Business Management

Accounting Practices for LLCs: What Every Real Estate Investor Should Know

Expertise: Business Management, Landlording & Rental Properties, Personal Finance, Personal Development
65 Articles Written
Portrait of a concentrated Asian accountant at her workplace using her calculator. Concept of accounting in business.

Disclaimer: This article does not constitute legal advice. As always, consult your CPA or accountant before implementing any tax strategies to ensure that these methods fit with your particular situation.

In the forums we always see both new and experienced investors inquiring about entity structuring. Should they use LLCs, and if so, should they use multiple LLCs? The end goal is usually liability protection and anonymity, the latter of course being difficult to achieve.

I tend to find it somewhat disturbing that investors will go through the hassle of setting up an LLC to legitimize their business and protect their personal assets, yet they fail to invest time in learning how to operate the LLC. A lawyer that I refer my clients to told me that, "A key reason LLCs' asset protection veils are pierced is because the owner doesn't treat the LLC like a business entity."

There are several important aspects of treating an LLC like a business entity; however, today I am going to address only one: accounting.

What new (and sometimes experienced) investors don’t realize is that there are specific sets of journal entries that must be recorded when you move an asset into an LLC or purchase an asset via your LLC. There are also journal entries that deal with moving cash in and out of your LLC that are critical to maintain that entity’s status.

If you do not have the discipline to learn these accounting entries (or hire it out), then please do not waste the time and money in setting an LLC up. Without the proper accounting, your LLC is nothing more than an extension of your personal finances, which is always in reach of litigation.

Accounting 101

Before we jump into the specific transactions, I need to provide you with a high level “Accounting 101” course.

The golden equation is:

Assets (A) = Liabilities (L) + Equity (E)

When this equation rings true, you have effectively “balanced your books.”

A journal entry is how transactions are recorded in accounting. A journal entry consists of an equal debit and credit. You will book assets and transactions and will even make adjusting entries with journal entries. Journal entries are the lifeblood of accounting and the backbone to your understanding of how transactions are accounted for on your books.

Why am I teaching you about journal entries? Technically, every transaction ever has been recorded with a journal entry. Software programs make it easy to do, and all the journal entries occur behind the scenes. So, two reasons for teaching you this are: (1) it’s important to have a basic understand of what happens when you have a transaction, and (2) sometimes software programs will mess up, and you need to ensure the journal entries the program records are accurate.

Debits increase asset and expense accounts. Debits decrease liability and revenue accounts. On the other hand, credits increase liability and revenue accounts and decrease asset and expense accounts.

Have you ever wondered why your cards are called “debit” and “credit” cards? When you use a debit card, you will immediately debit an expense account and credit a cash account, which is fancy talk for increasing your expenses and decreasing your cash.

When you use a credit card, you debit an expense account, but credit a liability account. By purchasing something on credit, you have increased your liabilities (a credit), and your cash remains untouched. Accounting is all around us folks; it makes the world turn!

For future reference, Dr = debit and Cr = credit. Let’s look at examples below.

A typical journal entry for a sales transaction in which you receive cash may look like this:

Dr: Cash               $20,000

Cr: Sales               $20,000

The transaction above increases your cash account and increases your sales (revenue) account. Cash is considered an asset, while revenue is part of your equity accounts. Because both accounts are increasing (revenue increases equity), our golden equation A = L + E remains true because both A and E are increasing. Notice that a debit is increasing our asset account and a credit is increasing our equity account.

A typical journal entry for a purchase transaction in which you paid cash may look like this:

Dr: Supplies Expense      $1,000

Cr: Cash                                $1,000

The transaction above will be seen when we book expenses. Expense accounts are part of equity accounts, while cash is an asset account. Because our expense account is being debited, it is increasing. When an expense account is increasing, our overall equity account is decreasing.

So, for our golden equation to remain true, we must see a similar decrease in an asset account OR an increase in a liability account. In this case, our equity and our assets are decreasing at the same rate.

Pro Tip: Equity can be tough to wrap your head around. Just remember that a debit increases expenses, and a credit increases revenues. Expenses decrease your overall equity, while revenues increase it. When we decrease equity, we need to see a decrease in assets or increase in liabilities. When we increase revenue, we need to see an increase in assets or a decrease in liabilities.

A typical journal entry for a purchase transaction in which you pay with a credit card may look like this:

Dr: Supplies Expense      $1,000

Cr: Payables                       $1,000

In this transaction, we’ve purchased supplies “on account,” meaning we were extended credit to purchase the supplies. This journal entry occurs every time you use a credit card. Again, our golden equation is still intact because our equity account is decreasing and our liability account is increasing (credits increase liabilities), so A = L + E remains true.

