Rental Property Accounting using Quickbooks Online

19 Replies

Does anyone do their own accounting? I'm trying to set up "asset" reserve accounts for Vacancy, repair & maintenance, and cap ex. how do you do this or are you accruing your expenses? How do you save for the expenses that have not happened yet?

I do the bookkeeping but use CPA's for tax preparation. Been advised from day one to do accounting on a "cash basis". Been doing it that way for the pass 40 years.

The way yo save for expenses is to budget so much for repairs and vacancies, through a separate account, moving so many dollars into a money market fund account.

Thanks for the advice, and why were you advised on a cash basis? I too am going to do the bookkeeping and use a CPA for tax prep, I am just getting started on my first duplex and would like to know why on cash basis? Do you not accrue your property tax expenses?

The are lots of stuff written on cash vs accrual accounting. 

I spend 90% of my career in Accounting and Credit Management, including visiting clients to check their books to determine how much credit we should extend them, to the other end, calculate the amount of "bad debt reserves" required, and adjusting them when necessary if the bad debts over time is actually larger or smaller than projected.

When I visit clients, many keep two sets of books. One for reporting purposes, usually on a accrual basis. The other one is cash basis, where you see the actual cash coming and going. These companies has full time accounting staffs to handle it, unlike a small time landlord that has a full time W2 job to attend to. You must really like accounting to do two sets of books.

If you start off with one or two tenants, on a cash basis, your income is what your tenants actually paid you. For expenses, it's what you actually paid.

If I start off with, say one tenant, who pays rent of $2,500 month, on an accrual basis, I book the income regardless if he paid or not. Depending on your acumen in selecting tenants. they may or may not pay. Now, if you do accounting on an accrual basis, your not playing around, you expense you bad debts based on your estimation of how the tenants pay, and say your estimate is on the average, your bad debts is 3% or total rents on an annual basis, you picked one wrong tenant, he moves in, pay three months rent, and didn't pay the next six (actually happened to a landlord friend), which is how long it takes you to evict him. If you're a small time landlord, and you only have a handful of clients, figuring out reserve for bad debts is hit or miss at the most. Then, you wind up paying taxes on rents you never received.

For larger operations, where we have hundreds of customers, and we have experience with the type of business we're dealing with, figuring out bad debts reserves is statistically a lot easier than someone owning just six rentals. One year, when I had about 12 tenants, three of them fell behind for a few months. Then vacancy was above normal when these tenants left and I had to rehab the place Normally, I do well enough that maybe one tenant had trouble. In this bad year, had I been on an accrual basis, I have to rack my brains out and adjust the reserves, and wind up paying taxes on what was not collected. With cash accounting, I just add up all the rent checks collected, and booked, and I'm done. 

I remember when I was with the large trading company, it was a bad year, a few of our large customers didn't pay. We had grueling management meetings where they want to up the reserves, and deduct more for bad debts, considerably more. I objected, because I knew the customers, and convinced management not to expense so much. The result was we were able to report a profit for the year, not a loss, and management received bonuses. Then the following year, the customers paid in full, so it turned out they were wrong, panicked, reserved too much, and I reduced the reserves, and took the money back into income. Management was so thrilled I received a large bonus.

Now, for my real estate business do I really have to do all that? Should I spend my time juggling the hypothetical income and expenses, or is my time better spent on going around finding deals. In the last real estate crash here, I go to RE auctions every week, instead of figuring out why my accruals are all wrong. I was able to purchase properties $100,000 below market, instead of playing with reserves.

@Bruce Weyer Good question! I would recommend @Frank Chin 's advice to not get too fancy for the 1st couple of properties. Income when received and expenses when paid=cash basis. Also, one strategy would be to transfer 50% of rents to a savings account to start building up reserves.

In QuickBooks Online this reserve build up would just be marked as a transfer between accounts if you have both checking and savings linked up to bank feeds.

Thanks Josh, and Frank for your replies. currently set up sub accounts for my main checking to work on accruing some reserve funds for my duplex. I have Cap Ex. at 5% of gross monthly income, Vacancy at 8% of gross monthly income, and repair and maintenance at 8%. and the property tax I accrue monthly based on last bill. Do you think this is a good way to go about it? am I missing anything? Should I set up another reserve account for "Other" just in case unforeseen things take place? I would love to hear how you do it? Also It has been suggested to keep doing these reserves until I have about %5 of the total value in the duplex, then I should stop saving and put the money to work for me elsewhere...

