Accounting Best Practices for Landlords
April 25, 2023
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What are the Best Accounting Practices for Landlords?
As a landlord, you need to understand rental property accounting if you want your business to be successful.
We know it’s not a fun or glamorous topic, but it’s a critical one.
Managing your money well leads to tax savings, enhanced rental income, fewer costly expenses and a better overall business.
In this article, we’re going to look at the best practices for rental property accounting, to help you handle your finances well.
The Basic Principles
Rental property accounting is important because you must analyze your business’ financial performance to adjust and improve your operation. Here are some basic principles that will help you succeed:
Separate Your Personal and Business Accounts
The first best practice is key to your finances. Open separate checking and savings accounts, credit cards and debit cards for your business. Separation ensures all the income and expenses from your business won’t get confused with your personal affairs. Not only does this help when tax time rolls around, it may be required by local landlord-tenant laws in your area.
Furthermore, creating a savings account specifically for your business allows you to earmark future rental property expenses (I.e., vacancies), in addition to holding onto security deposits.
Track Income and Deductible Expenses
Sound bookkeeping practices are the foundation of rental property accounting. If you keep track of all your expenses as they occur, then you won’t find yourself scrambling at the last second to account for everything throughout the year. The better prepared you are for tax professionals; the easier tax season will be.
With many property management software platforms like Innago, bookkeeping is automated, which saves you a lot of time and potential headaches. Rent payments you collect through our system and recorded maintenance expenses will automatically sync to your dashboard.
One of the most vital parts of tracking is understanding deductible rental expenses. These can substantially reduce your tax bill at the end of the year.
Here’s a list of potential deductions related to property management:
- Legal fees
- Management fees
- Real estate taxes
- Lease cancellation fees
- Repair costs
- Supply and equipment costs (even if they’re just rentals)
- Travel, specifically mileage between properties for any kind of work-related tasks
- Mortgage interest payments
- Payment for yearly tax preparation (from the previous year)
- Maintenance payments to contractors
Choose Between Accrual or Cash Method of Accounting
There are two main types of accounting methods you need to choose from: Accrual and Cash Accounting.
Simply put, if you want to record income and expenses as they’re incurred (regardless of when the cash leaves or enters your account), use the accrual method. But what does that mean?
As an example, let’s say a tenant pays rent in February. You then record that transaction in February.
However, if the same tenant pays for two months upfront, you’d still only mark down this month’s rent as a transaction even if the funds are in your account.
The following month you’d mark down that rent payment as it occurs for that month.
On the other hand, you should use the cash method if you prefer to track income and expenses as they get to your account.
As an example, let’s say a tenant pays you $1,600 for rent in January. You immediately record that transaction. It really is that simple with this method.
It’s important to note, though, that you cannot use the cash method if your business maintains inventory, is a corporation, or has gross receipts exceeding $26 million per year.
Most big businesses use accrual accounting to get a clearer picture of income and expenses during different time periods. That said, smaller businesses may benefit from using the cash method to keep track of precisely how much cash they have at any given time.
Ultimately, the choice comes down to personal preference and what works best for your specific business. The key is consistency. Pick one accounting method and stick with it.
Embrace Digital as Much as Possible
Digital accounting and bookkeeping are massive difference makers for businesses. Whether it’s applications that can digitize receipts and invoices, accounting software like QuickBooks to integrate your bookkeeping and financial analysis in a central location, or property management software to automate record-keeping, digital tools will enhance your business.
Going digital makes it so that you rely less on paper, which can easily be lost or misplaced. It’s also better for the environment. Additionally, sharing reports and exporting data is easy when everything is digital.
Familiarize Yourself with Relevant Tax Forms
Another critical principle of accounting for landlords is familiarity with relevant tax forms. Most of the time, the Internal Revenue Service (IRS) requires landlords to fill out a Schedule E (Form 1040). This form is for reporting rental income and expenses for each of your properties. Additionally, you’ll need to report rental income that exceeds $600, in light of the IRS’ newer 1099 requirement.
Schedule E is a tax form that rental property owners complete to report profit and loss for rental properties. You need to match your expenses to the correct category on the form (or the closest related expense category available). This form keeps you compliant with IRS standards and gives you an official document for your yearly income and expenses. It will also be used to calculate your taxes owed for the year.
In addition to the forms above, every employee or contractor that does work for you will need W-9 and 1099 forms. A W-9 form lists a contractor’s tax ID number and their kind of business.
Taking the time to read about these forms and understand what is needed will help your business. The penalties for errors related to these forms aren’t cheap, so it’s in your best interest to do things right the first time.
Hire a Certified Public Accountant (CPA)
No matter how smart or well-read you are, taxes are complicated. Consulting an expert in the field is a wise idea. A CPA can advise you on how to implement proper accounting systems, show you best practices and aid you in analyzing financial reports. Then, they can help you when tax season rolls around.
One error can trigger an audit and that’s not something anyone wants to deal with. This is avoidable by paying a CPA who will review and sign off on your books.
Accounting is an integral part of being a landlord. It may not be the best part of the job, but you won’t have a successful business if you don’t understand it.
These best practices for rental property accounting will help you create a great foundation to run a successful business.