Whew, hopefully you don’t have a headache. Let’s move on to the cool stuff.

Purchasing an Asset and Transferring It to the LLC

Alright, so you’ve purchased an asset in your personal name, whether it be a property, vehicle, equipment, etc. and you want that asset to be transferred into your LLC. How will you account for such a transaction?

Related: Do I Need an LLC for My Real Estate, and How Will That Impact Taxes?

Well, first we need to understand that we are going to be updating the entity's books, not your personal books. So in the eyes of the entity, we need to record the asset coming in and also how the asset was contributed to the LLC (owner contribution vs. mortgage or notes).

If transferring property into an LLC, the LLC will increase (debit) asset accounts called “Buildings” and “Land.” At the same time, in order to keep our golden formula in balance, the LLC will need to increase (credit) liabilities and/or an equity account. The liability and equity accounts most commonly used are “Notes Payable” and “Owner Contributions,” respectively.

Here’s an example of transferring a $100,000 property with a $70,000 note to your LLC:

Dr: Building                                         $80,000

Dr: Land                                               $20,000

Cr: Notes Payable                            $70,000

Cr: Owner Contributions               $30,000

If nothing else were on the LLC’s books, assets would be $100K, liabilities $70K, and equity $30K. Therefore, our golden equation balances: $100K = $70K + $30K.

Purchasing an Asset Through the LLC

This becomes a bit trickier from an accounting perspective, mainly because the LLC will likely pay some amount of cash at closing. The question is, how much cash and where did the cash come from? Assuming this LLC was formed a day before closing, we need to first transfer cash into the LLC, then purchase the building through the LLC.

Funding the LLC with cash:

Dr: Cash                                               $30,000

Cr: Owner Contributions               $30,000

We now have assets of $30,000 and equity of $30,000. We are balanced. Now let’s buy the asset:

Dr: Building                                         $80,000

Dr: Land                                               $20,000

Cr: Notes Payable                            $70,000

Cr: Cash                                                $30,000

It’s essentially the same as transferring a building into the LLC; however, when purchasing through the LLC, we just need to account for the cash movement. Notice though that our golden equation still balances. Our assets are $100K since we’ve increased our building and land accounts but decreased our cash, our liabilities are now $70K, and our equity remains at $30K, as it was unchanged during the actual purchase transaction since we credited cash instead.

So, $100K = $70K + $30K. Pretty cool, huh?

Moving Cash to Other Entities

This can cause accounting nightmares, so prior to moving cash between entities, make 100 percent sure you understand journal entries or hire an accountant. Poor accounting in this area exposes liability risk in the event of litigation. Proceed with caution.

Let’s say LLC B needs cash and LLC A has the cash available. LLCs A and B are not related, meaning one does not have any ownership stake in the other. To account for a cash transaction, we will use “Due To/From” accounts. The “Due To” account is a liability account, as it basically means the entity owes another entity or person. The “Due From” account is an asset account, as it means that the entity is owed money from some other entity or person.

So, LLC A sends over (does NOT loan) money to LLC B. The transaction looks like this on LLC A's books:

Dr: Due From LLC B          $20,000

Cr: Cash                                $20,000

On LLC B’s books, the journal entry looks like this:

Dr: Cash                               $20,000

Cr: Due To LLC A               $20,000

As the cash extension is paid back, you simply reverse the transactions on each of the entity’s books.

What if you want to move cash from a parent LLC to a sub LLC? Assuming LLC B still needs money from LLC A, here’s what the journal entry looks like on LLC A’s books:

Dr: Investment in Sub – LLC B     $20,000

Cr: Cash                                                $20,000

And on LLC B’s books:

Dr: Cash                                               $20,000

Cr: Owner Contribution – LLC A $20,000

Owner Contributions and Distributions

Every entity needs to be appropriately capitalized; otherwise, you are exposing your personal assets to undue risk. What business the entity engages in determines how it should be capitalized. As a general rule, as yourself, “How much money will my entity need in its bank account to fund transactions?”

Whatever the answer, that’s how much you need to initially deposit into your entity’s bank account.

You don’t want to transfer money from your personal bank account into the entity’s bank account every other day, or it will look as if you have not appropriately capitalized the entity, which exposes your personal assets to liability in the event the corporate veil is pierced.

What the journal entry looks like:

Dr: Cash                                               $5,000

Cr: Owner Contribution                 $5,000

Now the entity has cash (asset) and has increased its equity account to account for that inflow of cash.

Everyone also always asks, “How do I pay myself?”

