Property Management Accounting 101
Managing the finances of a rental property is not the same as traditional business accounting.
This is because there are unique accounts and records that must be kept for both the properties and the tenants.
Most notably, the fact that you need both tenants and properties in your accounting program, something a program like QuickBooks isn't designed to handle.
Additionally, if you have a team, it's important to keep the two sides of your business separate in terms of accounting.
- The business-facing administrative tasks such as payroll and utilities, and
- The client-facing property management activity
In this comprehensive guide, we aim to break down the complexities of property management accounting in a manner that is easy to understand and implement.
To begin, let's go over some of the most important accounting terms that you will need to know for the future.
Quick Guide: Important Accounting Terms
Accounting is something people major in at college.
What does that mean?
It has many terms that sound completely foreign and which take a while to learn. But, no worries, we're here to help.
We've simplified the most important accounting terms to make them ultra-easy to pick up and digest so that you can get moving.
Here are the necessary terms to successfully manage your property accounting:
A set of time in financial statements, could be one day or several days, months, or years. You'll often see it in reports from accounting software.
What a business owes to vendors, could be for services or products used to run the business.
Opposite of Accounts Payable, it's what a business is owed for its services, like open invoices, unpaid fees, or rent.
Accrual Accounting Method
Records transactions based on the transaction date, mandatory for businesses with employees.
Anything a business owns with value, like properties, cash deposits, land or accounts receivable.
Checking the balance of a business's G/L against actual bank statements, to make sure they match.
Recording business transactions to get accounting data.
Cash Accounting Method
Records transactions when payment is made or received, used by sole proprietors and small businesses.
Refers to transactions on the right side of an asset account, which decrease the asset.
Refers to transactions on the left side of an asset account, which increase the asset.
The measure of an asset's value over time, which can be written off on taxes.
Ownership interest in a business. Equals assets minus liabilities.
Costs incurred to run a business, like payroll, vendor payments, marketing, etc.
Reports giving information on a business's financial health, like balance sheet, profit & loss, or income statement.
A complete record of a business's transactions, generated by accounting software.
Revenue minus the cost of offering services.
Something a company owes, like accounts payable, loans, mortgage, or payroll.
Revenue minus all costs associated with running a business, including overhead and operating expenses.
Costs to run a business outside of providing its service, like office rent, utilities, and insurance.
Income generated by a business for a specific period, could be from tenants or landlords.
For lots more definitions to learn as well as other amazing resources, visit DoorLoop's Resources Page.
Setting Up Your Property Management Accounting
Now that you have a solid understanding of the essential property accounting terms, it's time to put them into practice and set up your accounting system.
In this section, we will be discussing all of the necessary steps that need to be taken to make sure your property management accounting is completely set up.
Let's begin with the first step, setting up your business account.
1. Set Up a Separate Business Account
It's important to keep your business accounts separate, as in the eyes of the IRS, those are two separate organizations.
Specifically, as we talked about briefly earlier:
- Business-facing: Payroll if you have employees, utilities, rent for your business location (again, if you have one), etc.
- Property-facing: Anything you pay for related to maintaining your properties
Not doing so can wreak havoc on your books and makes it very difficult to track anything.
One of the steps you can take to remedy this is creating two separate accounts, one which is for all business-facing activity and another for all client-facing activity.
Pretty straightforward, right?
Both property-related income and property-related expenses should flow into one business checking account.
This is far easier to work with than using the same account for everything. After a while, it becomes virtually impossible to balance both sides of the business and only becomes a bigger headache over time.
2. Choose Your Accounting Method
When it comes to accounting methods, there are two main options: accrual and cash.
The choice of which method to use is less important than understanding the differences between them.
Let's break both of them down to make sure you understand what each one entails.
Cash Basis Accounting
Cash basis accounting involves recording transactions as soon as money is received or sent, such as when a tenant pays rent or a contractor is paid for their services.
For example, if a tenant pays you $1,500 rent for September, you would record that transaction right away.
This method is straightforward and intuitive, which is why many sole proprietors choose to use it.
However, once you have employees on payroll, it is required to use the accrual accounting method.
With accrual accounting, transactions are recorded when they occur, regardless of when payment is received or sent.
This method is required by law for businesses with employees, hence why it's less about choosing which way to go and more about understanding each method.
3. How to Set Up Your Chart of Accounts
As you begin to set up your accounting system, it is crucial to establish a solid foundation.
This foundation is built on your chart of accounts, which acts as the backbone of your accounting system, organizing all financial activity within your business.
Your chart of accounts includes all the financial accounts that your business uses, including:
Every transaction you make will be recorded within one of these five areas, with subcategories under each of them.
