Investment Property Bookkeeping

It’s about the end of the month, so soon we will be getting next month’s rent checks. No matter if you are a new or experienced landlord, your financial bookkeeping is crucial.

How do you track the income collected from investment property, and how do you forecast future expenses? (This will be an Accounting 101 course, more experienced readers may want to jump directly to our Landlording with QuickBooks training).

Every investment property owner needs to keep track of that money separate from the rest of his or her income and expenses. Ideally you have a landlording / property management legal entity set up already – perhaps an LLC. Even if you did not do that, opening another checking account can help to keep things more organized.

You need to separate your investment and personal funds.

  • Assuming you have an entity, it protects you from piercing of the corporate veil.
  • It makes taxes easier.
  • It helps tracking how much money you earn or lose.

When you have your new checking account, check with your bank about using smart phone apps to deposit your rent checks. Or use a high speed scanner they can provide you with. This way you don’t have to make a trip to the bank to deposit the money. Better yet, enroll your tenants in a direct deposit program to automatically transfer the money into your account.

You can be more or less aggressive in creating separate accounts for checking, security deposits, and the like. Note: some states require security deposits be kept in a different account than your regular business funds.

Here’s one possible setup of different accounts, from the husband and wife team at Rental Realities:

Checking Account – where all rent is initally deposited, and always holds the budgeted funds for PITI ($1,104), repairs ($87.50), and excess cash flow ($200). Cash flow we can apply to anything we want, like mortgage pre-payment, upgrades, miscellaneous expenses like office supplies, or saving for the next duplex.
Variable Expenses – this savings account includes the budgeted funds for things that are irregularly paid, including: future vancancies ($87.50), HOA dues ($50), and professional fees ($25). This savings account is automatically funded $162.50 from our checking account each month.
Income Taxes – I need to dig deeper into this, but my git-r-done way of estimating our tax burden was to start with total rent minus deductions for HOA dues, insurance, property taxes, and 75% of the principal/interest payment (only the interest is deductable). Then I take 25% of that number to get an estimated amount to save for each month, which comes out to $192.47. Rounded up, this savings account is automatically funded $195 from our checking account.

 

Security Deposit A & B – these were transferred to us at closing, and we named each one in ING as Security Deposit + the name of the address the security deposit applies to. I’m leaving those alone until a tenant moves out. The amount allocated to each fund is directly related to the balance sheet I created previously, with roughtly half of the positive cash flow money being allocated to income taxes.

Hopefully this gives you some ideas of investment property bookkeeping. We have a lot more in the blog, or order our full training kit on managing properties in QuickBooks today. It comes with a money back guarantee. And thousands of customers love it (read testimonials ♥).

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Rental Properties Legal Entity Choices – Sole Proprietorship, LLC, or Multiple Entities?

As an investor in rental property, you have several important priorities.

  1. Delight your tenants so they stay, refer friends, and pay on time.
  2. Protect your personal and business assets.
  3. Grow according to your goals.
Creating a formal entity is very important to shield you from personal liability for actions taken by the business.

Sole Proprietorship

Operating any business as a sole proprietorship is generally not advised by attorneys as you are exposing yourself to personal liability if something happens in the business. This is not an actual entity, but rather the “default” that happens when you just start doing business. Some people start this way, but then have to transfer that property into a different entity. (See section 4.08, Transfer a Property you own into your Company in the full guide ($)).

Limited Liability Company, or LLC

This is very common among real estate investors and management companies. This is the structure assumed in the sample company files in our guide. Laws differ from state to state, and LandlordAccounting.com does not provide legal advice. Consult your attorney. Nolo is also a great place to start reading legal books about setting up your entity.

S-Corp / C-Corp

S-Corps are still a popular option, although in recent years LLC’s have become much more popular. C-Corps are rarely advisable due to their inefficient tax characteristics compared to other entities.

Multiple Entity Structure

You may consult with your attorney and resolve to create several entities. Some may hold assets but not be exposed to liability, and others do the management (liability activities), but do not own the assets. This is sometimes referred to as the “Hot entity / Cold entity split.” The hot one has all the risk, but no substantial assets.

