The Rental Property Balance Sheet
Do I need a balance sheet for my rental properties?
Many investors don’t think about their balance sheet as they begin to track the operating income and expenses from their properties. However, your balance sheet records the basis of your properties, which you or your CPA will need to calculate your annual depreciation expense at tax time. You’ll also need it to file taxes upon the sale or 1031 exchange of a property. Finally, your balance sheet provides a snapshot of other metrics for your business’s overall financial health like security deposits held, outstanding mortgage principal, and cash distributed to owners.
A complete record-keeping system should be capable of producing a balance sheet; it is one of the three core reports in accounting.
How do I set up a balance sheet for my rental properties?
What is the difference between owner's equity on the balance sheet and the market value of my equity?
When real estate investors say “equity”, they are typically referring to the market value of their properties minus loans outstanding - not owner’s equity on the balance sheet.
The balance sheet shows the book value of your business assets at a particular point in time, as well as how they have been financed through a combination of liabilities and owner equity. However, in real estate this picture can be incomplete. Properties are added to the balance sheet at cost the time that they are purchased and only change value via depreciation expenses and capital improvements. The book value and market value of an asset (and its associated equity) will start out the same but gradually grow more and more different over time. Price appreciation or depreciation due to market conditions is not included on the balance sheet, and the book value of properties generally declines year over year - potentially even reaching $0 at the end of their IRS-determined useful life.
Tracking the book value of assets is necessary for depreciation and capital gains calculations, but a market value of equity report can provide better information on the current value of your assets and the equity which you could cash-out if you were to liquidate your portfolio. Using the market value of your equity is a better lens for how real estate is contributing to your net worth and for calculating the rates of return which your investments are generating.
Adding real estate to the balance sheet
- The property’s tax assessment is used to determine the percent of the purchase price to be allocated to land versus buildings, each of which is debited on a journal line. This allocation is important because, tax-wise, land does not depreciate; buildings do.
- Certain closing costs are also added to your basis with a debit to capitalized closing costs.
- Additional closing costs may be debited as expenses flowing through to the P&L.
- The starting loan balance is set with a credit if you’ve obtained financing for your purchase
- The cash due at closing is either credited to a bank account or an owner contribution.
Conclusion: Your balance sheet is important but doesn't show your true equity
Last updated: January, 2021