By having a well-organized chart of accounts, you are able to create important financial reports such as a balance sheet, which will give you an overall understanding of the health and future performance of your business.
When it comes to organizing your chart of accounts, a number system is often used to keep everything in order.
However, this number system may not always be visible within your accounting system.
Property Management Chart of Accounts Example
To better understand how a chart of accounts can be set up, it is helpful to look at an example.
A snippet of the chart of accounts from a typical property management company might include different types of accounts and their corresponding subaccounts, along with the purpose of each account.
Keep in mind that this is just one example, and further resources on chart of accounts examples can be found in guides such as Chart of Accounts Examples (Property Management, Medical).
4. Financial Reports You Should Know and Use
Lastly, let's look at some of the key financial reports you should become familiar with.
Financial reports allow you to gain insights into all kinds of things. Such as:
- Obtain loans and other funding
- Find areas of improvement
- And do your taxes
- Among other things
Some of the most important reports include:
- Profit and loss (P&L) statement
- Balance sheet
- Income statement
- And cash flow statement
It is important to understand the significance of these statements, as they provide valuable insights into the health of your business and help identify areas for improvement.
This will allow you to make informed decisions and take the necessary steps to ensure the success of your rental property business.
Part III: Best Practices
Now, let's jump into practice.
If you're looking for some straightforward steps you can take to ensure your accounting system is well organized and as little a timesink as possible, this section is for you.
Also: Even if you're working with an accountant, these will still be useful to you.
Here they are:
1. Include gaps in your chart of the accounts numbering system
When setting up your chart of accounts, it is important to consider that you may need more accounts in the future.
In order to accommodate this growth, it is recommended to set up your number system with gaps in between categories.
For example, your master category can take a thousand (4xxx), while each subcategory can take a hundred (41xx, 42xx, 43xx). This will prevent your chart of accounts from becoming overly complex and confusing in the future.
2. With that said... add accounts sparingly
One common mistake in accounting is adding too many general ledger accounts.
While it is normal for the chart of accounts to grow over time, it is important to avoid adding unnecessary accounts that can make accounting more cumbersome.
Only add accounts when it is necessary to keep the accounting as simple and streamlined as possible.
3. Have separate accounts for administrative and property management
We touched on this earlier, but given how important it is, I'm going to harp on it again.
Whether you're doing property management or you're a landlord with a team that has payroll, a place of business, utilities, etc., you should have two business checking accounts.
- A service account (property-facing): For managing your properties
- And an administrative account: For managing your business activity such as payroll, rent for your place of business, related bills, etc.
It becomes incredibly difficult to uncover any kind of meaningful information from your accounting reports with these two data buckets combined.
Plus, you'll run into major issues with your taxes down the line as well. And one thing you never want to mess with is Uncle Sam.
4. Track deductible expenses
Accurate tracking of expenses is crucial for tax reporting purposes, particularly when it comes to deductible expenses.
Fortunately, there are a ton of potential deductions, including:
- Tax prep costs
- Mortgage interest payments
- Fees such as legal, management, real estate-related, and lease cancellation
- Repair costs
- Supply and equipment
- Contractor payments (for maintenance)
- And more
While it takes work, keeping track of these deductible expenses can significantly reduce your tax bill at the end of the year.
Also, keep in mind that this isn't an exhaustive list of deductions.
For that, reference IRS Publication 535, Business Expenses, page 3 (see screenshot below):
5. Use a professional accountant
Regardless of the size of your property management business, it's recommended to have your annual taxes handled by a professional.
While it may seem cost-effective to handle your taxes yourself, it is important to consider the potential consequences of making a mistake.
Hiring a professional accountant can help ensure accuracy and avoid the hassle of an audit.
Plus, they can typically net you a better number and amount of deductions, reducing your tax burden.
6. Analyze annually
It's important to review your financials on an annual basis in order to identify areas for improvement and make better decisions.
This becomes even more important when managing a property, given the fluctuations in property value.
At the end of each year, you should review your financials, including your cash flow statement, in order to determine profitability and make necessary changes for the following year.
7. Save time with accounting software
While it is possible to manage your accounting using a simple spreadsheet, it is much more efficient to use accounting software, particularly property management-specific software.
This type of software can automate many processes, provide a range of reports at your fingertips, and offer features not available in general accounting software, such as a tenant portal, automated rent payments, and work order management.
Get Started with Property Accounting Right
Property accounting isn't easy.
It's an area that becomes a major timesink for most landlords, so learning how to manage it properly and keep everything in order is a huge benefit if you're willing to take the time to learn and implement.
Speaking of timesinks, another area that can become property maintenance. So, we'll tackle that in the next guide in this section.