Real estate accounting: A clear and simple guide for 2024

Real estate accounting is an essential part of owning and operating rental property. While accounting is probably one of the least favorite tasks that most investors want to do, good accounting can help keep property profits higher by accurately tracking income, expenses, and tax deductions.

Key takeaways

• Bookkeeping and accounting in real estate describe two different things.
• Benefits of good real estate accounting include improved cash flow, accurate tracking of income and expenses, and being prepared for a tax audit.
• Basic steps in setting up a real estate accounting system include creating a chart of accounts, separating business transactions from personal funds, and keeping documents and receipts organized.

Bookkeeping vs. accounting

Although many people use the words bookkeeping and accounting to describe the same thing, there’s actually a big difference between the two:

Bookkeeping

• Setting up a chart of accounts
• Creating a process for invoicing tenants for rent and posting receipts
• Accurately tracking payments made to vendors and charging to the right account
• Monitoring automatic recurring payments made to business credit and debit cards
• Reconciling bank statements and vendor invoices to ensure a paper trail is being created

Accounting

• Understanding property income and expenses, profits and losses, and gains in asset value
• Learning how to manage money smartly to help maximize profits
• Knowing what to look for when performing a financial audit or analysis
• Making sure business regulations and tax collection and remittance requirements are met
• Correctly preparing reports for quarterly and year-end tax filing and meeting tax due dates

Many real estate investors are pleasantly surprised to learn that bookkeeping and accounting tasks can often be automated.

Rental property owners can sign up for a free account with Stessa to automatically track income and expenses, receive personalized recommendations for maximizing revenue, and access the Stessa Tax Center.

Benefits of good real estate accounting

Often, when people hear the word “accounting” their eyes glaze over and they quickly try to change the subject. But as unexciting as accounting might be, there are several big benefits to understanding how good real estate accounting works:

Improve cash flow

Sending out rent statements as quickly as possible, getting tenants to pay on time, and waiting until the due date to pay vendors are three ways that real estate investors can improve cash flow.

A good real estate accounting system simplifies keeping track of accounts payable so that vendors are paid on time or early, to take advantage of an early payment discount. (Online rent payment services such as RentTrack report rent payments to all three credit bureaus, providing tenants with an incentive to pay the rent on time.)

Control income and expenses

A rental property accounting system like Stessa automatically tracks income and expenses and helps real estate investors to maximize revenue with personalized recommendations.

Using Stessa is easy and free. Simply sign up for a free account, enter your rental property address, connect your bank accounts quickly and securely, and see your real estate portfolio stats come to life.

When a tenant rent payment hits your bank account, Stessa updates your income statement. To track expenses on the go, just download the mobile app for iOS or Android, scan a receipt, and Stessa will parse the receipt data to create a new expense entry that is automatically categorized for you.

Reduce outside expenses

While an automated real estate accounting system may never completely replace your accountant, it can help to reduce outside expenses paid to a bookkeeper or CPA.

A CPA will tell you that come January 1st when tax season rolls around, they begin working seven days a week preparing tax returns. By providing your tax professional with tax-ready financial statements, you’ll make their job much easier and reduce the number of billable hours they charge to you.

Backup for a tax audit

Although there is a chance that a real estate investor may never be audited, an ounce of prevention is worth a pound of cure. There are three types of IRS tax audits a rental property owner could face:

1. Correspondence audit with an IRS request for additional documentation.
2. Field audits conducted face-to-face, typically in a taxpayer’s home or business.
3. Office examinations conducted in IRS offices.

A good real estate accounting system automatically creates a paper trail to back up every income and expense item claimed. Instead of having to dig for information the IRS requests, documents are neatly organized if you are ever audited. An accounting system for real estate will help you keep track of documentary evidence like invoices and receipts, to help you defend each deduction.

Monitor property and portfolio performance

Detailed record keeping also can make it easier to monitor financial performance at both the property and portfolio level. By comparing past rental property performance to the current year, investors are able to form strategies to maximize revenues and increase net cash flow:

• Spotlight rental properties that are performing well.
• Identify underperforming properties to help decide to hold or sell.
• Compare year-over-year financial metrics such as cash on cash return.
• Create historical property performance data to help make refinancing a rental property easier.

