5 Steps to Successful Real Estate Accounting for Investing Newbies
The goal of real estate accounting—or “doing the books”—is keeping an accurate record of all the money going in and out of your business. Bookkeeping is a vital task for your real estate business, and there are several benefits to staying organized, such as freedom, legality, and profitability. When you know exactly how your business is doing at any given time, you are able to make better decisions and sleep soundly at night.
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You don’t need to be a professional accountant to keep accurate records. Just make sure to begin bookkeeping early before your business gets too big. Your future self will thank you.
Why Organized Books Are Essential for Real Estate Investors
Bookkeeping is not the game of real estate itself. It’s the scoreboard and the game film. An organized, timely, and easy-to-use real estate accounting system serves many practical purposes. It helps you:
- Track key performance measurements like cash flow, profit and loss, and net worth
- Compare your growth (or lack of growth) from year to year
- Manage your cash so that you don’t run out
- Know whether novel business strategies succeeded
- Analyze which rental properties performed best
- Prepare for yearly tax returns
- Save money on tax preparation because your CPA doesn’t bill you for time spent correctly organizing your information
- Avoid extra time and stress digging up information for an IRS audit
- Steer clear of IRS tax penalties or back taxes because you can’t defend deductions you claimed
- Pay all of your bills and financial obligations on time as agreed
- Raise capital with lenders and partners using real data from your past performance
Good books help you meet your obligations to outside parties—and make better business decisions.
A Quick Breakdown
Before diving into the five steps to successful real estate accounting, let’s cover the basic terminology. The bookkeeping system is divided into two separate buckets.
This is a paper or digital record of all financial transactions coming through your business bank account(s). With everything in one place, you can easily track every transaction by entering your bank statements into the spreadsheet and organizing them. Your spreadsheet might look something like this:
Your “Account” column categorizes each transaction with simple labels. The “Memo” column describes in more detail what the transaction is. This is handy when you have to look back over transactions months or years later. And the “Property” column is self-explanatory—for which property did you incur the expense?
The supporting documents
This paperwork proves or supports all of the financial transactions. It could be:
- A box of simple manilla folders (or free Google Drive account)
- Small, portable file boxes or other filing cabinets (if using paper)
- Separate yearly folders for expenses, bank statements, tax return documents, and insurance documents
These two systems are two sides of the same coin, working in tandem. Books without the paperwork mean an IRS auditor may never believe your claimed expenses. But if you have paperwork and no records, you’ll never have a clear, easy-to-understand summary of the financial happenings of your business.
1. Keep Things Separate
The first rule of real estate accounting is keeping your personal expenses completely separate from your business expenses. 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.
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.
Investors with large portfolios: Real estate accounting tips
As you start to invest in more properties, you might ask yourself, “Should I use just one bank account for all my rental properties or one bank account per property?” When you’re first starting out, 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. 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.
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 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 accounting software.
What records should you keep?
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
These two categories are commonly examined during IRS reviews and audits.
3. Itemize Income and Expenses
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 accounting software updated semi-daily 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 income and expenses on a regular basis, which is much easier to do with professional accounting software such as QuickBooks or Xero. As you gain more properties, you may even consider hiring an 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:
- 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 (at BiggerPockets, we call this capital improvements)
Typically, finances are tracked on a monthly basis—e.g., January 1 through January 31 and February 1 through February 28. If you are using a spreadsheet, you can simply list the above categories on the lefthand 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, the goal of real estate accounting is 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 balance 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 operation.
5. Create Accurate Reports
Lastly, after entering in all this data for the property, you now will be able to generate reports on the success of your property. With 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 is a profit-loss statement, which shows all the property’s income streams, expenses, and cash flow. 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 business 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 are a pro with spreadsheets, this will be much easier using accounting software.
Real estate bookkeeping can seem overwhelming at first, but the process quickly becomes 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.)
Easily Distracted? Don’t Feel Bad
Staying on top of your transactions is harder than it may seem. Real estate accounting can be hard, so don’t beat yourself up. Regardless of how meticulous you are, there’s no doubt that you’ll miss expenses. Here are a few tips to help minimize the amount of missed and improperly recorded transactions:
- Place some sort of indicator on your debit cards to tell you which property it belongs to—like writing the property address in Sharpie.
- Use self-checkout so that you don’t feel guilty when you check out multiple times at once. You might be buying pipes for your duplex and window sills for your multiplex. Don’t get the two confused.
- Use a smartphone application to snap photos of receipts and upload them in real-time.
- If you accidentally pay for an expense out of your personal account, simply transfer money out of the respective rental account and into your personal account. By transferring money from your rental property’s account and into your personal account, you will, in effect, see an “expense” when you reconcile your bank statements at year-end. For the transfer’s memo, input a brief description of what the expense was for.
- Remind yourself every day via a sticky note or some other indicator to keep track of transactions on an ongoing basis.
What process do you use to keep your records straight?