So you recently purchased an investment property (for less than market value) in a city with a huge rental demand, and a quickly growing job market. In other words, you have just invested in cash flowing real estate that has a great chance for appreciation in the future. Congrats! The hard part’s over…
Or is it?
The truth is: you may have done an excellent job of finding a great deal, securing a low-interest loan, and (if you’re a passive investor) you also hired a turnkey property provider/management team with an amazing reputation. So now you think you can just sit back, relax, and the money will roll in.
If this sounds like you, you’re forgetting one very, very, very (very, very, very, etc.) important thing.
What is it?
Bookkeeping of course! 🙂
Ugh! I know, it’s not the most exciting topic. BUT, before you X out of this web page here’s what you should know: bookkeeping is an essential part of owning rental properties (even if someone else is managing them, and perhaps even more so).
Unfortunately, a lot of investors, especially newbies, don’t understand how true this statement is.
It’s mind blowing, but many investors don’t diligently track their income and expenses, and some don’t track them at all. They get a check in the mail every month, they cash it, and they go on their merry way. Meanwhile, they’re paying for repairs and other non-routine maintenance with credit cards, checks, and cash tied to their personal bank accounts. (Hint: don’t do this).
If this sounds like you, you should know this is the WRONG thing to do as a property owner. Why? Because you could be losing a lot of money… and you wouldn’t even have a clue.
The good news is that keeping accurate books isn’t complicated… If you have the proper education. So do yourself a favor and keep reading this preview from The Real Estate Basics Course. You’ll thank yourself later, we guarantee it! (Side note: All 12 modules of The Real Estate Basics Course will soon be available to download free, so keep your eyes peeled!)
Before we get any further, you should know that there’s one thing that may be worse than not tracking your income and expenses. That thing is: not protecting yourself from the IRS and liability. One example of this is owning properties in your personal name rather than an entity (BIG MISTAKE). We’re not going to discuss this, or any other, asset protection nightmare scenario in this article. So, if you haven’t created an asset protection/preservation plan with your accountant or CPA, please click here to learn more about protecting your real estate assets. (It will open in another tab, so you won’t lose your place here.)
For the rest of you, here’s what you’re about to learn about Bookkeeping in this article:
1 – The importance of bookkeeping for your real estate business.
2 – What you should be tracking and how often you should be doing it.
3 – Tracking tools and resources to simplify your accounting efforts.
If you’re ready to understand the basics of bookkeeping, and how it can make you a lot more money, let’s get started.
Why Bookkeeping Is So Important For Investors
If you own rental properties (or you’re considering it), it’s important to understand the factors that contribute to the return on your investment.These ROI factors, as one might call them, include: monthly cash flow (income earned from your tenants rent), appreciation, and write offs/tax benefits.
On the flip side, there are also several factors that negatively affect your ROI. These negative-ROI factors, as one might call them, include: regular maintenance and management fees, repairs for unexpected damage, mortgage payments and interest, taxes, etc.
If you’re smart, you’ll track every single penny you spend – regular expenses, repairs, every mile you drive (if you’re self-managing), and you’ll also record when your rent payments come in every month. Not only will this give you a better understanding of how much money you’re really making, but it will also make your life A LOT easier come tax time.
To make things simple, here’s a list of the top benefits of proper accounting for your real estate holdings:
- Track how much cash flow you’re making every month, what your expenses are (profit/loss), and clearly see your net income.
- Analyze how your properties are performing year to year (so you know when it’s time to sell)
- Compare properties to see if some are doing better than others (again, so you know which ones to sell, and which to hold onto).
- Keep all of your records for each property organized, so you don’t get overwhelmed as your portfolio grows.
- Pay your bills and other financial obligations in a timely manner.
- Get a head start on your yearly tax returns and avoid last minute stress.
- Save money on tax preparation services, and make your CPA will love you. They won’t have to spend time gathering and organizing all of your information, which means you won’t have to pay for that time.
- Avoid making mistakes that may cause you to get audited by the IRS.
- But if you do get audited, you can avoid paying penalties and back-taxes to the IRS. Why? Because you’ll easily be able to defend deductions you claimed.
Metrics That Real Estate Investors Should Track Every Month
Keeping track of a single property might not seem like a big deal, but as you grow your portfolio, the number of necessary investment related activities you need to track can really start to build up. This can get really complicated!
The best thing you can do is to set some time aside every month for bookkeeping. Here are the most important things you should track:
1. Profits and Losses
It’s important to know how much cash flow you’re generating every month, and how much money you are spending. You should know these numbers for each of your properties, AND for all of your properties combined. This is the only way you’ll have a clear understanding of your net income.
As you grow your portfolio and invest in more properties, Kathy Fettke also recommends that you “keep track of rent payments and make sure none of your tenants are late with their checks. Also, some tenants may pay on different dates and you’ll need a way to keep it all in order.”
2. Write-Offs & Taxes
You’ll need to keep track of expenses that can be deducted, the values at which you’ll be taxed, and evidence of all appropriate writes offs. Note: if you’re not keeping track of every possible tax perk available, you’re doing yourself a major disservice.
