Steps of Real Estate Accounting
Anyone who decides to enter the real estate industry with the goal of investing in rental properties needs to have a professional real estate accounting system. Taking the time to set up a reliable, easy-to-follow real estate accounting process can make it easier for many real estate professionals to stay on top of their business finances, which frees up brain space to focus on growing their business. Here are some steps to follow.
1. Keep things separate
The first rule of any good real estate accounting system, this not only makes bookkeeping easier, but keeps you out of legal hot water. It’s a bad idea to commingle personal and business funds—especially if you are using (or plan to use) an LLC or other legal entity. The bank account, savings account, and credit cards should all be separate from personal finances.
Related: Do Landlords Need an LLC for Rental Property?
Also, be sure to have a primary account for travel, memberships, dues, and initial due diligence costs for investing opportunities. Tracking these expenses properly prevents the IRS from taking money it’s not entitled to.
Tips for investors with large portfolios
As you start to invest in more properties as a real estate investor, you might ask yourself, “Should I use just one bank account for all my rental properties, or one bank account per property?” When creating a real estate accounting system to manage your cash flow, setting up a bank account for each rental property works wonders.
But as you gain units, you will likely want to begin using one “management” account for simplicity. After all, you don’t want to have to deal with 40 checking accounts when you have 40 properties. However, the bookkeeping becomes a little more time-consuming, as you will still need to run the numbers separately for each property.
Dividing up hundreds (or thousands) of transactions into separate properties takes some additional work. When you get to this point, you will likely want to use a more professional bookkeeping system like QuickBooks, or even hire a professional if you aren’t comfortable using real estate accounting software on your own.
However, take note that multifamily properties are considered one property. You may have 20 units, but if that is made up of five fourplexes spread across town, you only need five accounts.
2. Track receipts
Keep every receipt, and designate which property the receipt was for. You can even write down the property and the purpose on the receipt. This is not only helpful for deducting the right amount at tax time—and proving to the IRS that you are legit—but it will keep you financially organized.
When you first start, the most important habit is to track and categorize everything, even if it’s through a simple spreadsheet. This builds a firm foundation to expand upon when you choose to get more advanced. You can do this by hand or using Excel or Google Docs. As your business grows, you may consider real estate accounting software.
Related:
All receipts over $75 should be kept per IRS standards—however, receipts do not need to be kept in a hard-copy format. Take a photo of the receipt and recycle the paper.
There are two categories we always recommend keeping receipts for, even if the amount is less than $75:
- Meals and entertainment
- Travel
These two categories are commonly examined during IRS reviews and audits.
3. Itemize income and expenses
The key to mastering real estate business accounting is knowing that every dollar that flows in or out of your business must be categorized and tracked. This is when the aforementioned receipts come in handy. Keep real estate software designed to manage accounting updated as income is received or bills are paid, and make sure you’re using the correct debit or credit card for each property’s expenses.
If you are using a spreadsheet, you may decide to wait until the end of the month to categorize each item—but don’t wait too long. The longer you wait to categorize the dollars going in and out of your business, the greater the chance of error. This is the benefit of itemizing your rental income and expenses on a regular basis, which is much easier to do with professional software, such as QuickBooks or Xero (more on these later). As you gain more properties, you may even consider hiring a real estate accountant.
When itemizing the income and expenses, it’s best to categorize them in the same categories that the IRS lists on Schedule E, the form you’ll need to fill out each year at tax time. The expense categories that the IRS defines are:
- Advertising
- Auto and travel expenses
- Cleaning and maintenance
- Commissions
- Insurance
- Legal and other professional fees
- Management fees
- Mortgage interest paid to banks, etc.
- Other interest
- Repairs
- Supplies
- Taxes
- Utilities
- Depreciation expense or depletion (at BiggerPockets, we call this capital improvements)
- Other
Typically, finances are tracked on a monthly basis—e.g., Jan. 1 through Jan. 31, and Feb. 1 through Feb. 28. If you are using a spreadsheet, you can simply list the above categories on the left-hand side of the screen and make one column for each month.
4. Reconcile with your bank
Compare what should be to what actually is. Again, real estate accounting aims to make the numbers line up perfectly—or “reconcile”—between your bookkeeping and bank account statement.
The purpose of bank reconciliation is to double-check everything to make sure your books are accurate. Sometimes banks or businesses mess up, and you’ll be charged for things you didn’t buy. You could also get double-charged.
When reconciling with your bank, pay attention to the starting and ending balances of your bank account, which should match your own books. If you started with $1,000 in your account and you received $800 and spent $700, you should be left with $1,100 in your account at the end of the month (because you “made” an extra $100 during the month). This is an incredibly simple example, but the same concept applies no matter the size of your business operations.
5. Create accurate reports
Lastly, after entering all this data for the property, you now will be able to generate reports on the success of your property. With professional software, this can be as simple as clicking a button. If you are doing the books by hand, though, you will be slightly limited in the kinds of reports you can generate.
The most common report is a profit-loss statement, which shows all the property’s income streams, expenses, and cash flow statements. If you are bookkeeping in a spreadsheet, you essentially create the profit-loss statement each month while entering the income and expenses.
These statements provide an accurate snapshot of how your business is running. Want to know how much cash flow your real estate businesses generated in the past month? You can find that out easily. Perhaps you’re interested in a graph of your expenses over the past three years? A report can show you that trend. Again, unless you’re a pro with spreadsheets, this will be much easier to do using software.
Real estate bookkeeping can seem overwhelming at first, but real estate accounting practices quickly become routine. If you don’t feel comfortable doing it or don’t have the time, consider hiring a bookkeeper to help you make sense of everything.
You may also want to sit down with the CPA who will be doing your taxes and have them explain exactly how they want you to do the books to make their job easier. (Plus, organizing your finances however they prefer may make their services cheaper come tax time.)
