How To Survive an Audit: Best Practices for Real Estate Investors

An audit is anyone’s nightmare, but audits involving real estate can be especially complex due to all the moving parts. If you are a real estate investor—especially if you have invested in multiple properties—you would be wise to implement business practices from the get-go that make your finances easy to understand and comply with your state regulations. Managing your business well and being prepared will ensure you are audit-ready at any time.

Generally speaking, an audit is a review of a business’s documentation and records to ensure that all actions and practices comply with state regulations. Based on your licensing and business structure, you may be subject to a variety of audits including a Broker Audit, Department of Real Estate Audit, or a Housing Audit.

Depending on where your properties are located, you may be subject to a routine audit or be required to provide monthly reports. If you are operating in a state without a designated audit schedule, the IRS can still request an audit of your financial records and business documentation at any time.

How To Make Sure You’re Ready for an Audit

Being ready for an audit at any time will not only ensure your accounting and business practices are compliant with state regulations, but will also make the audit process faster and easier should you be subject to one. Being prepared will reduce your financial and legal risks, saving you time and money and protecting your reputation.

There are a few steps you can take in regard to your business practices before you are ever audited.

Consider property management software. The best businesses rely on accurate documentation and accountability routines that can easily be accessed when needed. Using robust property management software (especially if you manage more than one property) can help keep all of your most important information organized and at the ready.
Set aside time for data entry and review. It may seem time-intensive at the moment, but you’ll thank yourself in the future for taking the time to slow down and keep your records straight on a regular basis. Schedule weekly or monthly data reviews into your calendar, depending on how your business runs.
The more detail, the better. Carefully document and/or create memos when it comes to checks, invoices, and similar transactions as necessary. Attach notes to correspondence—the more detail you can reference about your finances and business practices, the better shape you’re in.
Ledgers are not the place to be creative. Consider using accounting software or property management software that has the resources you need to post transactions, upload files, manage security deposits, and anything else related to finances that you need to record.
Conduct your own in-house audit. On whatever schedule you decide, use audit checklists or conduct bank reconciliations to make sure your business practices are on track. Use the opportunity to see where you have room for improvement. Regularly review your business licenses and other documentation, and be sure to schedule reminders when re-application is due.

How To Survive an Audit

If you are audited, the first step is to make sure you understand the process and that your goals are in line with all state regulations. Your systems and protocols should complement the end goal of compliance. Auditors are looking for accuracy and accountability and will generally focus on the bookkeeping aspect of your business. Think of an audit as a tool to help your business be the best it can be for your tenants, owners, and investors.

The questions you may encounter will largely be around your accounting practices. Auditors will want to see that your business does things like:

Set up trust accounts correctly with financial institutions.
Keep separate accounting ledgers for each trust account, owner, and property.
Keep appropriate records of owner and property reserves.
Hold and return security deposits in a proper manner.
Maintain accurate data, reports, and balanced accounts.

An audit may also request information regarding business licensing, operations, property management agreements, agent and independent contractor licensing, or policies and procedures, in addition to reviewing financials. Some tips to help you through the process:

Avoid shortcuts. The process may seem long and overwhelming, but make sure you follow instructions and provide exactly what is asked of you. Avoid doing anything just to save time or in an effort to make the process quicker.
Try to capture what happened in real life. Your documents should reflect events as they occurred. For example, recreate bulk deposits using an undeposited funds ledger or a bulk deposit tool to mirror what happened at the bank level.
Transparency is key. Not only do auditors want to see accurate and detailed records of your business, but your owners and investors deserve the same. Total transparency will dismantle any question about mismanagement, commingling, or fraud.
Get help if you need it. Audit or not, invest in the time it takes to keep an accurate record of your business and accounting practices. Consider hiring a bookkeeper, personal accountant, office assistant, or even an intern to help you delegate tasks to others.

The end goal of an audit is to make sure your business is in compliance to benefit those you serve, which shouldn’t be too far off from your own business goals. For more information, the best resource to reach out to is your state real estate board or commission, who will have more information on the audit process and requirements.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.