One QuickBooks company file is designed to handle bookkeeping for one company. If you are using a multiple entity structure, you have a choice: one file, or several files. If one file, you could use classes for each entity and sub-classes for each property or owner. Some companies chose to create an account for each entity, and duplicate sub- accounts (like Rent Income and Maintenance Expense) under every entity’s account. Different files could also be used for each entity.

Intuit would want you to create separate files for each entity, because their tax line mappings are designed for one file to map to one company. And, when creating Balance Sheet or P&L reports they default to include all accounts. If you go this route, it will take some effort to and open and close and enter transactions in each company file. But, reporting will be straightforward. (And, recent year’s QuickBooks support opening several company files at once).

See also other posts and discussions on multiple entities.

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Q&A: How to deduct a tenant’s rent who also does work for you?

Today’s question comes from a creative landlord who wants to credit a tenant for work performed. (If you like this, consider buying our full training).

I’m a landlord, and sometimes I make an arrangement with a tenant to get a rent deduction in exchange for work done. How do I record this in QuickBooks?
- Judi

Great question.

Example: John Smith, a tenant of yours, also shovels snow for your apartment building. For this, he gets a $100 deduction on his rent during the winter months.

You want to indicate that you paid him $100 and decrease his outstanding rent due balance. Here’s how:

  1. From the Banking menu, select Write Checks.
  2. Select the Vendor from the Pay to the Order of drop-down.
  3. Enter the expenses and/or items for which you are writing the check.
  4. Select the Expenses tab.
  5. On the next blank line, select the Accounts Receivable (A/R) account from the Account drop-down menu.
  6. Enter a negative (-) amount equal to what you wish to deduct for the outstanding accounts receivable balance. Here, $-100.00.
  7. On the same line, select the customer:job “Smith, John” from the Customer:Job drop-down menu.
  8. Enter a memo into the Memo field on this line. This memo is an optional explanation of why money is being deducted from the check.
  9. Once all of the information has been added to the check, click the Recalculate button. This is located in the bottom-left corner of the Write Checks window.
  10. Now, click Save & Close.

pay a tenant with work due credit

Save the check and a credit will be added to the customer’s A/R account. Then apply this credit to the outstanding customer balance.
If you print the check, the deduction will now reflect on the check stub; along with the memo explaining the deduction.

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eBook Excerpts from Chapter 2: Accounting Fundamentals

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide.

We just finished posting our sample excerpts from all of chapter 2. Please take a look at them to get an idea about what content you can find in the full guide.

We hope to see you as a customer soon, where you can instantly download everything, including sample company files.

Chapter 2.    Accounting Fundamentals

2.01    Why Does a Landlord or Investor Need Accounting?
2.02    The Basic Accounting Equation
2.03    What is an Account?
2.04    What is The Chart of Accounts?
2.05    Debits and Credits
2.06    Introducing the Balance Sheet
2.07    Introducing the Income (P & L) Statement
2.08    The Sum of all Debits = the Sum of all Credits
2.09    What is Double-Entry Accounting?
2.10    Cost Basis and Adjusted Basis of Property
2.11    What is Depreciation?
2.12    What are Capital Improvements versus Repairs?
2.13    Cash Accounting, not Accrual

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Cash Accounting, not Accrual (eBook excerpt chapter 2.13)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.13 Cash Accounting, not Accrual. We hope you’ll become a customer today, or sign up for the free e-course.

Two methods exist in tracking income and expenses. Each can be recognized as they are earned/incurred (accrual method), or recognize them as they are actually deposited/paid (cash accounting). Cash accounting is used in this book.

Accrual Accounting records financial events in the period they are incurred. Even if cash is not received or paid in a transaction, they are recorded because they are significant to the future income and cash flow of the company. If you record an income event on the day rent is due, and not when it is received, that is accrual accounting.

Cash Accounting records financial events based on cash flow. Revenue is recognized when cash is received and expense is recognized when cash is paid.

