Rental Property Accounting 101: What Landlords Should Know

Real estate investments can be a profitable way to add a passive income stream to your bottom line. You bring money in from rent, spend money to maintain the property, and hopefully have a decent profit at the end of the year.

But all this money going in and out must be tracked and not just with pen and paper. Investing in real estate is a business that requires you to file your taxes appropriately and account for all income and expenses.

Before you invest in real estate, here’s what you should know about rental property accounting.

Basic Rental Property Accounting Tips

When you own investment properties, you have many other expenses and even income to consider. When it comes to filing your taxes, you’ll have a lot more to worry about than just income from an employer.

You must claim the income you earn from the rentals, but you’ll also want to claim your expenses. Anything you pay in reference to the property that either helps you find tenants or makes your property more comfortable for current tenants may lower your tax liability by decreasing your income.

The key is to be organized, so you account for all costs (and income too). Here are the best ways to make sure you don’t miss anything.

Have a Separate Business and Personal Checking Account

Don’t mix your personal and business accounts. It gets messy and complicated at tax time. Instead, have a separate account for your rental properties. If you’re feeling incredibly organized, you can even have a different checking account for each property you own.

The more separated you have your income and expenses, the easier it is to differentiate between money spent for the rental property and money spent for your property. Any money you spend to maintain or repair the rental property is a business expense that you can write off. Money spent on your primary residence isn’t tax-deductible, though.

Consider Separate Accounts for Each Property

If you own multiple properties, you may consider having a separate bank account for each property. It sounds time-consuming and overwhelming, but it makes things a lot simpler. If you only spend from the account for the corresponding property and only deposit the rent from that property, it’s a lot easier to keep track of your bottom line.

Keep a Separate Credit Card if You Charge Expenses

If you use a credit card to cover the home maintenance expenses (why not earn rewards), keep a separate credit card for it for the same reasons. Unless you feel like combing through every transaction for a year, deciding if they were for personal or business use, a credit card for your rental properties is key.

Set Up Automatic Rent Payments

As a part of your lease, you can require tenants to make their rent payments electronically or even set up automatic monthly withdrawals. Whether you require automatic payments or just electronic payments, it’s one less step for you.

The money goes directly to your checking account. You don’t have to keep track of checks, track down your tenants to get the check, or even go to the bank. The money appears in your account at the same time each month.

Automate Your Mortgage Payments

If you borrow money to buy the rental property, automate your mortgage payments for the same reason you’d automate rent payments. If you have enough money coming in each month to cover the rent, everything happens for you without any work on your part. It’s easier on you and ensures your payments are on time each month. You can easily track the payments at tax time, too, especially if they’re in your separate checking account.

Store All Receipts Digitally

Put the days of shuffling through a shoebox to find your receipts at tax time behind you. Make it easy on yourself and take a picture of your receipts each time you spend money on a rental property. 

Before you snap a pic, write the property address and date on the receipt or highlight the date on the receipt for easy viewing. You can then email the receipt to yourself, store it in Google Drive or any other online cloud storage you choose.

We suggest creating a separate folder for each property so, at tax time, it’s easy to report all income and expenses. 

Implement an Accounting System

You’ll have money coming in and going out each month. While having a separate bank account helps, you still need a system that tracks every bit of cash flow for you. There are hundreds of options available today, but many investors use Stessa. It’s a free accounting program that tracks all income and expenses and even creates personalized financial reports to make tax time a breeze.

Choose Your Accounting Method

You must also choose your accounting method. There’s the cash and accrual method. Most investors use the cash method, but the accrual method works too. Here’s the difference:

The cash method reports your income and expenses as they occur. You claim income the minute you receive the rent and the expenses the minute you make them. Your cash flow will match your accounting method because you don’t count income or expenses until you have the money in hand or it leaves your bank account.

The accrual method reports your income and expenses as you invoice them or receive a bill. For example, if you invoice your tenants for January rent, but they don’t pay it until March, the accrual method counts it in January. The same is true of expenditures. They count when you receive the bill.

