Bookkeeping. It’s not the first topic that comes to mind when you’re looking to invest in real estate; however, it is an essential part of managing and owning property. It may even be the most important part, as good bookkeeping can keep a company in the black. Keeping accurate books isn’t complicated, but it can be time consuming. The most important factor a good bookkeeping system can help you understand is your return on investment (ROI). Positive ROI factors, or gains, are monthly income, appreciation or gains, and tax write-offs. Negative ROI factors include maintenance bills, damages, mortgage payments, and taxes. Any real estate investment is going to have its share of both positive and negative ROI factors, and you should be as prepared as possible, should the unexpected occur.
Understanding these factors and tracking them diligently can help keep your real estate business profitable. An organized bookkeeping system should allow you to track net profits and losses, annual gain or loss, analyze business property value, determine successful business plans, prepare annual taxes quickly and easily, generate data, and more. Listed below are the top five bookkeeping tips for novice real estate investors.
1. Keep Your Business and Personal Accounts Separate
One of the most important aspects of real estate investment bookkeeping is to keep all business expenses completely separate from your personal expenses. If you are an LLC, this is a legal requirement. Even if you’re not an LLC, keeping your personal expenses and your business expenses together is not a great idea. Should you be audited by the IRS, the IRS will have to look through all of your personal expenses as well as your business expenses for evidence regarding your tax claims, which can be a harrowing experience.
A good place to start is by opening a separate bank account and a credit card in the name of the business or property, as this makes accounting easier. You can track cash flow in and out of your property’s account, and thoroughly track month-to-month revenue, which helps you gain a better understanding of your business’ needs. You can use this information to generate reports, which we will discuss the importance of later in the article. Most importantly, by creating a separate bank account, your personal assets and tax documents will not come under fire in the event of an IRS audit.
2. Track Your Expenses by Creating a Book and Supporting Documents
Tracking all of your expenses and setting up your ‘book’ can be time consuming at first, but you will reap the rewards later on. A book is a record (be it soft or hard copies) of every financial transaction your business makes. A book can easily be kept using an Excel spreadsheet. If you create your own bank account for your business (see tip #1) and have a debit card or credit card for your business, it is easy to track your expenses online and place them into your Excel spreadsheet. You can also utilize helpful software systems like Quickbooks to keep track of rent payments and your expenses.
Supporting documents consist of all of the receipts, or proof, of every financial transaction notated in your book. Like your book, supporting documents can either be hard copies, like a filing cabinet, or soft, computerized copies. Whether hard or soft, your supporting documents should be organized per annum.
A good way to get started is to create annual files for the following: proof of expenses, bank statements, credit card statements, tax return documents, insurance documents, contracts, leases, and other property documents. If you are keeping hard receipts, be sure to write the purpose for the receipt on top of the receipt with the date of purchase, if it is not already stated, so you know what you were spending money on and when.
Supporting documents provide evidence in the event of a tax audit by the IRS that you the expenses you claimed for your business are valid. Although there are advantages and disadvantages to hard copies, having mobile bookkeeping is convenient because you can keep your records up-to-date in real time, as they occur. Although the set-up of a book can be time consuming, the upkeep of your book should be quick and easy.
3. Track and Itemize all Income and Expenses
Keeping track of monthly costs and profits is essential for a successful business. Each profit or cost must be accounted for and categorized correctly. The IRS actually defines different expense categories to aid in itemization:
- Auto and Travel Expenses
- Cleaning and Maintenance
- Legal and Other Professional Fees
- Management Fees
- Mortgage Interest Paid to Banks, etc.
- Other Interest
- Depreciation Expenses
It is important that you file your expenses under one of the categories listed above, as it will be easier to prove these expenses to the IRS should you be audited. Anything that doesn’t quite fit into a category can be filed under the ‘other’ category. Finances should be tracked monthly, and then filed into annual folders. This is where soft copies of documents come in handy; categorizing receipts can happen instantly on a mobile device, as opposed to sitting down and creating a spreadsheet for a large amount of receipts later. Waiting to figure out net profit at the end of the month creates a larger margin for error.
Another important item to track the interest on loans. You need to track the monthly amount that you owe, payment due dates, any changes in interest rates, and the amount of time until the loan is paid off in entirety. Additionally, you should be aware of any expenses that can be deducted from taxes and provide evidence for any write-offs. Working with a good team of financial advisors can help you understand potential tax breaks and perks.
4. Make Sure your Book Matches your Bank Account
Although this seems like a no-brainer, you’d be surprised at how many errors can occur between your book and your bank account. The process of matching your books to your bank account is called bank reconciliation. Making sure your receipts match the amount debited from your account is imperative. Mistakes happen, and companies can overcharge you, or even charge you twice! This can occur more often than you think and can help your business save a lot of money by catching errors. Another way bank reconciliation helps your investment business is by double-checking your books and making sure that you recorded everything correctly and making sure your bank balances match with the cash flow from your profits and losses. Bank reconciliation is, essentially, a triple-check to ensure that all of your numbers are correct. Although it can appear tedious, this triple-check is essential to any well-run investment business. Bank reconciliation catches errors and helps you visualize your true state of financial affairs.
5. Generating Solid Profit-Loss Reports
After creating a book with supporting documentation, opening bank accounts to track expenses, itemizing profits and losses, and bank reconciliation, you’re ready to create accurate reports. Reports are a quick reference point to determine how well your business is running. A profit-loss report is a quick reference for all income and expenses, and any profit (or loss) that may have occurred as a result. This report can be generated monthly, quarterly, and annually, and will very clearly display the profitability or depreciation of your business.
Your profits and losses report should include operating earnings, or the profit made before income and tax. Operating earnings is not to be confused with net income, which is the sum income after taxes and expenses. From this data, you can generate all kinds of visual displays, like graphs, which can clearly show fiscal trends from year to year. You can also learn invaluable things, like objects of expenditure, or looking at which items cost more money, which will help to save you money in the future. Some profits and losses reports include sales volume as well, or the number of total units (in this case, real estate) sold during a particular time period.
Getting started in real estate investing can feel overwhelming but following these tips will get you started on the right track. Although correct bookkeeping can feel tedious at first, it will make your business run smoothly, and aid you in decreasing errors and increasing profit. Perhaps the most important thing to track, however, are your goals for the future. Real estate is a long-term, not short-term game, and identifying where you want to be in five to ten years from now can help you get achieve your goals. Keep in mind that the best businesses are built with a good foundation.
Anderson Advisors are here to help you maintain profitability in your business, from bookkeeping to tax advice. For advice regarding your specific circumstances, please reach out to our experienced and knowledgeable team at 1-800-706-4741, or send us an e-mail [email protected]. We will use our years of experience to guide you in establishing your real estate investments and assist you in making well-informed business decisions for you and your property.
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Mr. Bowman is a Partner with Anderson Law Group in the firm’s Las Vegas office. He received his Bachelor of Science degree in business from Arizona State University. After spending five years in the computer industry, Mr. Bowman received his Juris Doctor from Seattle University School of Law and is licensed to practice in multiple states. His experience includes commercial and civil litigation, construction defect law, complex real estate transactions, and business law.