Accounting is probably not the first topic that comes to mind when you want to invest in real estate. However, it is an integral part of managing and owning real estate. Keeping accurate books is not a difficult task, but it can be time-consuming.
An essential factor that good bookkeeping can help you understand is the return on investment (ROI). The positive factors of ROI, or profit, are monthly income, appreciation or profit, and tax write-offs. Negative ROI factors include maintenance bills, losses, mortgage payments, and taxes.
Any real estate investment will have its share of both positive and negative ROI factors, and you should be quite prepared for the unexpected to happen.
Understanding these factors and tracking them carefully will help keep your real estate business profitable. You may review Solution Scout for more information about how to approach bookkeeping if you choose to invest in real estate.
An organized accounting system should allow you to track net income and loss, annual profit or loss, analyze the commercial real estate’s value, determine successful business plans, prepare annual taxes quickly and easily, generate data, and more. Here are a few practical bookkeeping tips for investors.
Keep Your Business Account “Clean”
One of the essential aspects of bookkeeping for real estate investments is to separate all business expenses from your expenses completely. If you are a limited liability company(LLC), this is a legal requirement. Even if you are not an LLC, keeping your personal and business expenses separate from your expenses is not a good idea.
If the IRS is auditing you, they will have to look at all of your expenses and your business expenses for evidence regarding your tax claims, which can be a frustrating experience.
An excellent starting point is to open a separate bank account and credit card in the business or property name, as this makes bookkeeping easier.
You can keep track of the cash flow coming into your real estate account and closely track your monthly income, which will help you better understand your business needs.
You can use this information to create reports. The most beneficial part is creating a separate bank account. Therefore, your personal assets and tax records will not come under fire in the event of an IRS audit.
Keep each receipt and indicate what it was for. You can even write on the receipt what it was for and why it was intended. It is useful not only for deducting the right amount at tax time but also for proving to the IRS that you are legal and making sure you are financially organized.
An essential habit is to keep track and categorize everything, even if it is done through a simple spreadsheet when you are just starting.
It lays a solid foundation for expansion when you decide to become more advanced. This can be done manually or with Excel or Google Docs. As your business grows, you will probably want to consider using accounting software.
What Records Should You Keep?
All receipts over $75 must be kept following IRS standards. However, receipts do not have to be kept in paper form. Photocopy the receipt and recycle the paper.
There are two categories for which we always recommend keeping receipts, even if the amount is less than $75:
These categories are usually addressed in IRS reviews and audits.
Track Your Expenses And Supporting Documents
Keeping track of all your expenses and setting up a “book” may be time-consuming at first, but you can take advantage of it later. A book is a record (electronically or in hard copy) of every financial transaction you make in your business. A book can be easily saved using an Excel spreadsheet.
If you have opened your bank account for your business and have a debit or credit card for your business, it is easy to track your expenses online and put them into an Excel spreadsheet. You can also use useful software systems, such as Quickbooks, to track rent payments and expenses.
Accompanying documents consist of all receipts or documents supporting each financial transaction, notarized in your book.
Like your book, supporting documents can be either paper, such as in a filing cabinet, or electronic, computerized. In both paper and electronic form, your supporting documents should be produced annually.
A good way to get started is to create annual files for the following: expense confirmations, bank statements, credit card statements, tax return documents, insurance documents, contracts, leases, and other real estate-related documents.
If you keep receipts with hard documents, be sure to put the receipt’s purpose on top of the receipt with the date of purchase, if it’s not already listed, so you know what you spent the money on and when.
Although hard copies have their advantages and disadvantages, having mobile bookkeeping is convenient because you can keep records in real-time as they occur. Although it can be time-consuming to create a book, keeping it should be quick and easy.
Itemize Income And Expenses
Every dollar in or out of your business should be classified and tracked. In this case, the receipts mentioned above would come in handy. Update your accounting software every six months as income comes in, or bills are paid, and make sure you use the correct debit or credit card for each property expense.
If you use a spreadsheet, you may decide to wait until the end of the month to classify each property – but don’t wait too long. The longer you wait to classify dollars, the more likely you are to make a mistake.