The distinctions appear if you incurred an expense (were billed) at the end of December, although did not pay until the 5th of January. Accrual accounting would recognize the expense and enter an accounts payable entry in the previous year but not reduce your cash and liability account until January. Cash accounting lumps those two transactions into one, reducing cash and recognizing the expense on January 5th.

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What are Capital Improvements versus Repairs? (eBook excerpt chapter 2.12)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.12 What are Capital Improvements versus Repairs? We hope you’ll become a customer today, or sign up for the free e-course.

Caution: Have a conversation with your accountant about what he or she wants you to capitalize and what to expense. This is a grey area due to court rulings in which owners expensed some things (and got away with it) the IRS suggests one capitalize. Do your own homework and talk to your accountant.

Routine maintenance and repairs are not treated the same as capital improvements. This becomes very important when you enter the transactions into QuickBooks. Repairs go into QuickBooks one way (as expenses), while capital improvements go in another way (as increases to the value of your real estate assets). The following definitions are from IRS publication 527.

Repairs keep your property in good operating condition. They do not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement. For instance, in a large rehab project if you repaint the walls (typically this is a repair) it is an improvement.

Capital Improvements add to the value of property, prolong its useful life, or adapt it to new uses. If you make an improvement to property, the cost of the improvement must be capitalized. The capitalized cost can generally be depreciated as if the improvement were separate property.

The following Frequently Asked Questions are taken from the IRS’ website. The questions were current at time of publication. I suggest you ask the same questions to your accountant. It will help you learn how aggressive he or she is.

We have incurred substantial repairs to our rental property: new roof, gutters, windows, furnace, and outside paint. What are the IRS rules concerning depreciation? (This question comes from an FAQ from the IRS.)

Replacements of roof, rain gutters, windows, and furnace on a residential rental property are capital improvements to the structure because they materially add to the value of your property or substantially prolong its life. The items would be in the same class of property as the rental property to which they are attached. Since the property is residential rental property, the items are generally depreciated over a recovery period of 27.5 years using the straight line method of depreciation and a mid-month convention.

Repairs, such as repainting the residential rental property, are currently deductible expenses. A repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or out, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows are examples of repairs. If you make repairs as part of an extensive remodeling or restoration of your property, the whole job is an improvement. In that case, you should capitalize and depreciate the repair costs as the same class of property that you have restored or remodeled as discussed above. For more information, refer to IRS Publication 527, Residential Rental Property and IRS Publication 946, How to Depreciate Property.

The full guide has more content on this section, but it is limited in this preview…

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What is Depreciation? (eBook excerpt chapter 2.11)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.11 What is Depreciation? We hope you’ll become a customer today, or sign up for the free e-course.

We discuss this in another article as well about depreciation vs expenses.

If you have purchased a new car before, you already have experienced depreciation. As soon as that brand new car is driven off the lot, it loses significant value (it depreciates). As you continue to drive it, time and wear and tear continue to decrease the car’s value. The value of an older car is less than a new car because of depreciation.

For real estate, depreciation is a little different. First of all an older property will likely be worth more now than it was when it was first purchased because of the appreciation of property values. Appreciation is uncertain, though and not realized until you sell. Depreciation, for our purposes, is a tax issue.

Depreciation is an annual income tax deduction that allows you to recover the cost or other basis of certain property over the time you use the property. It is an allowance for the wear and tear, deterioration, or obsolescence of the property.

Straight Line Depreciation uses a constant amount to depreciate every year for the useful life. It is equal to the adjusted basis minus salvage value, divided by the useful life. The yearly depreciation could change if the useful life decreased or substantial investments were made in the asset to increase its adjusted basis.

Accumulated Depreciation is the cumulative depreciation since acquisition of an asset. It is reported on the balance sheet as a reduction in the value of the related asset. The difference, asset value minus accumulated depreciation, is the asset’s “carrying amount” or “book value.”

See Also: IRS publications 946 regarding depreciation of real property and 527 regarding Residential Rental Property.

