March 13, 2018

The Ultimate Guide to Real Estate Accounting

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As a property manager, you probably know that there are a lot of moving parts to real estate accounting. Especially in this industry, bookkeeping tasks can be very tedious because of the large number of state regulations and myriad of transactions.That's why organization is the key to managing real estate accounting books.

So what do you need to get started? Well, you need a standard process to collect financial information. You need to choose an accounting method. You need to create a consistent filing and tracking system. You need to know how to pay your employees and your contractors. And, periodically, you need to be able to use the financial information you collect to analyze your processes and measure how profitable your properties are.

Yeah, there's a lot. But you're brave and intelligent and willing to learn, which is why we've created The Ultimate Guide to Real Estate Accounting!

Who uses real estate accounting?

Real estate accounting is used for property management. When you work in real estate, you deal with large sums of money, and it’s important to understand how to manage these transactions.

You should be familiar with real estate accounting if you:

  • Run a real estate agency
  • Manage real estate for clients
  • Handle the accounts of a housing association
  • Run a building construction firm
  • Manage an investment trust
  • Provide residential sales

Knowing how to do real estate accounting will help you run your business better and understanding how to manage your books allows you to track progress. You can see if you’re making a profit and which properties perform the best. It also helps you compare year-to-year growth, know how much cash you have on hand, prepare your tax return, and pay bills on time.

Sometimes, it’s hard to set aside time for managing bookkeeping. But, real estate accounting is a necessary part of property management for keeping up with financial records, catching issues and seeing growth opportunities.

The Ultimate Guide to Real Estate Accounting

Real estate bookkeeping can be difficult and time consuming. You must follow many state-mandated rules and handle large transactions.

By learning how to complete some real estate accounting tasks, you can reduce the number of hours an accountant spends on your books. Take a look at the following tips about real estate accounting.

Find out your administrative code rules

First and foremost, property managers must follow guidelines for financial management. These guidelines are created by the local real estate commission or state agency.

Your real estate guidelines should shape your accounting practices. Make sure that your real estate accounting books follow the rules administered by your state. You might want to ask a financial professional who specializes in real estate to help you get started with this.

Administrative codes can sometimes be difficult to understand, so make sure you read them thoroughly before you do any bookkeeping. Also be sure to stay informed on any changes in your state’s codes.

Choose an accounting method

You can choose between two accounting methods to complete your books: cash basis or accrual. The two methods use slightly different rules for recording transactions. 

Cash-basis accounting is a simple method for tracking transactions. You make one entry each time physical cash is exchanged. Record income when you receive it (e.g., someone pays you a deposit) and expenses when you pay them (e.g., you give a contractor a check for repair work).

Accrual accounting is a little bit more difficult than cash basis. You record at least two entries for every transaction. The entries are equal but opposite, which helps ensure that your books are accurate. Record income when you incur it (e.g., you send an invoice) and expenses when you incur them (e.g., you receive an invoice).

There are advantages and disadvantages to accrual vs. cash-basis accounting. Some businesses are required to use accrual accounting. Do some research before selecting a method of accounting. Then, familiarize yourself with how the method works and the basic terms used.

The IRS knows your accounting method by looking at your first business tax return. If you want to use a different accounting method, you must request the change with the IRS.

Get a system for recording entries

There are several ways to record transactions in your books.  If you can afford one, you might hire an accountant or bookkeeper who offers real estate accounting services; however, most professionals with smaller operations use accounting software for making accounting entries. Compared to using spreadsheets for your accounting, accounting software is designed to simplify, organize, and easily showcase all of your company's transactions.

Additionally, many accounting software programs are cloud-based. This means that you can access, update, and modify your information from anywhere with an internet connection.

Set up your chart of accounts

You need a chart of accounts to record and organize your accounting journal entries. A chart of accounts lists every real estate transaction you make. You can use the chart of accounts to create reports, measure performance, and locate historical transactions.

When setting up your chart of accounts, ensure to create different categories - or "accounts" -  for different transactions. For example, you might have accounts called “Repairs,” “Insurance,” “Management Fees,” and “Advertising.”

Every time you make a transaction, enter it under the appropriate account. Include additional columns to give more details about the transaction. Write a small note for each entry so that you know what the transaction is for. Also be sure to include which property the entry is for.

