It is essential to understand the principles of real estate accounting in order to own and operate rental properties. Accountancy is probably the least favorite task for most investors, but keeping accurate records of income, expenses, and tax deductions can help increase property profits.
The most important takeaways
- Real estate accounting and bookkeeping are two distinct concepts.
- It is important to maintain good real estate accounting records so that you can improve your cash flow, keep accurate records of your income and expenses, and prepare for a tax audit.
- The foundation of a successful real estate accounting system is an organized chart of accounts, which separates business transactions from personal funds, and which keeps receipts and documents organized.
The difference between bookkeeping and accounting
Many people commonly believe that bookkeeping and accounting are the same thing, but there is actually a significant difference between the two:
A book keeping system
The creation of a chart of accounts
- Setting up a process for billing tenants for rent and posting receipts
- Maintaining accurate records of vendor payments and charging them to the appropriate account
- Keeping track of business credit and debit card automatic recurring payments.
- To ensure that a paper trail is maintained, reconcile bank statements with vendor invoices.
- The understanding of revenue and expenses from property, profits and losses on the property, as well as gains in the value of the property.
- Maximizing profits by learning how to manage money effectively.
- Auditing or analyzing financial statements with an understanding of what to look for.
- Keep records of compliance with business regulations and requirements regarding tax collections and remittances.
- The preparation of tax reports in a timely manner for quarterly and year-end tax filings and the payment of taxes on time.
Many real estate investors are pleasantly surprised to learn that many bookkeeping and property management accounting tasks can be automated. In addition to tracking income and expenses automatically, Stessa also offers personalized revenue-maximizing advice and free access to the Stessa Tax Center.
Accounting for real estate has many benefits
People generally glaze over when they hear the word “accounting” and attempt to quickly change the subject. Understanding the principles of good real estate accounting may appear unappealing, however, there are several advantages to doing so:
Enhance cash flow
When dealing with real estate investors, it is possible to increase cash flow by sending out rent statements promptly, ensuring tenants pay their rents on time, and waiting until the due date for vendors to be paid.
Keeping track of accounts payable in real estate is simplified by a good accounting system. This enables vendors to receive their payments on time or early, allowing them to collect early payment discounts. For the purpose of encouraging tenants to pay their rent on time, All three credit bureaus receive rent payments from RentTrack.
Maintaining a record of income and expenditures
Using an automated rental property accounting system such as Stessa, real estate investors are able to track income and expenses and ensure that they maximize their revenue through personalized recommendations.
Using Stessa is easy and free. Get started for free with a free account, enter the address of your rental property, and connect your bank accounts in a secure and quick manner.
Whenever your tenant pays their rent, Stessa updates your income statement. By downloading the Stessa mobile app for iOS or Android, simply scan a receipt, and Stessa will automatically categorize the expense entry for you.
Reduce the cost of outside services
Even though an automated real estate accounting system may not entirely replace the services of an accountant, it can reduce the amount of money you spend on a bookkeeper or CPA.
Upon the start of tax season on January 1st, CPAs will begin working seven days a week to prepare tax returns. The more prepared your financial statements are, the easier your tax professional’s job will be, and the less billable hours they will charge you.
You will need a backup in the event of an audit
Even though it is unlikely that a real estate investor will be audited, prevention is always better than cure. Tax audits by the IRS can take three forms:
- The IRS requested additional documentation in response to a correspondence audit.
- In-person audits conducted in taxpayers’ homes or businesses.
- IRS offices conduct office examinations.
In a good real estate accounting system, every item of income and expense is automatically accompanied by a paper trail. Providing the IRS with information will be easier for you if you are ever audited by the IRS. A real estate accounting system will allow you to defend all deductions by keeping track of documents such as invoices and receipts. You may also visit our social media page.
Performance monitoring of properties and portfolios
Keeping detailed records will also enable you to monitor both the property’s financial performance and that of the portfolio. Analyzing past performance against the current year can help investors develop strategies for maximizing revenues and increasing net cash flow:
Highlight the most successful rental properties.
- Analyze the performance of underperforming properties and decide whether to hold them or sell them.
- Calculate the annual return on cash, for example, by comparing year-over-year financial metrics.
- Create historical data on the performance of rental properties in order to facilitate the refinancing process.
