Q&A: Rent to Own in QuickBooks

If you’ve signed up a tenant with a rent to own structure, there are unique requirements for recording the transactions. Here’s a recent question from Gloria.

How do i book rental income that is no longer rent but going to be payments for a purchase of property for 250,000 tenant pays 3500.00 a month towards payment?

Create a receivable? Chart of accounts “options to purchase” Asset? Help …

Great question. This can be complicated, and we recommend you work with an advisor.

Rent to own, or an Option to Purchase, is a contractual agreement between buyer (lessee) and seller (landlord). The buyer purchases an option to buy the property later. In your books, that will be recorded in a liability account (just like security deposits). Buyer and seller likely decide on a purchase price then, or let it fluctuate with the market. Traditionally, a price is agreed upon in the option. Both parties negotiate the terms, and the buyer (lessee) has exclusive rights to purchase the property during that time period. If the buyer eventually buys it or not, the option to purchase is non-refundable. Then, each month as the lessee pays rent, a portion of that goes into the purchase price. Over time, they “prepay” for the purchase, in addition to pay rent.

The initial option payment is not income until the renter exercises the option, or forfeits the option and leaves. So the initial deposit of the option payment posts to a liability account “Option – 123 Main St.”

Then, monthly payments often are counted towards a future purchase of the property. For a $1200 rent check, it could post like the following journal entry:

Cash Dr $1200
Option – 123 Main St  Cr. $100
Rental Income  Cr. $1100

Sometimes in option agreements renters also need to pay property tax and insurance. It is the same as if you were paying to an escrow / impound account when you get financing from a bank. In the above option, it would decrease the rental income, and credit another liability account for Impound.

This is just a start, there are other things you still need to consider such as if the tenant surrenders the option, or exercises it.

Great question – you were on the right track asking this question. We look forward to a followup in the comments below.

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Rental Property Expenses versus Capital Improvements

As landlords enter transactions into QuickBooks, they must decide if something is an expense or a capital improvement. The impact is significant.

Example: You have a property that will earn $12,000 in gross rent this year (and $5,000 after insurance, property taxes, depreciation, etc). You bought if Jan. 1st this year for $100,000. You expect to pay taxes on the $5,000 in income.

The purchase price is generally capitalizable (some exceptions are if it was already rented and in the $100K you also received cash for the current tenant’s security deposit. Then you’d need to transfer the security deposit.) What if you need to put on a $3,000 new front porch and replace the carpet in the living room for $450? You’ll spend the money, but how do you record it in QuickBooks?

Let’s say you expense everything.

Your expected $5,000 in income is reduced to $1,550. “Great!” you may say, you pay less in taxes, because all repairs can be deducted from income in the current year. Your balance statement will not change, only your income statement. Is this correct? Is this legal?

Let’s say you capitalize everything.

You will still earn almost $5,000. You will have a more valuable asset on your balance statement, and you will have a little bit more depreciation to offset income (which is why you will be taxed on a bit less than $5,000). “Terrible!” you say, you pay more taxes and have to wait for years for depreciation to offset income which could have happened all at once if you only expensed it. Is this correct?

The problem here is capital improvements must be depreciated. The problem with depreciation is you do not get to make a full deduction to your income in the year the payment was made.

What is the right way?

Generally speaking you do not have a say in what you can expense and what you must capitalize. The tax authorities have pretty clear guidelines. Everyone in the US should at least skim Pub 527 Residential Rental Property. You still get to deduct capital improvements from income to lower taxes, but they must be spread out over the particular asset’s depreciation schedule.
The IRS explains you capitalize what “extends the useful life” of the property. Examples of capital improvements:
  • replacing a roof
  • building an addition or a garage
  • replacing all plumbing, electric, or windows
Reparts are necessary to keep a property in working condition. The IRS says they “do not add significant value to the property or extend its life.” Examples of repairs:
  • fixing a bad patch of a roof
  • repainting a room
  • replacing bad flooring

What’s a smart landlord to do?

Skim Pub 527, but don’t stop there and try to do everything yourself. Many tax strategies have been tested in court and you need to find an accountant that can help you be aggressive, but entirely in compliance with what courts ruled and the IRS requires.