I’m about to show you the journal entry that describes how to book an owner distribution. But before I do, I need to insert a caveat: Do not take owner distributions more than once every two weeks while you are growing. Once you’ve stabilized, reduce the distributions to once a month. Once you’ve transitioned out of growth and into a maintenance phase, take owner distributions once a quarter.

The reason for the above caveat is to reduce the risk of your owner distributions being classified as “co-mingling personal and business expenses.” Co-mingling is a great way to involve all of your personal assets in a lawsuit caused by your LLC. Don’t do it!

What the journal entry looks like:

Dr: Owner Distributions                                $5,000

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Cr: Cash                                                $5,000

Now the entity has paid its owner cash, resulting in a decrease of assets and a decrease in equity.

Summary

Phew. That was a long article. There’s a ton of good information in there, and it may be tough to digest. Recognize the importance of your entity’s accounting, though. It’s imperative that it’s done correctly; otherwise, all that hard work and expense that went into setting up your entity is all for naught.

This stuff can be confusing, so either read back over it a few times, take a training or two, or talk to your accountant. It needs to be done, and it needs to be done correctly.

Disclaimer: This article does not constitute legal advice. As always, consult your CPA or accountant before implementing any tax strategies to ensure that these methods fit with your particular situation.

Do you invest using an LLC? Any questions about the accounting practices involved?

Leave all your comments and questions below!

