Investing in rental property is a great way to generate passive income. Practicing efficient bookkeeping methods will help generate the most profit from your rental property and enable you to reap the most in tax benefits.
Why is rental property accounting important?
Rental property accounting is important for several reasons. It will help you track your investments on each property so that you can compare profitability between rental properties.
It’s also an important factor when it comes to analyzing not only the income, but also the expenses on each property. This accounting system will serve as a guide on how to increase revenue and strategically reduce expenses. It will also serve as a timeline to make sure that all expenses are paid in a timely manner.
Rental property accounting also enables property owners to create financial statements so that they can track to see how their rental property is performing on a monthly basis. These monthly financial statements will make it much easier to complete their tax returns when tax season rolls around.
What are the basic principles of rental property accounting?
No matter how many rental properties you own, there’s a lot to keep up with when managing any kind of property. The following basic principles will help you develop an efficient rental property accounting system for your real estate business.
1. Separate bank accounts
In rental property accounting, you should do everything you can to ensure that your rental property business doesn’t mix with your personal affairs. Separate your business and personal finances by opening separate bank accounts for each. For your business, open separate accounts such as a checking account, a savings account, and credit cards. Business savings accounts are a good place to set aside future rental property expenses and security deposits.
2. Separate property accounts
As part of your rental property accounting system, you should open separate accounts for each rental property that you own. If you create a bank account for each individual rental property, this will make it much easier to track transactions by property. Income and expenses will be separated on a per property basis which makes it easier to prepare individual financial reports by property, file taxes, and know which properties are performing well and which aren’t.
3. Expense tracking
Setting up separate accounts for each rental property will make it easier to track expenses per property. You’ll need a system to track the expenses whether it’s an expense worksheet or tracking expenses through rental property accounting software. This too will make it easier at tax time and to see if there are areas where you need to cut back on expenses.
4. Cash vs accrual accounting method
Another important step in setting up a rental property accounting system is choosing which method of accounting to use. With the accrual method, expenses and income are recorded as they occur. With the cash method, expenses and income are recorded when the cash is paid or received.
Smaller businesses typically use the cash method so that they can see the amount of cash on hand at any given moment, while larger businesses typically use the accrual method to provide a better picture of income and expenses over longer periods of time. Determining which method to use depends on personal preference and what works best for your business.
5. Digitization for organization and decluttering
It’s highly recommended that rental property businesses digitize such things as receipts with rental property accounting apps. You can do this with scanning applications such as Shoeboxed. Digitization declutters your office by organizing your receipts digitally and makes it much easier to access specific receipts during tax time or audits.
6. Automate with accounting software
There are a lot of good options out there when it comes to accounting software for real estate investors. One way to make your rental property accounting system efficient is to automate your rental property needs with accounting software. This software has accounting features such as automatic payments, automatic withdrawals, and automatic reminders.
There are other advantages to rental property accounting software as well. It can help you track rental income on your rental properties, track business expenses, keep track of tenant rent payments, generate company financial reports, payment tracking, and accounts payable. Accounting software will make this process easier, less tedious, and more accurate.
7. Forecast future expenses
It’s important to use past data from rental properties to forecast future expenses. Rental properties come with a lot of unexpected and fluctuating expenses. It’s essential to set aside a percentage of your rental income into savings as a buffer each month to cover these expenses.
8. Understand your basic tax forms
Make sure that you are familiar with applicable tax forms associated with rental properties. Learning about the basic tax forms and what they are used for will make the rental property bookkeeping process run more smoothly. This will especially make tax time a little easier. Schedule E is one such tax form. We will discuss this form a little later in this article. Penalties for not filing tax forms correctly can be costly.
9. Hire a certified public accountant if needed
There are many times that real estate investors need some expertise beyond the rental property accounting basics. Never hesitate to hire a CPA for more advice on property management. They are specialized professionals who will make sure you are following the best accounting practices and help you analyze the financial performance of your rental property.
The different types of rental property income and expenses
There are different types of rental income and expenses. Rental income consists of rent payments, late rent fees, pet fees, termination fees, and appliance rental fees. Just as there are many different types of rental income, there are also many different types of expenses. Some of these expenses include repairs, routine maintenance, landscaping, utilities, marketing tools, property management fees, attorney fees, accountant fees, mortgage, property tax, and insurance.
What is the Schedule E tax form?
The Schedule E tax form is used by property owners to report their profit and loss on their rental property. On this form, income and expenses are matched up to the correct categories which in turn is used to calculate the taxes owed for the year.
An efficient rental property accounting system has many benefits. It saves valuable time, is an accurate forecaster for future expenses, tracks the financial flow of each rental property, is a valuable resource at tax time, and serves as a guideline to maximize income and minimize expenses.
Caryl Ramsey has years of experience assisting in different aspects of bookkeeping, taxes, and customer service. She uses a variety of accounting software for setting up client information, reconciling accounts, coding expenses, running financial reports, and preparing tax returns. She is also experienced in setting up corporations with the State Corporation Commission and the IRS.
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