or expense each time a transaction takes place. A robust real estate accounting system also enables the entry of transaction-specific information, making it simple to comprehend the purpose of each transaction.
5. Reconcile accounts
The procedure of reconciliation makes sure the balance of your bank account in your real estate accounting system matches what the bank displays.
Your accounting system’s beginning and ending balances should line up with those displayed by your bank. When accounts are reconciled, there might be gaps in the transactions as a result of delays in posting, mistakes in the accounting, or a bank error.
6. Keep documents organized
A backup or supporting document should be included with every income and expense transaction that is listed on the chart of accounts.
Typical rental property records that a landlord should keep track of include:
- Purchase and lease agreements
- Mortgage-related documents
- Vendor contracts
- Bank statements
- Invoices and receipts
- Credit card statements
- Insurance information
- Property tax statements
- HOA rules, regulations, and declarations
- Tax returns
Many landlords scan and upload each document to a safe, cloud-based storage system on the internet, while some investors keep hard copies. You might find paperwork faster by storing real estate receipts, bills, and records digitally rather than physically.
7. Generate accurate reports
The best real estate accounting software creates insightful reports with a single click and enables investors to see performance dashboards at the portfolio and property level online.
The following are three of the most typical financial reports for rental property:
- Income statement (also known as a profit and loss statement) focuses on revenues and expenses.
- Net cash flow reports the cash moving in and out of your account over a given period of time.
- Capital expense report tracks money used to improve or add value to a property beyond normal maintenance and repairs.
Accounting Best Practices for Real Estate Agents
It’s time to look more closely at best practices now that you are aware of the value of solid real estate accounting and what to anticipate in terms of trackable financial information.
These five factors can distinguish financially prudent real estate brokers from those who rely on jumbled-up or out-of-date records in their accounts.
Conduct a Monthly Review
Most of the administrative labor will be automated if you employ a formal accounting system. Although it saves a ton of time and is very convenient, you should still keep an eye on your accounts and check them once a month.
If you collaborate with a financial manager, the same holds true. Have a monthly meeting to go through your income and outgoing costs. This regularity enables you to pivot and find errors in your accounts without significant time lags if the numbers are out of whack.
Use Accurate Reporting Procedures
Since correct figures are necessary for proper reporting, a monthly review makes sense. You can run reports for your business accounts once you are certain that your financial data is accurate, such as:
- Profit and loss (P&L) statements
- Income statements, including rental income
- Outgoing cash flow
- Tax documents
The kind of reports you can generate with the touch of a button using manual accounting operations are limited, but using automated software, you can quickly pull, analyze, and sort data.
Separate Personal and Business Funds
Although commissions and other sources of income technically belong to you as a real estate agent, doing so can cause organizational problems. It’s a good idea to have a distinct company account so you can monitor each transaction. Then, you can establish a connection to your own account or plan automatic transfers of money across accounts.
It is simpler to connect your business’s checking and savings accounts to your accounting platform or software if you have separate checking and savings accounts for them. By doing this, you and your accountant can avoid having to complete an extra step or manual task.
Itemize All Incoming and Outgoing Transactions
Understanding how to correctly categorize your bank accounts will help you save time and effort during tax season and reduce stress. You’ll be able to finish this phase fast once you establish patterns and practice effective itemization.
Schedule E is used by the Internal Revenue Service (IRS) to specify significant business itemizations. Learn about these deductions and the other pertinent areas on this list so that you may manage your costs and sources of income effectively.
Learn Local Requirements
Real estate management is a local and regional game, so the requirements and rules change depending on where you live and work. To improve real estate accounting, one of the best pieces of advice is to start by becoming familiar with the local laws that apply to your jurisdiction.
In other words, managing your real estate accounting processes is more than just a matter of taste. You must abide by the rules set down by your county, city, or state regarding real estate revenue, including any requirements for business licenses or state taxes.
It’s important to comprehend the expectations and policies because they may affect how you decide to manage or outsource your bookkeeping needs.