For instance, you may find some tax lawyers will advise you to expense most of the costs spent to bring a rental up to service, even if these would normally be capitalized in a very strict reading of the tax law. He or she will have very specific reporting requirements for you, fortunately these are quite easy when you set up QuickBooks correctly and have an organized office.

If you must depreciate, and you are operating a profitable company, then you can optimize current year’s deductions by using an accelerated depreciation schedule instead of a straight-line schedule.

The verdict? Set a goal this year to meet several new accountants and ask them about how they optimize taxes for other landlords. First meetings will be free, and you will be able to ask lots of questions and find someone who can help you find a legal balance between capitalizing and expensing your outflows.

Want more? Read our blog for other articles (like this one previewed from the training guide) or go ahead and buy the full course right now to learn how to use QuickBooks for Landlords and Property Managers. (We have lots of screenshots of how to enter expenses and capitalized transactions.)

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Q&A: one or two QuickBooks companies for US and Canadian businesses?

Chris, a training customer of ours writes in:

I am going through your course now. It’s very helpful (♥) and am looking forward to mastering it.

I had a question about using QuickBooks for two different real estate companies. We have one based in Canada, and one in the US registered as separate entities. Would you recommend keeping both companies in the same Quickbooks document, or having two separate docs to work off of?

I am wondering if it makes more sense to amalgamate all our activities, or to keep them compartmentalized?

Thanks, Chris

Chris, thanks for writing in. Two company files is almost always the better approach.

Generally it is easier inside QuickBooks to have one company per company file. You can combine them into one (with separate balance sheet accounts for each) but it is more work. Now all recent versions of QuickBooks for Windows support opening multiple company files at the same time. (Note, I use a mac but more frequently use QuickBooks in VMWare with Windows since that version from Intuit is the most mature product). Note, if you are using the online edition, you will need to have multiple subscriptions to have more than one ‘company file.’

If you want to take advantage of the Canadian Specific version of QuickBooks, then you’ll certainly want two company files. One for Canada, in the Canadian version, the other in the US version. You can probably get away with just using one (Canada or US) version of QuickBooks too. Check that your accountants can open whichever country file you send them.

Have a question? Contact the team at Landlord Accounting; we look forward to hearing about your QuickBooks and Landlording questions – or order our training and get answers right away.

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Q&A: Partial Security Deposit Payments in QuickBooks

P.J. wrote in asking how to receive security deposit payments over time, such as in a payment plan.

How do I properly track partial security deposit payments (Some of our tenants cannot pay full deposit up front—but might take an additional month to pay in partial payments).

We need a easy way to know at any given time how much they owe. I read how to setup the security deposit in your book—but I am unclear on how to determine how much they owe vs. how much they paid.

I can look at Chart of Accounts and see how much they have paid in Security Deposit—Current Liability account—but I cannot determine how much is remaining—any help would greatly be appreciated.

Great question. Fortunately, after reading other parts of the book you practically know the solution already. You’ll want to create an invoice and invoice the tenant (job) for the security deposit. The key is you need to create an item, just like the Rent Item, but it is a new item to post to this tenant’s security deposit sub-account.

Create the new tenant’s security deposit account:

create security deposit account - partial deposits

security deposit accounts - partial deposits

Create the item to use on the invoice for the security deposit.

quickbooks item for security deposit of a tenant

partial security deposit item lists

Invoice the tenant for the item, as in the rest of the examples in the book. Then go through the book’s normal receiving of payments process as the tenant pays things back. Receive payments as many times as they pay. Choose if you want (and are allowed) to impose finance charges to a late payment.

How much does this tenant still owe in their security deposit?

Look at the Customer center and see the tenant (job’s) current outstanding balance. Or, click Reports > Customers & Receivables > Customer Balance Detail.

If all of this seems complicated, we have a simpler way that works in most cases. Usually security deposits are paid upfront, so we teach a quicker method in our training. Also, we show instructions for combining the first month’s rent with the security deposit. There are many more screenshots (with detailed arrows) in our book than in the abbreviated instructions above.

Learn about our Landlording Training for QuickBooks or order our full guide today. Money back guaranteed, no questions asked, read about some of the thousands of happy customers.

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Q&A: Escrow Account for Mortgages

I recently received a question from R.C.

After reading your book How to Use Quickbooks for Rental Properties, I have a question about escrow accounts.

