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

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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.

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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 out 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 increase 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: A CPA Answers: “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 use 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. Depending on what business the entity engages in depends on 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.

Related: 5 Reasons I Do NOT Invest in Real Estate Using An LLC

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 always asks “How do I pay myself?” and I’m about to show you the journal entry that shows you how to book an owner distribution. 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

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.

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

Leave all your comments and questions below!

About Author

Brandon Hall

Brandon Hall, owner of The Real Estate CPA, is an entrepreneur at heart who happens to be good at taxes. Brandon is a real estate investor and CPA specializing in providing business advice and creative tax strategies for real estate investors. Brandon's Big 4 and personal investing experiences allow him to provide unique advice to each of his clients. Sign up for my FREE NEWSLETTER to receive tips and updates related to business and taxes.

37 Comments

  1. Justin R.

    Thanks for taking the time to write all that out – this is an area that many folks don’t feel empowered to understand, and it’s helpful to see it all written out.

    When starting our LLC, I had hired a bookkeeper to come help me setup the books. There was DEFINITELY an “ah-ha” moment where everything became very clear. Mostly, the whole concept of accounting made sense after working backwards from the P&L and Balance Sheet.

    For those still struggling with this stuff, my recommendation would be to keep spending the time and learning the basics in whatever way you learn best – learning to think in terms of accounting as if you’re a native speaker has been a HUGE benefit for my in the projects we’ve done.

    • Brandon Hall

      Hey Justin – thanks for taking the time to read and comment. I’m glad you’ve had a good experience with your accountant(s) and have learned a lot in the process. Accounting is critical to understand as a business owner, and I try to teach my clients as much as I can without overwhelming them with the technicalities.

  2. Leigh Ann Smith

    I made it through the article Brandon, but a lot of it did go whizzing over my head! One thing I did finally understand was that the LLC is capitalized by owner contributions. I knew that the funds came from the owner, but that seemed to me to be co-mingling, so I didn’t understand how that would work. The article indicated that owner contributions are legitimate as long as you are accounting for them properly and not making them too often. One specific question, though. You said to be sure to properly capitalize the LLC. Capitalize it for how long? Should the owner contribution of cash be enough to keep it going for a quarter or for longer? Thanks!

    P.S. I think it might be worth it for my husband and me to hire a CPA!

    • Brandon Hall

      Hey Leigh, great question and I’m glad you made it all the way through! Capitalizing the LLC properly is going to be a question of the facts and circumstances of the LLC. Ideally, the LLC will never need another capital injection. That’s how you know you capitalized it appropriately.

      Of course saying “it will never need another capital injection” is unrealistic as you may partner with investors or have a one-off big time expense. But the idea is that you should capitalize it to the extent that you don’t need to constantly ass more money to it.

  3. Lyuba Barrington

    @Leigh Ann:
    Yes – do hire a CPA and don’t be shy to ask questions from him/her.

    A good CPA can reconstruct your accounting for tax purposes from LLC bank records, but do keep LLC bank account separate from personal bank account. IRS does not like co-mingling of personal and business funds, in case they do come out to audit you!

    Apart from tax compliance – accounting is also a tool to produce information for your day-to-day decision-making. Sometimes Excel download from your bank account will produce better and more understandable reports for you to make investing decisions, keep track of different projects and their profitability etc.

    Excel spreadsheets used in lieu of a full general ledger software is only scalable to a certain (limited) degree. Beyond that – as the volume of your business transactions grows – you may need something more sophisticated, like a cloud-based Sage or Quickbooks. Your CPA will recommend the accounting software which is compatible with his office software setup, otherwise you may end up incurring data conversion costs come tax time.

    And do trust your CPA when s/he is offering help setting up a “chart of accounts” and other once-in-a-lifetime variables for your new accounting system. I have seen too many business owners who had to start from scratch because the initial setup was beyond repair!

    Good luck!
    Luba Barrington, CPA

  4. Christopher Koonce

    Brandon,

    Thanks for the article, really hits home as I’ve been questioning some of the aspects of setting up multiple LLC’s and had so many questions. This certainly did shed a lot of light on getting started with my books. I am really interested in knowing what your other topics are on how investors don’t treat their LLCs like a business. Any chance you will be writing additional articles?

  5. Linval T.

    Excellent article that you painstakingly took the time to create and share with the community.

    Your efforts are really appreciated and its content is extremely useful.

    Yes, my theory is that only a fool would do his own accounting and represent him/herself in court.

    So, to be smart about your business, spend the money as a business expense and hire the qualified

    professionals.

  6. Samuel Vlahavas

    Wow just getting started in the fix and flip niche and set up an LLC. Great article and yes I did have to go back and read it a couple of times. Do you recommend getting a CPA to solely manage the LLC accounting and keeping our personal CPA for just that, our personal accounting? Again thank you.

