As the motivational speaker Tony Robbins once said, “In essence, if we want to direct our lives, we must take control of our consistent actions. It’s not what we do once in a while that shapes our lives, but what we do consistently.”
That’s true in life, and also true when it comes to real estate investing.
By creating a good rental property accounting template with the very first property, real estate investors gain better control over income and expenses, and may find it much easier to claim every tax benefit the IRS offers to real estate investors.
- Rental property accounting is a formal system used to keep track of income and expenses.
- A good rental property accounting template helps investors monitor profit or loss, make sure financial obligations are met, and export tax-ready financials.
- Most real estate investors use the cash method of accounting to record income when it is received and expense when they are paid.
- Steps to create a rental property accounting template include selecting an accounting method, setting up business bank accounts, and selecting a rental property accounting system.
- A rental accounting template modeled after Schedule E, Form 1040 can help make categorizing income and expenses easier, and simplify filing a rental property tax return.
What is Rental Property Accounting?
Rental property accounting is a formal, organized system real estate investors use to keep track of income and expenses. A good rental property accounting template helps real estate investors to:
- Keep track of rental income received for each property and an entire rental property portfolio.
- Make sure that financial obligations such as vendor payments, mortgage, and property taxes are met.
- Monitor the profitability (or loss) of each rental property owned.
- Run financial reports such an income statement, net cash flow, and capital expense report.
- Generate and export tax-ready financials to help take the ‘pain’ out of tax time.
Rental property accounting works a little bit differently than accounting in other industries. For example, real estate investors use rental property accounting to ensure that adequate rental income is generated to pay expenses.
A good rental property accounting system also allows an investor to create individual accounts for each rental property that is owned so that income and expenses are credited and debited to the right property.
How to Create a Rental Property Accounting Template
There are three main steps to follow to create a rental property accounting template:
- Select an Accounting Method
The cash method and accrual method are the two main methods for accounting.
According to IRS Topic No. 414 Rental Income and Expenses, most individuals operate on a cash basis, which means that income is recorded when it is received and expenses are booked when they are paid. For example, if a tenant pays the January rent before the first of the month, the income is recorded in the tax year it is received instead of the tax year the rent is due.
On the other hand, the accrual method of accounting records income when the rent statement is generated (even if payment has not been received) and records expenses when bills are received (even if payment has not yet been made).
- Setup Rental Property Banking
Setting up a bank account for each rental property can help to avoid commingling, such as mixing personal and business funds or using a tenant security deposit to pay for property operating expenses.
Creating a good rental property banking system also makes it much easier to accurately track income and expenses to generate accurate financial reports, and to claim every tax benefit the IRS offers to real estate investors.
Here are some steps to consider taking as you setup your banking for your rental properties:
- Create a bank account for each property, such as a checking account for normal operating expenses, a savings account for CapEx (capital expenses), and a trust account used to hold a tenant security deposit.
- Ensure that cash flows through the rental property bank account by making rent payments into that account and paying all property-related bills from the same account.
- Reconcile the rental property bank account each month and at the end of the year, to ensure that the property financial statement matches the business bank statement.
As we’ll discuss next, the best rental property accounting system will automatically upload and sync income and expenses to help keep finances accurate and make preparing year-end tax reports a breeze.
- Choose a Rental Property Accounting System
Rental property accounting systems fall into one of three main categories.
- Income and expense templates created on spreadsheet programs such as Excel, Numbers, Google Sheets, or OpenOffice are used by some investors to keep track of rental property income and expenses.
While a basic worksheet for rental property accounting can be okay, it’s easy to forget to report income or double-count an expense, two innocent errors that can create problems with the IRS.
- General purpose accounting software such as QuickBooks can be a good choice for landlords who understand bookkeeping and have the time to create a chart of accounts for a rental property business.
Although generic accounting software is used by different businesses in every industry, it’s possible to send monthly rent statements, track rental income and expenses, and create regular financial statements.
- Rental property accounting systems from companies such as AppFolio, Buildium, and Stessa.
Of these three options, Stessa is the only rental property accounting software that is free, while offering optional premium services such as rent analysis, mortgage financing, and market research.