It is advantageous to itemize your income and expenses regularly. It is much easier to do with professional accounting software such as QuickBooks or Xero. As you get more ownership, you may even consider hiring a bookkeeper or accountant.
When itemizing your income and expenses, it is usually best to break them down into the same categories that the IRS lists on Schedule E, the form you will need to fill out each year at tax time. The expense categories the IRS determines:
- Automobile and travel expenses
- Cleaning and maintenance
- Legal and other professional fees
- Management fees
- The mortgage interest paid to banks, etc.
- Other interest
- Depreciation expense or depletion (at BiggerPockets, we call this capital improvement)
Typically, finances are tracked monthly, such as January 1 through January 31 and February 1 through February 28. If you are using a spreadsheet, you should list the above categories on the screen’s left side and make one column for each month.
Reimburse Yourself For Business Expenses
Despite your best efforts, there are times when you pay for business expenses with personal funds. Remember, the Golden Rule says that these business expenses must appear in your bank account.
To do this, ask the company to write you a check for reimbursement of expenses that you paid out of your funds. It should be a separate check from your monthly salary.
The refund process should be the same as for employees. List the expenses and the date, supplier, and destination in the spreadsheet and attach them to the receipt. Your business will then write you a check for the exact amount.
While this can be a bit of a hassle, it ensures that your accountant will deduct the expenses because they were paid by check from the business account.
Track And Reimburse Business Mileage
Your business can deduct the standard rate per mile (57.5 cents for 2020) for any mileage you drive in your car. You should keep track of the date, miles, and purpose of each business trip and send them to reimburse your monthly expenses, as described in the tip above.
The business does not have to directly pay for any personal vehicle expenses, even for fuel used exclusively for the business. It is good if you use the 57.5 cents per mile received from the company to pay for fuel and maintenance.
Compare what should be with what is. Again, the purpose of bookkeeping is to make sure the numbers line up perfectly or “reconcile” between the books and the bank statement.
The purpose of having a bank reconciliation is to double-check everything to make sure your books are accurate.
Sometimes banks or businesses get confused, and you will be charged for things you didn’t buy. You may also get double charges.
When reconciling your accounts, pay attention to your bank account’s beginning and ending balance, which should match your books.
If you started with $1,000 in your account, received $800, and spent $700, you should leave $1,100 in your account at the end of the month (because you “earned” an extra $100 during the month). It is a straightforward example, but the same concept applies regardless of the size of your transaction.
Create Accurate Reports
Finally, after entering all this data for your investment, you will generate success reports. With professional accounting software, it can be as simple as clicking a button. However, if you do the bookkeeping manually, you will be slightly limited in the types of reports you can generate.
The most common report is the income statement, which shows all income, expenses, and cash flows from the investment. If you keep your books in a spreadsheet, you are essentially generating a profit and loss statement every month by entering income and expense data.
These reports give you an accurate picture of how your business is performing. Do you want to know how much cash flow your business has generated over the past month? You can easily find out.
Perhaps you are interested in the schedule of your expenses for the last three years? The report can show you this trend. Again, if you are not a spreadsheet professional, it will be much easier with an accounting program.
Real estate accounting may seem excessive at first, but the process quickly becomes routine. If you don’t feel comfortable doing this or don’t have the time, consider hiring an accountant to help you sort it all out.
You can also sit down with the CPA who handles your taxes and ask him or her to explain exactly how they want you to handle accounting to make their job easier.
To Sum Up
Getting started on real estate investing may seem overwhelming, but following these tips should help you get started in the right direction.
While proper accounting may seem tedious at first, it will allow your business to run smoothly and help you reduce errors and increase profits. However, perhaps the most important thing to keep track of is your goals for the future.
Real estate is a long-term game, not a short-term one, and determining where you want to be in five to ten years can help you achieve your goals. Keep in mind that the best businesses are built on a good foundation.
Real estate “bookkeeping” aims to keep an accurate record of the money that goes in and out.
Accounting is vital to 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 performing at any given time, you can make better decisions and sleep well at night.