I believe in the KISS principle.

I was struggling when we had a SFR in the 1980's. We decided to go into RE, we sold the SFR we lived in, and our first acquisition was a 3-plex. We lived in one unit, and rent out the other two. The way we did it, the two rents covered the mortgage, which includes the taxes, and we just about lived rent free.

We decided to pay an amount equal to rent, which back then ran $800. We deposited the tenant checks, and our contribution of $800 into what we called the rental account. Beyond the mortgage, utilities and repairs ran $200.00 so we had $600 left over every month.

Its strictly cash flow management, so we never go into Cap Ex, Vacancy, etc. For our purposes, $800 a month contribution is enough. We originally was going to do $1,000 dollars, in which case, if one tenant doesn't pay the rent, or if there's a vacancy, the cash flow covers it all.

Then we got our 2nd 3-plex, and a SFR. Back in the late 80's interest rates were high, tough to make cash flow, so we increased contributions $1,000 month, and with the small cash flow from the 2nd and 3rd properties, we cash flowed 3 years after we started at $1,300, which includes our contribution.

Then by 1993, interest rates dropped from 13% prevalent in the mid 80's to 7.5% by 1993, and I refied everything. Rents increased a bit also, so everything cash flowed about $1,500 without my putting any money in, but I still put in $1,000. I was looking for foreclosures, and one years I couldn't find something to buy. Guess I was a bit too fussy. So the $30,000 that I accumulated that year that I didn't know what to do with, so I opened up a Dean Witter account.

Now, I studied finance and I have an MBA in finance. You notice in my approach, it's all cash flow management. So Cap Ex, Vacancy rates is meaningless to me. In the mid 90's, my 2BR rents went for $1,100 market, if I find someone I like, I'll rent it for $1,000. Positive cash flow with full occupancy is $2,500/month, so if I have one vacancy, I can cover it. I can even cover two. When I opened the Dean Witter account, I had two years in a row with no vacancies.

So, bottom like, it's the KISS principle, basic CASH MANAGEMENT.

Now, as I explained to you earlier, my job in the company I worked for involves making accrual entries, so I know what it's all about, and what it doesn't do. Unfortunately, for real estate purposes, knowing CAPEX, and accruing for vacancy rates doesn't do anything for me. I rather spend my time figuring out what to do with the $30,000 I had that I couldn't find anything to buy, or spend the time looking harder for something to buy.

Oh, I almost forgot to mention, got a HELOC to cover major repairs if it came up. We used it to acquire properties instead as we had positive cash flow to cover repairs.

Thanks for the details. Yes, I understand what you are saying. I guess I just wanted to show these different reserve accounts on my balance sheet so that If I am going to get another private money loan, they lender will look at it and believe that I'm setting myself up for success instead of not accounting for what is for sure to come in the future...

I do differ from your opinion - not to track your books on accrual basis.

Here are a few reasons:

- If you do not create an invoice for tenants, then how are you tracking when they are late or how much was paid?

- How would you know their history, how often they were late. All this can be accomplished by simple reports from QB.

- If you do not enter bills when they come in, how do you know when they are due?

- If you do not track Escrows and Earnest Deposit, how would you know who is holding money for what, and the day you paid them?

Now with the construction loans, if you do not record it accurately, that is another long story....

So how would you.....?

Do you know your cash flow?

Do you know what your equity is?

I know this is not what you are asking, but I would take a look at the QB desktop version also if you are planning to buy more houses. You have to pay a very high monthly fee to be able to keep track of each property by "class" when using the online version. 

Originally posted by @Gita Faust :

I do differ from your opinion - not to track your books on accrual basis.

Here are a few reasons:

- If you do not create an invoice for tenants, then how are you tracking when they are late or how much was paid?

- How would you know their history, how often they were late. All this can be accomplished by simple reports from QB.

- If you do not enter bills when they come in, how do you know when they are due?

- If you do not track Escrows and Earnest Deposit, how would you know who is holding money for what, and the day you paid them?

