Superficially, real estate accounting is no different from any other form of accounting. But upon closer inspection, real estate accounting is potentially much more high stakes.
- Large sums of money are often involved in transactions.
- There are many rules, changes to keep track of, and regulatory bodies to report to.
- Bookkeeping is indispensable to maximizing profit.
Tax benefits are one of the main appeals of real estate investment. From 1031 Exchanges to the 20% QBI deduction, making use of tax benefits requires careful bookkeeping, which is the aspect of accounting focused on keeping up-to-date records. In some cases, failing to keep accurate records could compromise your ability to make use of a tax benefit, and cost you a lot of money, and ruin years of planning.
Here’s what you need to know about real estate accounting.
What are the basics of real estate accounting?
Evaluating expenses and spending
You want to keep your expenses as low as possible. For this reason, regularly revisiting your bills, expense records, investment strategy, and current regulations is important. You also want to reduce your exposure to surprising liabilities and discover new ways of limiting the likelihood of vacancies. A penny saved is a penny earned, after all!
Maximizing your business revenue
Some real estate investors mistakenly believe that the point of sale is the primary place where revenue can be increased, but that’s simply not true. When appropriate, you can increase rent. Just remember to do your due diligence!
- How to Raise the Rent (Without Losing Tenants)?
- Should I Raise the Rent on a Good Tenant?
- SFR Home Property Management 101: Seven Steps to Raising Your Tenant's Rent
- 6 Dos and Don’ts for Increasing the Price of Your Rental
Minimizing your business debts
Minimizing your debts can take many forms, from refinancing to snowballing income to pay off a mortgage entirely. If you’re refinancing, you may also want to consider the buy, rehab, rent, refinance, repeat (BRRR) investment strategy.
What are some considerations when practicing real estate accounting?
Avoid commingling your business and personal accounts
In real estate, commingling is when you pool money from multiple investors along with personal funds and/or other people's money. Commingling is not necessarily good or bad. For example, when it comes to REITs or crowdfunding, commingling is perfectly okay. But when it comes to investing in real estate with a self-directed IRA or making personal purchases using business funds, then commingling is bad and potentially illegal.
Follow these best practices.
- Document all the transactions between your business and personal accounts.
- Don’t make personal payments using your business account.
- Consider separate bank accounts for each investment property.
- Consider keeping investment funds in dedicated escrow or trust accounts managed by a third-party.
- If you’re investing in real estate with others, there’s a good chance your investment will be considered a security. That means you’ll have to follow the rules of the Securities and Exchange Commission (SEC). You may want to consider picking a legal entity for your real estate investment if this is the case.
Choose an accounting method
You have two options for how to do your accounting. The IRS will know which method you choose based on your first business tax return. If you decide to switch methods, you’ll need to register the change with the IRS.
This is the easier route. You use one entry for your income and one for your expenses, and you make your notations as payments are received and made.
Accrual accounting follows the matching principle, which encourages matching revenues to expenses when a transaction occurs rather than when a payment is made or received.
By combining current cash inflows and outflows with future cash inflows and outflows, investors get a more accurate picture of their finances. The accrual method is more accurate, but its increased complexity makes it pricier to implement.
A chart of accounts lists every single real estate transaction. Ideally, it’s updated every time a transaction is made, along with relevant information. It can serve multiple purposes.
- Make reports.
- Measure business growth.
- Keep a history of your transaction.
Compare your bank account and financial documents monthly
At least once a month, you should compare your chart of accounts to all the transactions in your bank accounts and organize your financial documents. You’ll need a system of organizing the following documents.
- Invoices and receipts.
- Bank and credit card statements.
- Tax returns.
- Insurance information.
- Contracts and leases.
Consider professional accounting
You’ll still have to participate in the process of collecting and organizing documents, but using a CPA or professional bookkeeper with experience in real estate investment can take a load off your shoulders and maximize your return on investment.
Accounting is indispensable to success in real estate investment. With bad accounting, you risk having years of strategizing and planning not pay off in greater gains because you failed to adequately meet deadlines, track activity, and follow the letter of the law. Taking care of all this for you is just one of the day-to-day frustrations a property manager can spare you from!