Reporting Your Rental Income and Expenses

At tax time, you’ll want a record of all rental income and expenses. The income is required - you’ll owe taxes on any profits. The expenses are optional but work to your advantage because they decrease your tax liability. 

It helps to understand what income and expenses you should report.

Income

You must report all income received from tenants. Besides the obvious - monthly rent, here are some other sources of income you may receive as a landlord:

• Security deposit - If you require a security deposit (usually first and last month’s rent), AND you use it to pay for damages the tenant caused, you must claim the income. If you refund the security deposit or you haven’t had to use it (but hold onto it), it’s not income.
• Prepaid rent - If you require the first month’s rent before the tenant occupies the property, it’s income. Even though you aren’t providing a service yet, you received income that you must claim.
• Late fees - If you charge late fees for missed rent and the tenant pays them, you must claim the rental income plus the late fees.
• Miscellaneous revenue - If you receive any other payments from your tenants, such as a pet deposit, pet rent, appliance rent, or any other income in exchange for a ‘service,’ you must claim the income.

Expenses

Income is required - you must report it, or you’re committing tax fraud. Expenses aren’t required to be reported, but if you do, it may decrease your taxable income, which lowers your tax liability.

So which expenses can you claim? Typically any expenses you incur to maintain or service the property you can claim, but here are the most common examples:

• Routine maintenance costs
• Cost to cover unexpected repairs
• Utility costs if you don’t make your tenant pay them
• Property tax and insurance costs
• Interest on any mortgages
• HOA fees
• Advertising costs
• Professional services
• Property management fees

Get Help With Your Taxes

Whether you like it or not, you’re going to get real familiar with taxes when you invest in real estate. You’re no longer ‘just an employee’ with straightforward taxes. Now you’re a business owner with business income and potential write-offs. 

You’ll need careful documentation of your income and expenses. You’ll need to be able to transfer or input this information into your tax system or use a CPA familiar with real estate investments to help you.

Even if you handle your own accounting monthly, which is easy when you use one of the many real estate investors’ accounting systems available, you may want help with your year-end taxes.

Not only do you not want to miss any possible deductions, but you also don’t want to miss income and file your taxes incorrectly inadvertently. 

When you file your real estate investment property taxes, you’ll file the standard 1040, but you must also report your ‘business’ income from your rental properties on Schedule E. This is where you’ll report your business income and expenses, which may add to your tax liability depending on the bottom line.

Why Rental Property Accounting Is Important

Rental property accounting is important for many reasons. Obviously, you want to make sure you account for your income and expenses, but there are many other reasons it’s important:

• You can see how your properties are performing. It’s hard to tell every month how you’re doing. You collect rent and pay the mortgage and maintenance fees. It’s all going how it should. At year-end, though, you may be surprised that you’re not coming out ahead. With proper rental property accounting, you’ll see where you’re falling short and what changes you should make.
• You’ll get a bird’s eye view of your expenses. You may not even realize how much you’re paying in expenses until it’s laid out in front of you in accounting reports. When you’re aware that you’re paying too much, you can find ways to lower your expenses and increase your profits.
• You’ll be more aware of your accounts receivable. If you manage many properties, they can start to blend together if you aren’t careful. If you lose track of who paid rent and who didn’t, it’s hard to make heads or tails out of your finances. 
• You’ll avoid missing accounts payable. Managing properties is expensive and time-consuming. If you miss a bill, you could damage your credit, making it harder to get financing for other properties. Regular accounting practices will ensure you stay on top of your accounts payable.
• You’ll be ready for the tax year. Rather than waiting until April to get your documents together and file your taxes, you’ll have everything prepared for tax time. It will make filing your taxes much easier and less stressful. 

The Bottom Line

Rental property accounting is essential. It’s how you know you’re paying the right amount of taxes (your legal obligation) without overpaying. The more organized your income and expenses are, the easier it is to file your taxes correctly, but it’s also a better way to make sure your investments are worth it.

As time goes on, you’ll see changes in your income and taxes, and you can determine if the rental property is still a good fit for you or if you should sell your rental property and buy another. The key is to be organized and keep all business finances separate from your personal, so it’s easy to do your taxes and accounting reports.

Image by Sebastian Wagner from Pixabay