Now with the construction loans, if you do not record it accurately, that is another long story....

So how would you.....?

Do you know your cash flow?

Do you know what your equity is?

I do my accounting on a cash basis. I understand the benefits of accrual accounting that you mentioned, but can easily be compensated for if I do cash accounting. Some years ago, a CPA named John Hyre who wrote a book on using QuickBooks for accounting, called "KISS Guide to Bookkeeping" where he done bookkeeping on a cash bases. He came to our real estate club meetings and I had a chance to critique his book and methods and discussed it with him.

First and foremost, tracking and follow-up for rent payments is most important for landlords. My big argument with his method in the book is he does not generate invoices, and have an AR where I can track tenant receivables and payments. He only records rent payments when received, technically cash accounting. He argued with me doing it my way is accrual accounting. He's right, but what I do at year end is do a "credit and rebill" to bring accrual accounting to match cash accounting. For instance, right now I have a tenant who's consistently one month behind, so he will have an AR with me of $2,250, because he's billed monthly. So his December rent will still be open on Jan 1, 2019. What I'll do is issue a credit of $2,250 as of 12-31-18, and rebill the Dec 2018 rent on Jan 1, 2019, calling it billing for outstanding 2018 rent. Fortunately I only have to do it occasionally, and only for one or two tenants when it happens. First time in five years I have to do it.

John argued with me credit and rebills is a bad way to do accounting. I worked in accounting departments in larger companies and these types of entries are quite common, though not used generally to adjust for accrual to cash accounting. John grudgingly agreed with me.

As to expenses, the checks for payments are cut when they come in. As common in companies I work for, if there's a cash flow issue, checks are simply held when cash comes available. No need to do accrual accounting for this reason. Nowadays, most bills are on autopay, usually paid within days of issuance, so the main task is to make sure cash is there to take care of it. My water, tax, bills are all on autopay.

Yes, there are deposit accounts, escrow accounts on the balance sheet, but these transactions does not preclude the use of cash accounting.

All and all, in prior discussions of this issue, only handling rental payments through invoicing is technically accrual accounting, But with credit and rebill, you'll wind up with what you should have on a cash basis. 

@Bruce Weyer

I think a lot of investors calculate whether they will invest in a rental property by taking into account reserves for vacancy, capital expenditures, repairs etc. 

However, most investors maintain their books via cash-basis of accounting.

You can certainly create a budget for the year(which would contain your accruals) and compare them to the actuals for the year and see what variances you had.

In regards to what the lender wants to see
They want to see your DTI is above a certain percentage
They want to see that you have enough liquid money to close on the property
non-traditional financing may want to see your assets. They will likely not factor assets such as reserve for vacancy or reserve for capital expenditures.

Also maintaining an accrual basis of accounting books can make tax return preparation difficult if the accountant does not know which expenses can not be used for tax purposes.

@Frank Chin  Keep track of your books on accrual vs cash basis is your choice. We as investors - not all are good at cash flow, are delinquent on payment or bounce their checks and have no clue what your equity on each property is. 

Because everyone teaches and stresses about making money in real estate, but not keeping track of their money.

We all talk about individuals making millions and billions like Apple, Microsoft, Amazon and they enjoy the tax savings. Well without accurate books, you cannot plan and cannot reach the goals you need. 

Analyze, Measure and Review Financials. Check your ROI on investment and loans.

Saying that keeping track of your books on Accrual basis is not wrong but will help you with projecting cash flow and make it easy to get your financials when you are looking for loans.

So for argument sake, if you had a loan on a property, 10K by Eric, 500K mortgage, 50K personal funds, how would you know what your equity is unless you record the loan in QuickBooks by Class (Property). 

We all know that Assets - Liabilities = Equity.

If you keep track on your books on a cash basis, it will show your payments (if you track your principal and interest and that also you do not expense it on Profit & Loss). Now if you keep on accrual - you will be able to track that you owe 560K on that specific property.

That is it - who knows how much money is held by other vendors such as utility deposit, taxes, insurance, escrow held at closing and the list goes on. All this goes on the Balance Sheet and has to be tracked.

So what would be the solution, you can certainly keep the books on accrual and cash at the same time. It all depends on your end goal. 

As for large companies, they would have multiple employees entering the data and they would not even realize how the books are kept. 