3 – Loans & Interest
Loans payments and interest are another big concern. This is especially true if you’re leveraging as much as possible (which you should be doing), because you may have a few different loans to deal with.
For each property it is essential that you know (a) how much you owe each month, (b) when the payment is due, (c) if and when the rate will change, and (d) how long you have until the loan is paid off.
4 – Maintenance & Repairs
If you’ve ever owned a home, you know that every house eventually needs some repairs. Whether these are large or small, you can often schedule them or predict when they’ll need to be done.
If still you’re not convinced you should be tracking all of this, maybe the IRS can scare some sense into you:
Keep track of any travel expenses you incur for rental property repairs. Separate receipts for minor repairs like plumbing, fixing a broken door or minor repainting from receipts for capital improvements like adding a new roof, remodeling a kitchen or installing insulation.
You must be able to substantiate certain elements of expenses to deduct them. You generally must have documentary evidence, such as receipts, canceled checks or bills, to support your expenses.
If you are audited and cannot provide evidence to support items reported on your tax returns, you may be subject to additional taxes and penalties. For example, if you cannot substantiate the rental real estate expenses of replacing the door locks, with appropriate records, the IRS may disallow that expense which may mean that you incur additional taxes and penalties.
You need good records to prepare your tax returns. These records must support the income and expenses you report. Generally, these are the same records you use to monitor your real estate activity and prepare your financial statements. Read more at IRS.gov
Is this consuming? Yes, it can be. Are you going to enjoy it? Doubtful. Should you do it anyway? Yes 100%. Why? Because spending a little bit of time now will save you a lot of time and hassle later. It can also save you THOUSANDS in taxes. Plus, it doesn’t have to be difficult or time consuming. It really only takes a few minutes.
In all seriousness, “the key to getting consistent results with less stress and waste” according to Kathy “is to create systems for everything important that needs to get done on a regular basis. The dullest pencil is better than the sharpest memory!”
How To Make Bookkeeping Even Easier?
Ok, if all this tracking still sounds like too much work…you’re not out of luck just yet. Here are a few more recommendations that can make accounting EVEN QUICKER AND EASIER. Here goes:
1 – Open separate bank accounts
Many investors say that opening separate bank accounts for each of their properties makes accounting way easier. First of all, it makes it super clear for you to see how much money is going in, and out of each property’s account every month.
One important thing to note is that you should NEVER use your personal account to pay for any of your properties expenses. Why? Because if you ever get audited (fingers crossed this will never happen), you don’t want to them to have to sift through all of your personal expenses to prove your case.
2 – Sign up for auto-pay or pre-authorized debit
Most mortgage companies offer some sort of auto-pay option or pre-authorized debit. This is pretty self explanatory, but for clarity sake it means that your lender will take the payment directly out of your account every month.
To make your life even easier, you might consider setting up auto-pay for other monthly payments too. For example, your insurance, property taxes, utilities, management fees, and other expenses. The benefit is that you can always be sure everything gets paid every month, no matter where life takes you – so go ahead and book that 10 day silent meditation retreat you’ve been dreaming of, a safari in Africa, or cruise around the world, and have a blast knowing your expenses are automated!
3 – Hire someone to do it for you
Hire help when needed! In addition to turnkey property management teams and facilitators, you can hire a bookkeeper or CPA to help you on an ongoing basis. Investor Tip: don’t keep all of your receipts and invoices in a box until April 1st and expect your CPA to be super stoked on you. You may also consider hiring a virtual assistant to help you with your administrative needs like compiling all of your profit and expense information to sending to your accountant every month.
Conclusion (Plus 1 More Thing)
You should now have a pretty good idea of why bookkeeping is essential for your real estate investment business. And you should also have a good understanding of what you need to do to make sure you do it correctly, maximizing your income and avoiding the IRS at all costs.
That being said, there is one more thing you shouldn’t forget to track. According to Kathy, the most important thing to keep track of when it comes to investing is…your goals!
You see it’s easy to have a clear picture of what you want today, but in five years – ten years – that picture will likely change.
This is important to note, because investing in real estate is a long-term game. Sure, you can make you a lot of money in a short period of time BUT to really make the most profit and avoid getting taxed, you’ll have to wait a while.
“As your portfolio grows, so will your life. You’ll have more money and more freedom. You may travel more, take on new hobbies, volunteer more, and do a variety of other things that change your life and who you are for the better.
Throughout all of this, however, you should never lose sight of your goals. That dream of sending your child to a great college, of providing for your parents when they need it, retiring early, taking that special vacation, and finally enjoying life to the max is what really matters.
Do whatever works best for you, but don’t ever lose sight of your most important goals. Write them down and post them somewhere you can see them. Life gets distracting and often people end up finding ways to spend more than they earn, no matter how much more they earn.
Staying connected to your most important goals, having the patience to wait for it, and the diligence to work towards it is how we make our dreams come true.” — Kathy Fettke