The full guide has more content on this section, but it is limited in this preview…

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Cost Basis and Adjusted Basis of Property (eBook excerpt chapter 2.10)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.10  Cost Basis and Adjusted Basis of Property. We hope you’ll become a customer today, or sign up for the free e-course.

The adjusted basis is the current value of a property for tax purposes. It includes money you initially invested (the cost basis) as well as recent capital improvements to add value in a property (such as a new roof) minus depreciation every year. For an explanation of depreciation, see the next section. The adjusted basis does not include money you spend for routine repairs or maintenance.

According to IRS Publication 551, when buying real property, the basis includes:

  • Legal and recording fees
  • Abstract fees
  • Survey charges
  • Owners title insurance
  • Amounts the seller owes that you agree to pay (back taxes, interest, recording/mortgage fees, charges for improvements or repairs and sales commissions)

Basis (Cost Basis) is the cost (including cash paid, debt obligations, other property or services traded, etc.) to bring a property up to the initial condition necessary for renting (i.e. rehabbing, carpet and paint). This is your starting reference number for the tax value of a property.

Adjusted Basis is the measure of your investment including additions or permanent improvements that increase the value of the property. (Depreciation deductions decrease the adjusted basis).

Caution: Remember this book is not a replacement for professional advice. Do not take any of this information as tax or legal advice. Consult with your own competent advisors.

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What is Double-Entry Accounting? (eBook excerpt chapter 2.09)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.09 What is Double-Entry Accounting? We hope you’ll become a customer today, or sign up for the free e-course.

 

Double-entry accounting guarantees that no matter what transactions you make, the basic accounting equation is always true:

Assets = Liabilities + Equity

Also, for any single transaction, the sum of all debits equals the sum of all credits.

Double Entry Accounting describes a business by a number of different accounts, each describing an aspect of the business in monetary terms. Every transaction has a dual effect in two of these accounts. For instance, buying property with cash increases fixed assets (by the property) but decreases available cash. Buying with a mortgage increases fixed assets (the property) but also increases liabilities (the mortgage).

If you followed along with previous sections’ examples, you’ve already performed double-entry accounting. When you received a $500 loan ($500 credit to liabilities) and deposited $500 in your cash account ($500 debit to cash), you followed the principles of double-entry accounting. $500 in debits equaled $500 in credits.

Look in the previous chapter when you earned $1000 for the sale of your tofu pizza recipe to Aunt Betty, see the figure “Aunt Betty 2: (corrected).” The transactions are repeated in the following table.

debits credits, what is double entry landlord accounting

Observe how there are two entries for each transaction. In this case, you increase or decrease the cash account and then recognize why that occurred. It was either earned revenue or a decrease in liabilities.

To repeat: for each transaction, the sum of debits equals the sum of credits. For transaction (1) this is $1000 = $1000 and for (2) $500 = $500.

In more complicated entries there could be multiple debits and credits for each transaction, but in the end… The full eBook has more content but this concludes the sample.
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The Sum of all Debits = the Sum of all Credits (eBook excerpt chapter 2.08)

A free sample from chapter 2 Accounting Fundamentals of our Landlord / Property Management in QuickBooks guide. Section 2.08 The Sum of all Debits = the Sum of all Credits. We hope you’ll become a customer today, or sign up for the free e-course.

 

As we talked about in recent posts about debits and credits, the accounting equation, and T-Accounts, there are basic accounting rules that, once learned, make complicated transactions simple.

The sum of all debits must equal the sum of all credits.

For one transaction (ex a Journal Entry), or for all transactions ever entered. It always is true.

If you have to enter a transaction that this book doesn’t have an example of, draw the T- Accounts and amounts involved. Try to figure out what to do, then talk to your accountant and confirm you have the correct method. The only time you use debits and credits is in Journal Entries, if the sum of all debits does not equal the sum of all credits, there is a mistake.

Keep moving through these sections, even if you do not completely understand them. The examples that follow will get you ready to work with QuickBooks. If you are terribly confused, that’s okay, skip ahead to the next chapter.
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