Gita

Hey @Gita Faust thanks so much for this post, it sounds like you are thinking the way I'm thinking. I am tracking every transaction in QB online. The only thing I am accruing is property tax, and that is a for sure expense that will be taken annually (in my case in OH, two times a year) this helps me keep my income statement as accurate as possible, and keeps my balance sheet at accurate as possible. It would be really easy to unwind the property tax accrual for each month if I wanted to look at the cash basis. 

As for the other items that I account for each month, to be a good investor, I reserve repair and maintenance of 8% of gross rental revenue, 8% for vacancy as well, and 5% for Cap Ex. but these are reserves. monthly it looks like this. 

Debit: Repair and Maintenance reserve account 8% gross rental revenue (this is a sub account of my main checking account, and only used in QB online, if you look in the actual account, the money has not moved, this is for cash flow/accounting purposes only!)

Credit: Cash Account 8% of gross rental revenue (again, money did not move in actual account, I just re allocated it to another reserve account. 

I repeat this process for Vacancy, and Cap Ex. this way I have not actually taken an expense! this also corresponds with the matching principal of accounting. 

If I have a Vacancy or repair, or cap ex. I Credit the correct reserve account and debit the actual expense. 

Please let me know if you have another, better way, of doing it. I feel that this way, they only expense actually accrued is property tax, and they other are just reserve accounts, this also lets me see how much I have saved for each expected reserve, and let's me know how much cash flow I have. 

this way my balance sheet is in order, and my income statement is correct. 

Originally posted by @Gita Faust :

@Frank Chin Keep track of your books on accrual vs cash basis is your choice. We as investors - not all are good at cash flow, are delinquent on payment or bounce their checks and have no clue what your equity on each property is. 

Because everyone teaches and stresses about making money in real estate, but not keeping track of their money.

We all talk about individuals making millions and billions like Apple, Microsoft, Amazon and they enjoy the tax savings. Well without accurate books, you cannot plan and cannot reach the goals you need. 

Analyze, Measure and Review Financials. Check your ROI on investment and loans.

Saying that keeping track of your books on Accrual basis is not wrong but will help you with projecting cash flow and make it easy to get your financials when you are looking for loans.

So for argument sake, if you had a loan on a property, 10K by Eric, 500K mortgage, 50K personal funds, how would you know what your equity is unless you record the loan in QuickBooks by Class (Property). 

We all know that Assets - Liabilities = Equity.

If you keep track on your books on a cash basis, it will show your payments (if you track your principal and interest and that also you do not expense it on Profit & Loss). Now if you keep on accrual - you will be able to track that you owe 560K on that specific property.

That is it - who knows how much money is held by other vendors such as utility deposit, taxes, insurance, escrow held at closing and the list goes on. All this goes on the Balance Sheet and has to be tracked.

So what would be the solution, you can certainly keep the books on accrual and cash at the same time. It all depends on your end goal. 

As for large companies, they would have multiple employees entering the data and they would not even realize how the books are kept. 

Gita

Gita, we all have different lives. priorities, and expertise. I was a credit and finance manager for a number of years in my early career, traveled widely and reviewed the books of our major distributors all over the world, many of who had large staffs to handle the books and maintain more then one set of books, cash, accrual and others.

Since I had a good W2 job, worked long hard hours, but chose to do my own bookkeeping, prepare the books so my CPA can do the schedule E as part of my personal taxes, I had to choose the most efficient mthods.  

Currently, I'm retired, my mortgages are all paid off, years ahead of schedule. But years ago, when I owe a number of mortgages, because I always put down a hefty down payment, make sure each property cash flow handsomely from the start, operate in a fast appreciating market, there is little need to know month the month how much the remaining mortgage is, let alone the escrows the bank is holding. 

To start with, each month, mortgage payments to the bank is booked to a holding account. This holding account is cleared once a year as described below. I have for a short period booked my monthly interest, mortgage pay down, escrow payments monthly, but it was too much work, and I was always several months behind, plus the information is of little interest or use to me.

But once a year, I do take a look. Banks send me a 1099 of the mortgage payments, summarizing the interest paid, principal pay down, bills paid via escrow such as insurance, and the outstanding escrow. So once a year, prior to preparation of taxes, and after the 1099's are received, I reconcile the mortgages outstanding, versus the payments made. As long as my calculated escrow balance matches the banks, I know it's done correctly.