I set up a mortgage payment of $5300 a month. $4400 is principal and interest and $900 goes to an escrow account to pay taxes at the end of the year. When I look at the escrow account the payments show as debits and the balance is a negative number. At the end of the year I do a transfer from the escrow account to the bank account and then pay the property taxes? The transfer from the escrow account shows up a credit. Can you help me understand why this is from an accounting point of view?

Great question. Why is the escrow account balance negative? I predict it is the wrong account type. Also, probably you are writing your mortgage checks something like this:

escrow check payment for bank loan

The key is what type of QuickBooks account is the Escrow Account? Is it a liability, an expense, or an asset? Because you are accruing money in there that you will later use to pay an expense, it is an asset you own. Thus, in QuickBooks create it as an Other Current Asset account type.

other current asset escrow quickbooks

When you do it this way, you will have the correct balance for your escrow. (If it were a liability account, it would show a negative balance).

transactions by account

At the end of the year, you can record a Journal Entry for your total taxes paid from the escrow account, making sure to also record classes in all the line items.

pay property taxes from escrow quickbooks

It is likely you would actually have several line items on this journal entry. One for each property. You have a choice to also create sub-accounts for each property under the escrow account. Generally that is not needed, but if you want it is an option for more reporting granularity.

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Debits and Credits for Landlords in QuickBooks

When you’re a busy landlord using QuickBooks, you may just want to use QuickBooks and not have to think about journal entries, debits, or credits. And, generally the way we teach things, you can do that. However, sometimes it is very useful to think about transactions as Debits and Credits.

“Accounts” are just a collection of transactions that sum up to give a current balance. There are always two kinds of transactions that come into play: a debit or a credit. In the image above, you can see the shorthand notation used, a “T-account.” where debits are on the left and credits on the right.

It depends on the account type if a debit increases or decreases the balance

This is just the way accounting works. A cash account is an assets, and they increase with a debit; but liability accounts increase with a credit.

cash and liability T-Account quickbooks

The example transaction below shows the two accounts involved in creating a loan. It increases your cash, and increases your liabilities.

cash and liability T-Account example deposit a loan

In any given transaction the sum of all debits must equal the sum of all credits. Here 500 equals 500, perfect.

In QuickBooks for Mac, the Journal Entry would look like this:
mac journal entry

Or for Windows, it would look like this:general journal short term loan windows

The equivalent could also be a deposit like this. It is not a Journal Entry directly, but it creates one behind the scenes.
quickbooks make deposit mac

You can verify the deposit creates the equivalent Journal Entry by opening up the Petty Cash register and highlighting the transaction. Then click Reports > Transaction Journal. In the mac version the following opens up. It’s equivalent for windows or online.
transaction journal

Use this chart to help you remember if a Debit or Credit increases each account type’s balance.

Extracted from page 23 of our training guide, the below graphic is a quick reference when you need to make a Journal Entry. Consult it to review which account increases by a credit and which by a debit.

debits and credits T-Accounts quick reference

Read more about this is our free debits and credits excerpt from the eBook.

Leave a comment with more details of what you want to learn about, or order our full training today.

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Opening Balance Equity Account Explained

opening balance equity quickbooks Opening Balance Equity is an account that QuickBooks automatically creates under certain circumstances, most commonly when creating a new account and setting an opening balance.

How does Opening Balance Equity get a balance?

The following screenshot someone created a new checking account and set the opening balance here. That seems tempting, but it just defers the real work. (Later you’ll need to zero out Opening Balance Equity and record the actual account that gave this new account the opening balance.) The money came from somewhere else, so read below for the preferable way to enter all opening balances.

new account creates opening balance equity

It is an equity account, which means it sits alongside Owners Equity, Retained Earnings, Capital Stock, etc. You can see the current balance by looking in the Chart of Accounts, or click Reports > Company & Financials > Balance Sheet Standard.

opening balance equity balance sheet report

When Opening Balance Equity has a non-zero balance, you need your accountant to make end-of-year adjustments into other balance sheet accounts and zero it out.

How do you adjust Opening Balance Equity to zero?

It could be as simple as a two line item journal entry from Opening Balance Equity to the actual balance sheet account that “funded” the opening bank account balance. Generally, it is one journal entry, just sometimes many accounts are involved.

