A Clean Start: Bookkeeping for Real Estate

Let’s face it – most new business owners are not financial professionals. So one of the most nerve-wracking tasks they face is setting up the necessary accounting books. And as with any industry, real estate will have its own bookkeeping nuances to consider.

Having a clean set of books allows for real time internal financial analysis and up-to-date information for your advisors. It also ensures your CPA has accurate numbers at tax time and you can provide financials to a bank when requested. So we’ve put together the basics to help you set up your accounting books with a real estate emphasis.

The most common accounting software today is QuickBooks online, so we’ll be using this software for our examples. However, other common software programs likely have the same or similar features (just under different names). Most accounting software walks the user through the initial setup, but it never hurts to understand the basics.

Chart of Accounts

The Chart of Accounts is the technical term for the list of categories used to organize transactions for your business. Having a comprehensive list of categories is important to accurately report your transactions. Coding all expenses to something vanilla such as “business expenses” relays no useful information.

Additionally, the IRS requires a minimum set of categories to be utilized on tax forms. This is the bare minimum required when categorizing transactions. Too many categories conversely causes clutter, making it difficult to perform analysis on reports.

Here are the general account types under which your more detailed categories will fall.

Assets categories represent resources owned by the business. These could be cash held in the business, receivables due from tenants or buildings generating business revenue.

Liability accounts represent obligations to third parties. Examples include mortgages on the buildings, credit card debt and loans to the business from you or investors.

Equity type accounts commonly represent your equity balance in your company. They can also show your movements of money in and out of the business. For example, taking profits out of the business is not an expense but rather a distribution of equity. Adding cash resources to the business is not taxable income to the business; it’s considered an owner contribution.

Revenue — often our favorite and most straight forward category — represents income generated from business activity. The two main categories in the real estate industry are collecting rents and property sales (or flips).

Cost of Goods Sold includes expenditures directly related to generating revenue. This usually has more to do with a business selling tangible items. All costs directly associated with the production of these items would be categorized as such. In the real estate industry, expenses tend to be more operational and general. So chances are you won’t use this much (if at all).

Expenses are exactly what the word says — money your business spends on business-related activities.

Many accounting software programs come with a starting chart of account. An example of what this may look like is provided here. This is a great starting point or guide as you organize your own chart of accounts.

Breaking it Down Even More

We don’t recommend creating revenue or expense categories specific to units or properties (for example, a “rents collected” account for each property). While this may make sense in the beginning, maintaining this practice becomes increasingly burdensome as units are added. However, having a fixed asset category per unit makes sense. This allows for easier tracking of capital expenditures (more on that later).

You can do this using a QuickBooks feature called Classes. (Other software may call this feature by another name, such as Funds.) In QuickBooks, the Class field adds another space to additionally categorize a transaction. An expense transaction with Home Depot can be recorded to a universal category called Supplies. Often, we are not just buying supplies for one unit. With Classes, this one transaction can be allocated to as many units as necessary. Effectively this simplifies the necessary upkeep on the chart of accounts.

Additionally, sub-classes can be used to add another layer of organization to your bookkeeping. For example, if we wanted to categorize commercial vs. residential or by region or county, properties and reports could be further segmented along logical lines.

There are additional methods for organizing how data is treated in the accounting software. For example, QuickBooks Online allows the use of tags. This facilitates an additional identification for each transaction (on top of category and class). However, if classes and categories are fully set up, this feature becomes redundant for your real estate business purposes.

Linking Bank and Credit Card Accounts

Most software solutions provide a way to link your accounting software to your bank and credit card accounts. This introduces a fantastic level of automation to the bookkeeping process. Transactions are added to a queue in the accounting software as they clear the account. Those already in the queue have the basic information filled out automatically (date, vendor name, etc.) Usually, the only step to take is to fill in the category and click Add to post to the books.

Some bookkeeping software also allows you to create rules to further automate the process. For example, Joe Smith is a vendor who performs maintenance on your units and is paid on a regular basis. A rule can be set up that detects when Joe is the vendor (if he’s paid electronically) and automatically categorizes his payment to Contractor Expense, Repairs, etc. Rules can be set up to key off the amount of the transaction or the vendor name that shows in the memo description.

You can also set the rule to post to the books automatically — removing all manual inputs completely. However, we don’t recommend this when your business is first getting started. By having the chance to review the transactions before posting manually, you give yourself a trial period where we you ensure the other rules are working as intended. After a month or so with no manual changes to the transactions with rules applied, feel free to turn on the auto add feature.