Annually I have a Excel template where I plug in the amounts paid each month, amount of interest each month, amount going into escrow, amounts paid out of escrow, compared to the 1099 to detect any errors. Using the output of the spreadsheet, I do an annual journal entry, from a journal entry template, where the interest paid, principal pay down, escrow account, expenses from escrow are paid and booked, taken out of the holding account. I need this for my for my CPA to prepare the schedule E.

Now, I have the luxury of doing this because early on I cash flowed over $30K a year, for several years, had no vacancies, and outstanding mortgages are simply a matter of bookkeeping. So I don't see the need to hire bookkeepers to fiddle around with my mortgage payments escrow accounts monthly. In short, I don't have the time, and I don't need the expense of a bookkeepers to maintain useless monthly info for me.

In addition, in the first ten years of a mortgage, the principal payments are minimal compared to the amount owed anyway, no need to play with the numbers every month. At one point, I created an amortization table in Excel for each of my mortgages, for the full term of the mortgages, 30 years, in the even I wanted to really know how much I owe. As it turned out, I only needed this info for my my annual mortgage reconciliation. 

Originally posted by @Bruce Weyer :

Hey @Gita Faust thanks so much for this post, it sounds like you are thinking the way I'm thinking. I am tracking every transaction in QB online. The only thing I am accruing is property tax, and that is a for sure expense that will be taken annually (in my case in OH, two times a year) this helps me keep my income statement as accurate as possible, and keeps my balance sheet at accurate as possible. It would be really easy to unwind the property tax accrual for each month if I wanted to look at the cash basis. 

As for the other items that I account for each month, to be a good investor, I reserve repair and maintenance of 8% of gross rental revenue, 8% for vacancy as well, and 5% for Cap Ex. but these are reserves. monthly it looks like this. 

Debit: Repair and Maintenance reserve account 8% gross rental revenue (this is a sub account of my main checking account, and only used in QB online, if you look in the actual account, the money has not moved, this is for cash flow/accounting purposes only!)

Credit: Cash Account 8% of gross rental revenue (again, money did not move in actual account, I just re allocated it to another reserve account. 

I repeat this process for Vacancy, and Cap Ex. this way I have not actually taken an expense! this also corresponds with the matching principal of accounting. 

If I have a Vacancy or repair, or cap ex. I Credit the correct reserve account and debit the actual expense. 

Please let me know if you have another, better way, of doing it. I feel that this way, they only expense actually accrued is property tax, and they other are just reserve accounts, this also lets me see how much I have saved for each expected reserve, and let's me know how much cash flow I have. 

this way my balance sheet is in order, and my income statement is correct. 

Your goal is to visually keep track of the reserve money and not for accounting. It works for you. What we have done for few of our clients is create multiple bank account for taxes, capital improvement, and savings with automated transfers to/from bank accounts. 

One of them went ahead and transferred 5% to a bank account called it "Me Time". He defined it as his sanity vacation fund. Go figure. 

@Bruce Weyer Your procedures as far as accruing your property tax and creating a bank sub-account for your reserve are perfectly fine since it serves your purpose without skewing the numbers. 

To minimize manual entry, you can set up both the accrual entry and reserve setup entry as scheduled recurring journal entry to automatically post every month. 

I was reading this thread and had a question.  I'm an accountant by trade and keep our books for our one rental and two flips on cash basis.  However, for my rental, we have our taxes and insurance escrowed.  When we pay our monthly mortgage payment, I'm splitting it out between mtg paydown, interest expense, ins expense, and r/e taxes.  Is that what everyone is doing as well?  What about the escrow reserves when you purchased rental property, setting it up as a liability, then journal entry at y/e to adjust to actual?  Thank you.

@Matt Matessa - old thread, but doesn't look like you got an answer.  I split the mortgage to paydown (to the specific long term liability for the property - as subaccount under mortgages), interest expense, and a Mortgage Escrow account.  When I see the taxes and insurance paid on a mortgage statement, I do a journal entry to move the amount from Escrow to the property tax or insurance expense (or I do this at year end).  

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