Basic steps of real estate accounting

There are seven main steps to follow when setting up a real estate accounting system:

1. Choose accounting method

The most common types of accounting methods are cash and accrual. Transactions are recorded differently, depending on which accounting method you use.

Under the cash method, income is reported in the tax year it is received, and expenses are deducted in the tax year the expenses are paid.

Under the accrual method of accounting, income is generally reported in the tax year it is earned, regardless of when the payment is received. For example, if you send the tenant an invoice for the January rent in December, income is credited in December and recorded as receivable from the tenant.

Expenses under the accrual accounting method work in a similar way. If you receive an invoice for landscaping service in December, the invoice is recorded as an expense in December, even if the bill is not paid until January.

There are pros and cons to each method. In general, most individuals and many small businesses use the cash method of accounting, according to IRS Publication 538.

2. Separate business and personal funds

Business and personal income and expenses should not be commingled with one another. That’s why most real estate investors open a business checking account for deposits and expenses, along with a debit card or card.

Business funds are kept in one place, making it much easier to review your business bank statement to locate a transaction. Having a business account for a rental property can also help to:

• Keep books organized
• Avoid inaccurate tax returns
• Improve cash flow management
• Identify opportunities to increase income and reduce expenses

Depending on your state landlord-tenant laws, a landlord may also be required to hold tenant security deposits in a separate bank trust account.

3. Create a chart of accounts

A chart of accounts is used to separate income from expenses. A chart of accounts for a rental property usually contains categories for assets, liabilities, equity, revenue, and expenses.

Accounts are created within each category for different transactions. For example, in the revenue category, a landlord may have individual accounts for rental income, late fees, and other rent (such as pet or roommate rent).

The chart of accounts for a rental property can be customized based on the property type and an investor’s specific needs. Many real estate investors model their chart of accounts based on Schedule E (Form 1040):

You can learn more about income and expense categories by reading this recent article from Stessa.

4. Track and itemize income and expenses

Money that flows into and out of your real estate business should be categorized and posted to the property account. Rental property financial management software such as Stessa automatically tracks income and expenses and auto-categorizes them for easy reporting.

Each time a transaction occurs, the income or expense is recorded under the appropriate category and account. A good real estate accounting system also allows details for each transaction to be entered, so that it is easy to understand what the transaction is for.

5. Reconcile accounts

The reconciliation process ensures that the bank account balance in your real estate accounting system is the same as what the bank shows.

The beginning and ending balance shown by your bank should match what your accounting system shows. When accounts are reconciled, there may be gaps in the transactions due to time delays in posting, accounting mistakes, or an error by the bank.

6. Keep documents organized

Each income and expense transaction recorded on the chart of accounts should have a backup or supporting document.

Common rental property documents a landlord needs to keep track of can include:

• Purchase and lease agreements
• Mortgage-related documents
• Vendor contracts
• Bank statements
• Invoices and receipts
• Credit card statements
• Insurance information
• Property tax statements
• HOA rules, regulations, and declarations
• Tax returns

While some investors keep hard copies, many other rental property owners scan and upload each document to a secure, cloud-based storage system on the internet. Storing real estate receipts, invoices, and documents digitally may allow you to find paperwork in minutes rather than hours.

7. Generate accurate reports

The best real estate accounting software allows investors to get performance dashboards at the portfolio and property level online and generates informative reports at the click of a button.

Three of the most common financial reports for rental property are:

• Income statement (also known as a profit and loss statement) focuses on revenues and expenses.
• Net cash flow reports the cash moving in and out of your account over a given period of time.
• Capital expense report tracks money used to improve or add value to a property beyond normal maintenance and repairs.

Real estate accounting software

There are a wide variety of accounting systems available, including real estate account software that is absolutely free. Some of the top rental property accounting platforms include:

• Appfolio: Good for beginning real estate investors. Minimum monthly fee of $280.
• FreshBooks: Helps investors grow revenues and boost ROI. Billing starts at $108 per year.
• Landlord Studio: Over 15 customized reports designed for landlords. Pricing begins at $5.99 per month.
• Quicken Rental Property Manager: Owner dashboard helps simplify rental property management. Pricing begins at $93.59 per year.
• Rentec Direct: Designed for landlords who want to do their own property management. Pricing begins at $35 per month.
• Stessa: Created by real estate investors for real estate investors seeking to maximize profits through smart money management. You can get started for free.