Common Real Estate-Specific Transactions

With all of the above set up in our accounting software, you’re now ready to begin recording transactions. What might you see at your real estate business?

Repairs and Maintenance captures the day-to-day upkeep and repairs associated with maintaining properties/units or restoring the original state of the asset. This category should not be confused with large expenditures like remodels or new roofs, which are considered improvements. These expenses occur relatively frequently and predictably. Typical examples include:

• Lawn maintenance (some prefer this as its own category, depending on the level of detail desired when reviewing per unit profitability)
• Painting
• Plumbing (however, replacing a house’s plumbing entirely would be a capital expenditure and not an expense)
• Handyman or contractor for small jobs

Capital Expenditures/Repairs includes large transactions that typically better the asset, improve it or increase its expected life. Capitalized assets usually have a useful life longer than a year; an example would be a new roof.

Capitalized means the expense of the purchase will be recorded over the life of the asset instead of right away when the purchase was made. For example, that new roof might have a lifespan of up to 25 years. The IRS and general accounting principles require the cost of the new roof to be spread out over that time. So you’ll record the expenditure to an asset category and not an expense category. Your CPA will then correctly depreciate the asset so the expense is spread out across the life of the asset.

And don’t forget the $2,500 rule. An expenditure over $2,500 typically needs to be capitalized and depreciated; otherwise you can expense it. However, a project like a remodel would have many transactions under $2,500. Can we expense them all since they are individually under $2,500?

The IRS rules say no. If the overall project runs over $2,500, we will need to capitalize all of those expenditures. Under our assets listing, set up a category for each unit called improvements to record these transactions. Once the project is complete, the asset is in use and your CPA will begin depreciating it.

Mortgage payments or debt service payments can also be tricky to record correctly. Mortgage payments consist of debt, interest and potentially an escrow amount. Make sure to add these additional categories to the mortgage payment when posting from the bank feed.

The rest of the expense transactions a typical real estate business is likely to incur are straightforward to record. Paid for a license or a permit? You have a category for that. Bought some supplies not part of a project? You’re good to go.

Rent income transactions. Recording rent received may depend on how you’re billing and receiving payments from customers. If you’re not invoicing tenants directly from the accounting software, then your bookkeeping process is simple. Money received by the bank account can be categorized as rent income in the bank feed queue. Just as with expense transactions, be sure to fill out the class portion to record the rent for each unit. If using a real estate property management software suite instead of (or in addition to) accounting software, you should still set up tenants/customers.

Invoicing directly from the bookkeeping software requires some additional setup. In QuickBooks, for example, set up each tenant as a customer. If invoices are being sent by email, be sure to add that information as well.

Next, we need to set up Products and Services, which is used when creating an invoice. The service used is what the client sees on the face of the invoice. Behind the scenes, each service is linked to an income category of your choosing. We suggest having a service set up for each kind of income category you would like to see on the income statement/profit & loss report.

Here are a few examples:

• “Monthly rent” service item is mapped to the revenue category “Rental Income” which is viewed on the profit and loss statement.
• “Pet fee service” item is mapped to either “Pet fee income” (make a new category in the char of accounts) or “Rental income” if that level of detail is not desired.
• “Nonrefundable deposit” service item is mapped to “Nonrefundable deposits” income category or “Rental income”.

Note that refundable deposits are not income and may need to be repaid to the tenant in the future. This item should be mapped to a liability account called Refundable Tenant Deposits.

Purchasing a Property

Recording the purchase of a property could be a full article all on its own. Here we’ll review how to record the related transactions likely to show up in the bank feed queue. For each property purchase, be sure to set up a fixed asset category and a class ahead of time.

• Earnest money deposit – An advance deposit required to be remitted ahead of closing on the property. Categorize this transaction to the fixed asset category set up previously.
• Cash to close – Assuming this is not a 100% financed purchase, cash to close will be required. Once the transaction clears the bank feed and shows up in the queue, record it to the fixed asset category
• Expenditures made to get the asset ready for its intended purpose (renting it out) – These should also be added to the fixed asset account. Once the unit is ready for rent, you can record operational expenses to their respective normal categories instead of the fixed asset. (A good benchmark of unit readiness is when you start advertising it as available.)

It will take some time (and adjustments along the way) to get your accounting books set up initially. But when it’s done properly, your real estate business will be better for it in the long run.

While this can serve as a guide, every business is different. So we strongly recommend reaching out to a real estate CPA. Since they’re well versed in the needs of businesses like yours, they’re a great guide when it comes to bookkeeping setup!

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a James Moore professional. James Moore will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.