After signing up for a free account with Stessa, rental property owners can automatically track income and expenses, monitor key financial metrics, and export tax-ready documents to help make filing taxes stress free.
Rental property accounting software from Stessa is designed for smaller investors with single-family rental homes, multifamily properties, and short-term rentals, as well as sophisticated investors with a large portfolio of rental properties.
Income and Expenses on a Rental Property Accounting Template
Real estate investors usually use Schedule E (Form 1040) (Supplemental Income and Loss) to report income and expenses related to rental property. A good rental property accounting template categorizes income and expenses according to Schedule E to help make financial reporting and tax filing easier.
Typical income and expense items with a rental property include:
Rental Property Income
Income from a rental property can include any of the following:
- Monthly rent received from a tenant.
- Advance rent such as the last month of rent received when a lease is signed.
- Expenses paid by a tenant in lieu of rent, like painting the home or making repairs.
- Amounts paid by a tenant to cancel a lease, such as an early cancelation fee.
Security deposits are not treated as rental income if the deposit is refundable. Instead, a refundable tenant security deposit is recorded on the balance sheet as a liability, because the money is owed to the tenant.
Rental Property Expenses
The most common rental property expenses include:
- Repair costs for work done to keep the rental property in good condition but to not add value to the property.
- Capital improvements made to the property, such as replacing the heating and cooling system or updating the appliances, must be added to the property basis and depreciated over time.
- Depreciation is a non-cash allowance deducted from pre-tax net income to compensate a rental property owner for wear and tear and is reported on Form 4562, Depreciation and Amortization.
- Operating expenses necessary for the operation of a rental property, including leasing and property management fees, landscaping and pest control, mortgage interest and insurance, HOA dues, and property taxes.
Rental property owners who use cash basis accounting can’t deduct unpaid rent as an expense, because the rent due has not been included as income.
However, depending on state landlord-tenant laws, a landlord may be able to use part or all of a tenant’s refundable security deposit to pay for past due rent by re-recording the deposit as rental income on the income statement instead of a liability on the balance sheet.
In addition to the above rental property expenses, some real estate investors may also be eligible to deduct an additional 20% of qualified business income (QBI) if all safe harbor requirements are met, as described in Revenue Procedure 2019-38.
Rental Property Depreciation
Depreciation is a non-cash expense that real estate investors use to reduce taxable net income. The IRS allows owners of residential rental property to depreciate the value of the property (excluding the land or lot) over a period of 27.5 years.
For example, if a single-family rental home is purchased for $120,000 and the value of the lot is $10,000, the depreciation would be $4,000 per year ($120,000 home value – $10,000 land value = $110,000 / 27.5 years).
In addition, the costs of capital improvements such as appliances and carpeting can be depreciated over 5 years. So, if an investor spends $6,000 to replace the carpet in a rental property, the additional depreciation expense for the carpet would be $1,200 per year.
Sometimes, rental property depreciation can create negative taxable net income, even when the property is cash flow positive.
Provided that the property is used as a rental investment and not a primary residence, deductible rental property expenses can exceed rental income, subject to the limits described in IRS Topic No. 425 Passive Activities – Losses and Credits.
Benefits of Using an Accounting Template for Rental Property
A good rental property accounting template helps a real estate investor to take more control over income and expenses to generate more potential profit and benefit from the numerous tax benefits owners of rental property receive from the IRS:
- Monitoring income and expenses can help to identify opportunities to decrease operating costs, increase incremental revenues, and claim valuable tax deductions.
- Keeping track of accounts payable ensures invoices are paid on time and may result in vendors offering ‘best customer’ pricing discounts.
- Auditing property performance at an individual and portfolio level helps an investor to compare the true profitability of each rental property owned.
- Generating tax-ready financial statements can help to reduce professional fees paid to an accountant or CPA when tax season comes around.
Creating a good rental property template right from the start can make it much easier to monitor income and expenses, identify potential opportunities to reduce costs and increase revenues, and to claim every tax benefit offered by the IRS. While accounting can be done on a simple spreadsheet, using a free rental property finance system like Stessa helps investors to easily keep track of property performance and generate a paper trail all in one place.