Brandon Hall is a CPA and owner of The Real Estate CPA. Brandon assists investors with Tax Strategy through customized planning and
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    Rick C. Rental Property Investor from Collingswood, NJ
    Replied almost 5 years ago
    Hi Brandon – Thanks again for another very informative article! I have a question regarding the below quote. “Every entity needs to be appropriately capitalized; otherwise, you are exposing your personal assets to undue risk.” Most of the investments into my LLCs are done from the margin on my personal brokerage account. Since the margin charges interest, I like to only transfer it into each LLC on an on demand basis. Usually that is every few months for my buy and hold LLC (when I am purchasing a property) or every few weeks for my rehab LLC (when bills come due for materials and labor). The rest of my assets are tied up in stocks and real estate, so I normally have very little hard cash on hand. That should eventually change as I cash out refi my buy and hold properties and sell my rehabbed property, but for now, that is the situation. Given those constraints, what would you recommend I do to prevent the corporate veil from being pierced?
    Brandon Hall CPA from Raleigh, NC
    Replied almost 5 years ago
    Hey Rick – great question. It may be a good idea to consult with an attorney in your state as you have an inherently more complicated scenario than most. When you appropriately capitalize your entities, the capital will meet the future financial needs and give the entity the ability to pay debts as they come due. You want to avoid the following: “A court may pierce the LLC’s veil of limited liability when it finds either of the following factors: The LLC had seriously inadequate capitalization, did not recognize a separation between the personal business of the members and the LLC’s business, or operated as its members’ alter ego.”
    Jeff D. Real Estate Investor from Portland, Oregon
    Replied 8 months ago
    ...just a little further clarification on this please. Is the “capitalization” mainly the start up money used to open up the biz checking account and pay for all the initial biz expenses in say month 1 or 2? Or is it capitalization all along the way? For example, say you fund a property mgmt biz with $10,000 up front and biz courts consider that sufficiently capitalized. But then say throughout year 2,3,4, etc you are only typically having say $1000 average in your biz account? (Except during the first week surge of each month when rents come in, immediately followed a big drop back down after bills get paid). Would courts consider that being under capitilized? Or is it just the initial owner funding they care about most?
    Russell Brazil Real Estate Agent from Rockville, MD
    Replied almost 5 years ago
    I hold my properties in my name, which is good since I pay so many bills out of the wrong account. If I had an llc, it would be pierced in 30 seconds.
    Brandon Hall CPA from Raleigh, NC
    Replied almost 5 years ago
    Admittance is the first step 🙂
    Tammy Parsons Investor from Akron, Ohio
    Replied almost 5 years ago
    Excellent article! I see I wasn’t the only one wondering how to correctly capitalize the LLC and how to pay yourself out of it. Question, at what point do you hire a CPA? For those of us that are new to this game and have not made much $$$, at what point is having a CPA necessary? I am by no means a genius (or a CPA for that matter) at keeping my books, I’m good with the Dr’s and Cr’s even though sometimes I need to pull out my Accounting 101 book to remind myself what goes where.
    Evgenii Puchkaryov
    Replied 8 months ago
    I may be missing something basic as this all sounds very counter-intuitive. First, A = L + E makes me think - how on earth my assets can be made of my liabilities? But if I turn it around, E = A - L, then suddenly it makes perfect sense - that's how I figure out my equity. Then comes "debit" and "credit". In my bank account, debit is negative, and credit is something I get, a positive. But when recording a sales transaction, why now the cash account change is recorded as debit, while it's positive? And I don't even have such thing as a "sales account". So, even after reading through these examples multiple times, it still makes no sense. The "Pro Tip" paragraph was the only one easily understandable. Maybe I am a pro :)
    Peter Philando Rental Property Investor from Hollywood, FL
    Replied 6 days ago
    Debit cards are named as such because its from the point of view of the bank's books .... not the books of the person using the card. The cash in the bank are depositor's money and as such a liability to the bank (they must give it back). When you use a debit card, you're basically withdrawing your cash and thus debiting or reducing the bank's liability. Credit cards are named as such because the bank it extending credit to the holder in the form of a card ..... they were not made out of plastic at the beginning.
    Dan V. Accountant from Norfolk, VA
    Replied 7 months ago
    The debit and credit in the bank statement is the exact opposite of how your accounting entry should affect your cash account. So do not compare the report from bank with the entries mentioned here. Basically, there are 5 major types of accounts, those are Asset, Liability, Equity, Income, and Expenses. Asset and Expenses are "normal debit balance accounts" which means you will debit the account to increase it and credit to decrease. Liability, Equity and Income accounts are "normal credit balance accounts" therefore you will credit the account to increase and debit to decrease. Hope that helps!
    Ron Trinh Accountant from San Diego, CA
    Replied 8 months ago
    In accounting, debit generally means "left" and credit generally means "right." Banks loosely use those terms to generally mean "minus" for debit and "plus" for credit. These are two different concepts. When a bank debits something, the bank is typically showing cash being taken away. However, on the books for accounting, that same transaction would show a "credit" to cash to show cash is decreasing and vice versa.
    Brendan Vaughan from Los Angeles, CA
    Replied 8 months ago
    Thank you so much for spending the time to write this out. I will definitely be hiring a CPA but it is so important to have an understanding of how this works.
    J.D. Madill
    Replied 8 months ago
    Brandon, good article. Something I never see anyone talk about is state Franchise and Excise tax. As that tax is charged on property of the business and for anyone purposely buying and holding we will have a large amount of property in the books that are subject to F&E tax. I know there are multiple opinions and maybe there is not a “best” answer, but do you have any comments in this regard? I know you can choose to be a disregarded entity and avoid F&E tax but then you forfeit the liability protection an LLC creates. My personal philosophy is that the properties will be very well ensured. - property insurance - enforce renters to have insurance - business has liability insurance - personal umbrella policies F&E tax can add up quick. 3-4 held properties may cost you $1500-$2000/yr in additional taxes. - those are numbers that no one takes into consideration for cash flow but is a tax you must pay even if your income statement shows a loss on the year... Would love to have your opinion. Thanks.
    Don Ireland from Holts Summit, Missouri
    Replied 8 months ago
    One of your examples was using s debit card. You said that would debit an expense account and credit the cash account. Isn't a checking account considered an Asset (similar to cash)? So if i use my debit card to move $100 from checking to cash, aren't I debiting the checking account (an ASSET) and crediting the cash account?
    Dan V. Accountant from Norfolk, VA
    Replied 7 months ago
    The entry for debit card transaction is always Cr. Cash in bank and the entry for credit card transaction is always Cr. Credit card liability. The Dr. side depends on the transaction it could be an asset (ie. purchased an equipment), liability (ie. paid another credit card) or expense account (ie. paying billsl. In your question, if you withdraw cash using your debit card the entry will be Dr. Cash on hand or Petty cash, Cr. Cash in bank.
    Lanash Latheef
    Replied 8 months ago
    Thanks for this really eye-opening article for newbies.
    Navid A. Rental Property Investor from Fayetteville, NC
    Replied 8 months ago
    This article has great information but the language used isn't friendly to those who don't have a background in accounting
    Steve B. Investor from Centralia, IL
    Replied 7 months ago
    Brandon, Thanks for your post, very helpful. Also, confirms why I hired a CPA, lol.
    Tristan Gale
    Replied about 2 months ago
    Great article. Very informative. Never get to geek out over entries, and this article sure feeds the need. Was curious about your opinion... In your article the LLC holds title, how would you account for a property management LLC paying debt service on behalf of the property's owners when it doesn't hold title, also the property's owners are also the property management owners? Debit to equity? Receivable that can be periodically cleared out to equity? Would you treat property improvement expenditure (capex) on behalf of the property owner in a similar manner? Appreciate your time and insight!