Accounting for real estate: basic steps
Follow the following seven steps to set up a real estate accounting system:
1. Select an accounting method
The accounting method you use determines how transactions are recorded, and widely used accounting methods such as cash accounting and accrual accounting play a significant role in this.
When income is reported under the cash method, it is reported in the year it is received, and expense deductions are deducted in the year in which they are incurred.
Under the accrual method of accounting, all earnings are generally reported during the year of their earnings, regardless of the date of receipt. Providing the tenant with an invoice for January rent in December will result in income being received in December.
According to the accrual accounting method, expenses are accounted for in a similar manner..
It is important to note that both methods have their advantages and disadvantages. Individuals and small businesses most commonly use the cash method of accounting, according to IRS Publication 538.
2. Ensure that business and personal finances are kept separate
It is not appropriate to combine the income and expenses of a business and a personal nature. As a result, for deposits and expenses, real estate investors typically open a business checking account, as well as a debit or credit card for purchases.
Reviewing your business bank statement makes it much easier to locate a transaction since all business funds are kept in one place. Your rental property may also benefit from a business account:
- Organize your books
- Make sure your tax returns are accurate
- Enhance the management of cash flow
- Increase income and reduce expenses by identifying opportunities
According to the landlord-tenant laws in your state, it may be necessary for a landlord to keep the tenant’s security deposit in a separate bank account.
3. Establish a chart of accounts
Organizations use charts of accounts to separate income from expenses. In a chart of accounts for a rental property, assets, liabilities, equity, revenues, and expenses are generally listed.
You can create different types of accounts within each category. For example, when it comes to revenue, landlords may have separate accounts for rental income, late fees, and other rent (such as rent for pets or roommates).
It is possible to customize the chart of accounts for a rental property according to the property type and the investor’s requirements. Many real estate investors use the Schedule E of Form 1040 as the basis for their chart of accounts:
4. Analyze and itemize your income and expenditures
You should categorize and post any money flowing into or out of your real estate business to the property account. Stessa’s rental property management software automates expenses and income tracking for ease of reporting.
The appropriate account and category record income or expenses immediately following a transaction. Additionally, a good real estate accounting system provides details for each transaction, so that it is easy to understand the purpose of the transaction.
5. Reconcile accounts
Reconciliation ensures that the balance in your real estate accounting system matches the balance in the bank. Your bank should show the same beginning and ending balance as your accounting system. As a result of delays in posting transactions, accounting errors, or bank errors, there may be gaps in the transactions during reconciliation.
6. Keep documents organized
Each entry on the chart of accounts should be accompanied by a backup or supporting document.
Landlords must keep track of the following documents for their rental properties:
- Leases and purchase agreements
- Documents relating to mortgages
- Contract with a vendor
- Statements of accounts
- Receipts and invoices
- Statements of credit cards
- Information on insurance
- Statements of property taxes
- Regulations, declarations, and rules of the HOA
- Returns of taxes
Instead of keeping hard copies of documents, most rental property owners scan and upload them to a secure, cloud-based storage system.
You may be able to find real estate receipts, invoices, and documents in minutes instead of hours if you store them digitally.
7. Generate accurate reports
Online performance dashboards at the portfolio and property level are provided by the best real estate accounting software, as well as informative reports generated by a click of a mouse..
Rental property financial reports include the following three:
- Income statements (also known as profit and loss statements) provide information regarding revenue and expenses.
- Net cash flow measures the amount of money moving into and out of your account over a particular period of time.
- In addition to routine maintenance and repairs, capital expense reports include expenses incurred to improve or add value to a property.
Accounting software for real estate
In addition to free real estate accounting software, accountants have access to a wide range of accounting systems. There are several top platforms for accounting for rental properties, including:
- Portfolio: Ideal for first-time real estate investors. There is a minimum monthly fee of $280.
- FreshBooks: Enhances revenue growth and returns on investment for investors. A one-year subscription begins at $108.
- Landlord Studio: Over 15 custom reports designed specifically for landlords. Monthly subscriptions begin at $5.99.
- Rental property management: It is simplified with Quicken Rental Property Manager’s owner dashboard. A one-year subscription begins at $93.59.
- Property management service: It is designed specifically for landlords who wish to manage their own properties. The monthly rate begins at $35.
- Stessa: Real estate investors have developed a smart money management software for other real estate investors. Pricing is free.
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