The goal of bookkeeping is to have an accurate record of all the money going in and out of your business. Also known as “doing the books,” bookkeeping is a vital task in your rental property business and something that is not optional, but required. The same benefits to being organized that we talked about earlier (freedom, legality, and profitability) hold true for bookkeeping. When you know exactly how your business is doing at any given time, you are able to make better decisions and sleep more easily at night.
But don’t worry—you don’t need to be a professional accountant to have accurate records. Instead, anyone can become a successful bookkeeper by following these five simple steps.
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The 5-Step Newbie Guide to Successful Real Estate Bookkeeping
1. Keep things separate.
The first rule of bookkeeping for your real estate business is to make sure you keep your personal expenses 100 percent separate from your business expenses. Not only does this make the bookkeeping easier, but also from a legal standpoint 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. So set up a separate account for your real estate investments; this includes a separate bank account, savings account, and credit cards.
If you have multiple properties, a question that often arises is, “Should I use just one bank account for all my rental properties or one bank account per property?” Although you could do it either way, if you have fewer than five properties, we would suggest having separate bank accounts, savings accounts, and credit cards for each property. However, if you are investing in multifamily properties, all the units at one location with one loan, they are considered “one” property. So you may have 20 units, but if that is made up of five fourplexes spread across town, you only need five separate accounts.
As you gain units, you will likely want to begin using one “management” account to manage all the ins and outs of your business for simplicity. 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. When you use one checking account per property, this becomes a much easier process, but when you need to divide up hundreds (or thousands) of transactions into separate properties, it takes some additional work. When you get to this point, you will likely want to use a more professional bookkeeping system like Quickbooks.
2. Track receipts.
The second rule of bookkeeping is to keep every receipt and designate which rental the receipt was for (we like to handwrite 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 also help keep you organized as to where your money is going, and what bills were paid and
what bills were not (because trust us, businesses will bill you for things that you already paid for, and it’s up to you to catch their mistake!).
For example, when we get a bill for a carpet cleaner and pay it, we always write the check number we used to pay the bill, the date the payment was made, and the property the bill was for. Then, we place the bill in the colored folder for “receipts to process” in the file for that property. If you are using a computerized bookkeeping software, you will likely want to record this transaction immediately, maybe even using the program to print the check that goes out. If you are doing the books by hand or with a spreadsheet, you may wait until the end of the month to track these expenses properly. When you have just a few properties, doing the books by hand can be easy enough, but as you gain units, you will eventually want to upgrade to a more professional accounting software, such as QuickBooks or Xero, or you may even consider hiring a bookkeeper.
3. Itemize income and expenses.
Every dollar that flows in or out of your business must be categorized and tracked. This is when the above-mentioned receipts come in really handy. If you are doing this with a computerized accounting software, you will likely enter this information semi-daily as income is received or bills are written.
If you are using a spreadsheet, you may decide to wait until the end of the month to categorize each item, though we would caution you against waiting too long. The longer you wait to categorize the dollars going in and out of your business, the greater the chance of making a mistake or forgetting what a certain expense was. This is the benefit of itemizing your income and expenses on a regular basis, which is much easier to do with professional accounting software.
When itemizing the income and expenses, we find it 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 following is a screenshot taken directly from the 2014 Schedule E form:
As you can see, the expense categories that the IRS defines are:
- Auto and Travel Expenses
- Cleaning and Maintenance
- Legal and Other Professional Fees
- Management Fees
- Mortgage Interest Paid to Banks, etc.
- Other Interest
- Depreciation Expense or Depletion (we call this Capital Improvements)
Therefore, we try to place every expense into one of these categories.
Of course, there is the “other” category if something just doesn’t seem to fit, but we seldom use this. It’s just easier to make it fit within one of the other listed categories.
Typically, finances are tracked on a monthly basis, as in “January 1–January 31” and “February 1–February 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.
Bookkeeping is somewhat of a “game” or a “puzzle.” To win the game, your books should match perfectly with what your bank account shows for that property. We just talked all about tracking your income and your expenses for the property using either accounting software or a spreadsheet. Now it’s time to compare what should be to what is. Again, your goal is to make the numbers line up perfectly between your bookkeeping and bank account statement, a process known as “reconciling your bank account.”
The purpose of bank reconciliation is to double-check everything to make sure your books are accurate. Sometimes banks or businesses will mess up, and you’ll be charged for things you were not supposed to be charged for. For example, let’s say that you purchased insurance for 123 Main Street for $348.83. In your accounting software or spreadsheet, you recorded that $348.83 and labeled it correctly as “insurance.” But when you looked at your bank statement, you noticed TWO charges, each for $348.83. The insurance company double-charged you!
You might think this is rare, but trust us: It’s not. There is seldom a month that goes by that we don’t discover some kind of mistake that some business did to overcharge us. Because of this process of bank reconciliation, we can get on the phone with whoever is at fault and straighten everything out. Bank reconciliation can help save you a lot of money, and it can also help you know when you messed up and forgot to record something correctly (but of course, we never mess up anything).
When reconciling with your bank, you should also pay attention to the starting and ending balance of your bank account, and they should match. If you started with $1,000 in your account and you received $800 in income and $700 in expenses, you should be left with $1,100 in your account at the end of the month (because you will have “made” an extra $100 during the month). Of course, this is an incredibly simple example, but the same concept applies no matter how large of an operation you are running. This is just another way of double-checking (or triple-checking) to make sure everything is correct.
As we mentioned, bank reconciliation is a bit of a game or a puzzle, and when you “win” after double and triple-checking, it feels good! We know that sounds incredibly nerdy, but trust us: When the numbers line up perfectly, you will sleep better at night.
5. Create accurate reports.
Lastly, after entering in all this data for the property, you now will be able to generate certain reports about how well your property is running. If you are using professional accounting 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 you will be looking at is often known as a “profit-loss statement,” and it shows all the forms of income for the property, all of the expenses, and the cash flow that resulted. If you are doing your bookkeeping in a spreadsheet, you are essentially creating the profit-loss statement each month while entering the income and expenses. If you are using accounting software, you simply need to export the profit-loss report to see how things are going in your business.
The purpose of looking at these reports is to get an accurate snapshot of how your business is running over different perspectives and over time. For example, want to know how much cash flow your business generated in the past month? You can find that out easily. Want to see a graph of the expenses over the past three years? A report can show you that trend. Again, unless
you are a pro with spreadsheets, this will be much easier using accounting software. If you are not using a professional accounting software, you can simply give the spreadsheet you have been building throughout the year to your CPA, as it contains all the information they (or if you do your own taxes, you) will need.
Bookkeeping can seem overwhelming at first, but the process quickly becomes fairly 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 at the end of the year and have them explain exactly how they want you to do the books to make their job easier (and cheaper for you). The above five steps are fairly basic, but they should help you get started on the right foot. As you can see, there are a lot of different ways you can do the books, but the important thing is that they are done—and they are done correctly.
By doing so, you will realize greater freedom in your life, less stress in your work, and the increased profitability of your operation.
What process do you use to keep your records straight?