Other times it is not that simple. There may be multiple sources of the Opening Balance Equity balance. And it takes your accountant’s help to correctly allocate them to the right accounts depending on which owner contributed them and whether they happened in the current, or a prior, year.

If you only entered the beginning bank balance during the set up of the bank account in the chart of accounts, you may have a simple fix. Quickbooks automatically offsets the amount in the Opening Balance Equity account. Since the beginning amount is generally from prior period activity, do a Journal Entry to retained earning to zero out the Opening Balance Equity. It could be that simple. Or, it could need to go to the member’s Equity account, or split among several owners.

Recommended steps for creating a new company file, preventing any Opening Balance Equity.

Thanks to fellow QuickBooks ProAdvisor Laura D. for sharing what she does with a new company file and existing data:

  1. If you have an accurate trial balance from a previous month/year, enter it as one journal entry. (Do not enter any opening balances when setting up new accounts in the chart of accounts.)
  2. Start your journal entry with a blank line.
  3. For the Checking account, enter only the reconciled bank statement amount in that journal entry.
  4. Enter all other Balance Sheet accounts except Accounts Payable and Accounts Receivable.
  5. Enter your Profit & Loss accounts.
    1. If you want your income/expenses by class, you can enter each year-end amount on a separate line in order to attach the class to it. (Following our training, you will want to do this for each property’s class).
    2. If you want your income/expenses by job, you can enter each year-end amount on a separate line in order to attach the job name to it. (As landlords, you don’t want to do this).
  6. Let the variance hit Opening Balance Equity.
  7. Then, enter any outstanding checks/deposits and hit Opening Balance Equity. (Use the write checks/make deposits windows).
  8. Then, enter Unpaid Bills and Open Invoices, one at a time with the vendor/customer name, offsetting Opening Balance Equity. (Use the enter bills/create invoices windows – you will have to set up an item which points to Opening Balance Equity for the invoices).
  9. When you complete these three steps, your Opening Balance Equity should be zero.

This will give you the detail of outstanding checks/deposits so that you can reconcile next month’s bank statement.

This, also, will give you an accurate A/P and A/R with enough detail to move forward in paying bills and receiving payments.

Hopefully, the LandlordAccounting.com blog is helpful to you. Read more, or order our full training for Landlords in QuickBooks today.

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Calculate Cap Rate in QuickBooks

calculate the cap rate for landlords in quickbooks Calculating Cap Rate (Capitalization Rate) for real estate investments is straightforward. We previously explained cap rate for real estate investors and landlords. Recall that Cap Rate = Net Operating Income / Value.

Here’s how you calculate the Capitalization Rate for one of your rental properties in QuickBooks. This uses the Sample Data File included in our training course.

Step 1. Find the value of your property. Check the Chart of Accounts for the property’s value. Since we keep depreciation in a separate contra-account, you can grab the value that you see without adjustment. Here we will compute the cap rate for a duplex, 3304 Covenant.

The value is $90,000.

Step 2. Go to the Reports menu and choose the LandlordAccounting.com memorized reports menu. Choose profit and loss by class and filter to only show the 3304 class and sub-classes.

The Net Adjusted Income for this property is $8,362.57.

Step 3. Calculate the Cap Rate. In our example that is $8,362.57 / $90,000 = 9.3%.

Questions? Contact us, or leave a comment below. Want to quick start your real estate investing? Purchase our full training today, with a money back guarantee.

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Return to the blog for more articles on QuickBooks landlord accounting and real estate investing.

How to Import the Sample Company and Template File (QuickBooks Online Instructions)

Previously, we explained for Windows and Mac users how to import the training files you purchased. Now, we break it down for users of the Online versions of QuickBooks.

Step 1. Email us requesting the online edition data files. They are not currently in the members only area because most customers still use the desktop versions of QuickBooks.

Due to QuickBooks Online limitations, you must use Windows and Internet Explorer for importing. Read more about how to work around this if you only have a Mac.

Step 2. Log into QuickBooks Online. It is important to note that having multiple online company files requires multiple subscriptions. With only one subscription, you can create and delete many company files, trying new things each time. But, you may only have one active company at a time, and delete any existing company file so you can import the sample company.