Update the chart of accounts often for accurate records. Make sure you record every transaction and calculate correct balances for each account. The chart of accounts can be used to create financial reports and track financial health.

Separate personal and business funds

Use a separate business bank account for real estate transactions. That way, all the money for your business is one place. You can easily look at your bank statement to find information about which transactions have processed and which are still pending. If you don't have separate personal and business accounts, deciphering which transactions are personal and which are for real estate can be difficult. The confusion causes several issues, including:

  • Disorganized books
  • Inaccurate tax returns
  • Poorly managed cash flow
  • Missed growth opportunities

By opening a separate account, you can better manage your business transactions and stay organized.

It's also worth noting that having a separate business bank account also makes you more credible and professional in the eye's of your clients. This way, clients can write your property management name on checks rather than your personal name. This improves your image and makes your business more reputable.

Organize documents

Keep supporting documents to compare to your accounting books. You can go back to these documents to solve discrepancies. Organizing your real estate documents helps you manage records faster and more easily.

Some important documents to keep on file include:

  • Invoices and receipts
  • Bank statements
  • Credit card statements
  • Tax returns
  • Insurance information
  • Contracts
  • Leases

You can maintain documents in hard-copy or digitally, whichever you prefer. Whichever you choose, the important thing here is to establish an organized filing system for keeping track of your finances, as you may need to locate them down the line. When storing files digitally, ensure you are using a secure platform so that your sensitive information is safe.

Fine tune collections

For any growing business, one of the most difficult things to stay on top of is payment collection. If not organized properly, this can be a difficult, time-consuming activity. Luckily, there are a few ways that you can expedite this process.

The first key is to create effective payment terms on your invoices. The terms you give affect how quickly and frequently you get paid, and can also dictate which payment platform is used. Use the following tips to improve your invoice terms:

  • Include all necessary parts, such as contact information, the due date, and the amount owed.
  • Shorten your payment terms to get paid faster.
  • Number your invoices to keep track of outstanding bills.
  • Send invoices promptly to speed up collections.
  • Have a process for flagging and contacting delinquent payers.
  • Be polite when speaking with clients.
  • Split large bills into multiple payments.

As with many administrative tasks, there are technologies that can help you ensure effective payment collection. For example, Contactually allows you to create custom emails and automate personal messages. With their contact management software - designed specifically for real estate professionals - you can automate reminders of upcoming payment dates, or inform your client that they are behind on a payment.

Reconcile your bank account

Staying on top of your transactions is one thing, but you must also validate that theses transactions are being reflected in your bank account balance. To ensure accuracy, you should reconcile your books with your bank account on a monthly basis. Through this reconciliation, you can identify any gaps in your transactions, and also flag any outstanding payments. 

Through this reconciliation process, you should make sure that the balances are the same. Check for accounting mistakes, bank errors, timing delays, and other gaps that could be causing discrepancies. Use your supporting documents to verify correct entries.

Paying your workers

If you business is growing, there's no doubt you'll need extra help managing your properties. You might hire agents, salespeople, or contractors. You need to properly classify your workers as employees or independent contractors. Mis-classifying a worker could lead to costly audits, back wages, penalties, and interest.

So let's clarify. When you classify someone as a contractor, you do not deduct taxes from their wages or pay employer taxes. Contractors also don’t benefit from FLSA rules on minimum wage and overtime pay. You do, however, deduct taxes from wages and pay employer taxes for employees. To make sure you classify workers correctly, use the U.S. Department of Labor’s six-part economic realities test, follow the IRS’s requirements, and learn your state-specific rules.  

In real estate, some of your employees might earn a commission, so make sure you understand how to pay them. A commission is paid in addition to regular salaries. It should be included on an employee’s paycheck according to a separate monthly or bi-monthly schedule. You must withhold taxes from commissions.

Ask a pro

Real estate accounting comes with a lot of different regulations so it’s a good idea to consult an accountant periodically to help you manage your finances.

Talk to a financial professional who specializes in real estate accounting. Along with following the rules, a real estate accounting firm can help you choose a business structure, avoid unnecessary spending, and create reports.

(Guest post by Tony Mastri of Patriot Software)