    • Brandon Hall

      It depends. For me personally, I would not hire to separate CPAs unless I was running a large business and needed very specific business expertise. At that point, the business CPA may not do taxes, or have the tax knowledge, so I’d also hire a tax CPA.

      For most of the people here on BP, I’d say hiring two separate CPAs isn’t going to be cost effective. Most tax accountants will also keep their client’s books, so I’d start there. If anything, you can hire a cost effective bookkeeper and have your CPA review your books quarterly or semi-annually.

  7. Brenda H.

    Very good “cheat sheet” for common RE accounting entries if you do your own books. Even if you outsource the whole bookkeeping/accounting bit, this give you an overview of the fundamentals so you can check the work of those you hire, or figure out what questions you need to be asking about how they are categorizing transactions.

  8. Brandon, thanks so much for the informative article. We purchased a property through an LLC, using some personal capital contributions and some private investor funds. I have yet to figure out where all the entries belong from the (purchase) HUD-1. I’ve kept up with subsequent transactions however. I need to sit down and think it through as it’s been haunting me for some time. The subject might be fodder for a future post.

    • Brandon Hall

      Hey Jess – well thanks to the truth in lending act, Hud-1s are going away! But they are being replaced with Closure Statements which is essentially the same thing. I’ll write an article on it whenever I get a real one in my hands.

      If you have Hud-1s, a real estate CPA should be able to help you sift through it. It’s important to get someone that knows what they are doing as some of the expenses are currently deductible, some are capitalized and depreciated over 27.5 years, and some are amortized over the loan period.

      Hope this helps!

  9. David Spurlock

    Brandon,

    I’m angry with you for two reasons. You made my head spin around on my shoulders and hurt. Then you woke me up out of my blissful ignorance.

    Just teasing! This information is critical to the success of any business however it is extremely difficult to understand for a lot of folks who do not have the CPA gene in their DNA.

    I will have to reread you article many times to get it to a eureka moment where I understand it. I manage my Mother’s trust and I have always struggled with the accounting documents provided by her Custodian.

    If you can share with me any other educational material, aimed at a caveman level of understanding, that I can read and put under my pillow to see if it will soak in.

    Thanks again for your great article.

  10. Justin C.

    Well I’m sure glad your my CPA!! Great Article Brandon. I asked this of my attorney just last week at the refi and he simply encouraged me to increase my personal liability and call it a day. As long as I’m sticking with SFH and small Multi’s, personal liability is cheap and provides enough coverage for our needs. Large multi’s are a different ball game all together. Thanks Brandon!

  11. Lyuba Barrington

    Jess – which tools/software are you using for bookkeeping? Are you trying to post general ledger journal for your purchase? The treatment of investor contribution depends on either the investor is an LLC member or an outsider.

    In the first case you should first record cash contribution from investor to LLC capital (Dr cash, Cr Capital), and then record the purchase as Dr Property-Asset Cr Cash.

    In the second scenario, the investor’s contribution becomes a liability of your LLC to the outsider. The first entry would be Dr Cash Cr Liability-Owed to Investor; and the second entry is the same in both scenarios.

    In short – the difference is about the source of investor’s cash – which is either part of capital, or a liability of your LLC to the outsider.

    Hope it helps.

    • Jess Robinson

      Thanks for the follow up advice, Brandon. Lyuba, thank you for weighing in. I’m using QuickBooks. The private money is in the form of an interest-bearing loan. My confusion lies around all the ancillary items on the HUD-1. I think what I need to do is eat this elephant one bite at a time, as it’s intimidating to tackle it all at once. I know there must be an example published out there somewhere; I just need to find it.

  12. Jordan DeLozier

    Great article, thank you for writing! Can you elaborate on this:

    “Once you’ve transitioned out of growth and into a maintenance phase, take owner distributions once a quarter.”

    I spoke with the CPA firm that does our bookkeeping and our lawyer after I read the article initially. Both said that distributions can be taken monthly from any of our LLCs and our S-Corp (non-real estate) without piercing the veil. According to them, the only time they would be classified as co-mingling is if the distribution wasn’t transferred to a personal account first (IE: buying groceries directly from the business accounts).

    Have you actually seen the veil being pierced because of this? If you have, we’ll be switching to quarterly as you suggest.

    • Brandon Hall

      Hey Jordan – I have not read a case the specifically attributes the piercing of the corporate veil to monthly distributions. Monthly distributions are perfectly fine. The reason I suggest quarterly distributions is because you will be acting like a large company, so there will be no contest whatsoever over co-mingling. However, this is not feasible while you are growing, and “growing” can last a number of years, even decades.

      If you stick to monthly distributions religiously, then you will be okay. Hope this helps!

  13. Rick C.

    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

      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.”

  14. Tammy Parsons

    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.

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