If you must delete an existing company file, here’s how:

Log into your old company and click the dropdown in the top right. Go to My Apps.
go to my apps to cancel quickbooks online to create a new company file

Go to the Manage My Apps tab and click Cancel subscription.
confirm to cancel quickbooks online to create a new company file.jpg
Confirm you want to do this.
Cancel Subscription - YourCompany, LLC Sample Company File - QuickBooks Online Essentials-1

Then go to http://quickbooksonline.intuit.com/ to sign up for a new account, at whichever cost level you want. (Try the free trial to learn if it will work for you.) For more help deleting and creating a new company, read this. (If you are paying, you won’t have to pay any more because this new account will replace your previous account).

Step 3. Logged into a brand new QuickBooks online company file, choose to Import QuickBooks Desktop Data.

import quickbooks desktop data

Upload the the special online edition file that we gave you. When prompted, if you want to view sample transactions, choose to import everything, if you want a template just import the lists.

You may need to wait a short while once you imported the file before it is available to use. Check for an email from QuickBooks when your file is ready. When it is imported (it only took a few minutes for us), explore all of the data and transactions you now have.

quickbooks online after landlordaccounting import

When it is time for you to create a real company file, you can erase all this data, or go through the import process again. Questions about landlording and QuickBooks? Contact us, we’re glad to chat.

Want to start learning today with our custom landlording training? You can buy our full training with hundreds of pictures explaining everything.

Entering Landlords’ Historical Transactions in QuickBooks

If you are starting a new QuickBooks company file for an existing company, you probably want to enter all those old transactions from the company into QuickBooks so that you can track current performance versus the past. For many landlords’ businesses, this is the right approach, and we will present two methods to quickly enter these historical transactions.

But for other businesses (especially the very small) it may make sense to cut over to use QuickBooks and leave historical reporting in your old system (Quicken, Excel, etc). If you create summary reports and some spreadsheets you can get a lot of the benefit of comparison, but less effort in migrating the data.

Forms method to ender historical transactions in QuickBooks

First, you can re-enter every transaction using the forms and windows you would normally. (Create invoices, receive payments, etc.) This is a great way to learn how to enter new transactions into QB’s. We recommend it for everyone to try, even if only to scrap that company file, as you learn much about how to do property management in QuickBooks by entering actual transactions.

If you do this, the order you enter the transactions is important, do it in the following order.

Enter Accounts Receivable in this order:

  1. Invoices
  2. Statement Charges
  3. Cash Sales
  4. Returns
  5. Customer Payments
  6. Deposits of customer payments sales tax payments

Enter Accounts Payable in this order:

  1. Bills
  2. Credits from vendors
  3. Bill Payments

Enter historical payroll txns.

Enter bank and other txns in the following order:

  1. Checks (do not duplicate bill payments)
  2. Deposits (do not duplicate customer deposits) bank fees and transfers
  3. Credit card transactions

Reconcile each bank account for each month as you go. Getting each month perfect will save a lot of time versus having to reconcile many months at once.

Summary journal entry method (“monthly rollup transactions”) to enter historical transactions in QuickBooks

This method is more useful for quickly entering your transactions, but only gives transaction data on a monthly rollup level.

Enter all historical transactions by creating a summary journal entry for each month between the start date and current date. Each entry will have the net impact of the month: rent receipts, maintenance (per property/class), capital investments per property’s asset account, owner draws, etc. You can enter in on the first of the month, for all transactions that happened each month.

Remember, even though this is not entirely accurate, it gives you a granularity that enables year over year monthly comparisons. For some people this is helpful enough, and potentially faster to calculate these net transactions from their old system than enter everything individually.

Reports to verify correct entry of old transactions into QuickBooks.

There are several reports you can run after migrating the data to ensure your new company file has the correct information.

  1. Run a Balance Sheet report as of the start date to verify beginning account balances.
  2. Generate a Profit and Loss report for periods since start date to verify historical transactions.
  3. Create an Open Invoices report and verify accounts receivable as of the start date.
  4. Use the Unpaid Bills report to verify accounts payable details as of the start date.
  5. Verify inventory by running inventory valuation summary report (probably not applicable for rental property companies).
  6. Run the Payroll Liabilities report to verify payroll liabilities detail as of the start date.
  7. Use the Payroll Summary report to check year-to-date payroll transactions.

We hope this helps, remember at Landlord Accounting you can learn more about tracking rental properties in QuickBooks and invest in our training.

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