Rental Property Accounting 101: Setting Yourself Up for Success
You have scoured your market, stalked the MLS, and networked with wholesalers to find the ideal rental property. You carefully researched comps and local rent trends to make an informed offer. You navigated financing, inspections, and surveys to successfully close. Congratulations! You’re a rental property owner.
Now, you can start to reap the rewards of your hard work. However, that doesn’t mean the job is over. You need to manage tenants and maintain the property, or pay someone to do so on your behalf. And last but certainly not least- you need to maintain good records and accurately track your income and expenses in order to file taxes.
This last segment of responsibilities- broadly referred to as accounting or bookkeeping for your rental properties- is what this article will focus on. We will lay out the basics of what you need to know (or what you need to discuss with a professional) so that you can move forward with confidence.
Why Bookkeeping Matters
Bookkeeping and accounting are central to running a small business, including a rental or real estate investment business. It is very difficult to operate for long without a solid understanding of your finances.
Good bookkeeping ensures that you don't miss deductions and keeps your numbers organized- saving you money on your taxes and stress in preparing them. Good bookkeeping helps you see where your money is going and how your investments are performing- allowing you to make smart, data driven decisions. Good bookkeeping gives lenders insight into your financial house- making it easier to attain financing for your next investment. Need we go on?
Should Your Keep Your Books Yourself?
Whether you are keeping your own books or have help, it is important to remember that understanding your financials is the key to knowing the health of your business.
Most investors keep their own books when getting started in rental property investing. With just a unit or two proper bookkeeping should not be hard, and by starting out tracking your own income and expenses you learn some valuable lessons. You learn where every dollar is going and stay connected to the ebb and flow of your new small business (yes, renting property is a small business and you need to treat it as such). You learn about what impacts your financials, what you can and can not deduct, and gain a better understanding of whether or not bookkeeping is a task that you want or need to outsource.
Once you have more than a few units, everyone is going to have their own individual point where outsourcing monthly bookkeeping begins to make more sense based on unit count, transaction volume, and personal preference. Options range from bookkeeping firms, to part time CFO’s, to full-time employees. Outsourced bookkeepers are not inexpensive, but neither is turning over poorly organized books to your tax preparer at the end of the year. Monthly costs can range significantly.
Setting Yourself Up for Success
Maybe you’re closing soon on your first rental property and want to get your books set up right from day one. Maybe you already have a sizeable portfolio, but still don’t have a business bank account. Maybe you have no idea how your investments are performing outside of what your accountant tells you one time a year.
Whatever your circumstance, you want to structure your books in a way that:
Saves you as much money, time, and stress as possible
Is prepared for your portfolio to grow, and can be managed personally OR be easily outsourced
Provides meaningful performance information and business intelligence for you to make smart, data-driven decisions
So you turn to your real estate mentor, a trusted family member, your financial advisor, or the internet and ask how you can accomplish all of the above.
HERE IS OUR ANSWER & BASIC GUIDE TO SETTING YOURSELF UP FOR SUCCESS:
1) Keep Your Business & Personal Finances Separate
Maintaining a clear separation between your business and personal finances is the bedrock on which the rest of this list relies. The easiest way to accomplish this separation is to open a separate business bank account, and ONLY use that account for activities related to your rental business. It’s that simple!
We don’t mean to say that you can’t keep good books without a dedicated business bank account- we are just saying it is harder, riskier, and inherently not able to scale with your portfolio.
The biggest benefits of separating your business and personal finances include:
Saving money and time. When all your rental transactions are in one account, you can easily make sure you are claiming all of your expenses. Business expenses you do not claim means paying more in taxes than you should.
Allowing you to scale. If you don’t have separate accounts, it can be easy to miss deductible expenses even when you have 1 or 2 units. If you have 12 or 20? Forget about it. Additionally, if you ever want to outsource your bookkeeping, a separate business account will be a requirement.
Protecting your assets. Comingling business and personal finances pierces the veil of any corporate structure you may utilize- leaving your personal assets in danger of being frozen or on the table in case of a lawsuit.
Read our full article on separating personal and business finances here.
2) Use Accounting Software
Now that you have a separate bank account for your rental investing business, choose some form of accounting software and link that bank account to it. Most small business accounting software platforms can be used for rentals, but they usually require extra set up for real estate. Accounting software can:
Save you time and manual data entry by automatically importing transactions from your bank account
Give you an accounting framework to work within and keep you organized
Store receipt images alongside your transactions
If you want accounting software that has already been set up for rental property and real estate investing, check out an industry specific provider like (yours truly) REI Hub.
Read our full article on how accounting software can help here.
3) Align Your Expense Categories with Your Reporting Goals
All real estate investors HAVE to keep accurate books so they can report their income and expenses to the government and pay taxes. Savvy real estate investors also WANT accurate books so they can understand their business, objectively evaluating their portfolio, and make smart decisions with good data.
Setting up your chart of accounts in a forward thinking fashion can make both of the above goals easier. If you know you’re going to have to file a Schedule E- just use the exact expense categories from the Schedule E from day one so you never have to change or re-categorize transactions. Similarly, if you know that you want more granular data about where your money is going than a very broad ‘Cleaning and Maintenance’ category can provide, go ahead and set up sub accounts underneath Cleaning and Maintenance for ‘Turnkey Unit Cleaning’ and ‘HVAC Repair’ and ‘Plumbing Repairs’ so you can easily access that data, while still maintaining the easiest possible reporting.
You also want to be able to segment all of your reports out on a property by property basis. In most non- rental accounting specific softwares, this is done with classes or tagging.
Read our full article on how to set up your chart of accounts.
4) Consider an LLC
Forming a limited liability corporation, or LLC, to hold your rental property in is a common way to draw clear lines between your assets, and thus de-risk your portfolio. If you own a property in your name and are sued, your personal assets (in addition to the property in question) are not protected or shielded in any way from the lawsuit. But if you hold that same property in an LLC, and have maintained separation between the LLC and your other assets through disciplined recordkeeping, your personal assets, as well as other business assets held in separate companies, would not be at risk in a lawsuit.
In addition to the risk reduction and asset protection offered, LLCs provide tax flexibility. You can choose to be taxed at the corporate level, or elect for pass through taxation, where your rental income and losses come through to your personal tax return. However, its not all sunshine and roses, and an LLC does come with costs, additional to-dos, and some downsides.
Read our full article on the advantages and disadvantages of using an LLC for your rentals.
A Note on Tax Preparation
Keeping your own books is not the same thing as filing your own taxes. Most real estate investors work with a qualified professional CPA or tax preparer. In addition to making sure taxes are filed appropriately, they are often the best person to consult on specific considerations for your unique tax situation and can provide advice on how to structure your investments legally and financially. For those seeking a DIY option, the most common home tax preparation software packages now also include real estate schedules.
It is important to remember that even if you seek professional help at tax time, your advisor will still base your returns on your records from throughout the year. You are responsible for providing accurate records for your business activities. They are responsible for arranging them and submitting your return.
Conclusion
Bookkeeping and accounting doesn’t have to be hard! Thinking about your goals and being intentional in structuring your books will pay huge dividends of time savings, maximum deductions, and a stress free tax season.
Last updated: September, 2020
