An Overview Of Rental Property Accounting For Landlords

The world of rental property accounting is vast and complex. Whether you’re a seasoned pro or just getting started, all real estate investors have something new to learn. In this article, we’ll dive into everything you need to know in order to establish yourself in the world of accounting and tax benefits for rental property.

Tracking Your Firsts

If you’re diving into property management accounting without a plethora of experience, tracking your first rent payments, transactions, and creating your first income statements can be daunting. Luckily, there are a few straightforward concepts that will get you off on the right foot.

For starters, you’ll want to keep detailed records of every transaction, as well as any receipts, bills, invoices, or the like. When filing taxes, being thorough will come to your aid and ultimately increase your deductions. You can track your transactions in a rent ledger, a spreadsheet, or online, with the help of rental property accounting software.

Rental property income statements (which we’ll expand on later) are helpful reports for beginners as well. Considering your rental property expenses, income, and other metrics, it essentially creates a thorough report that assesses your business’s profitability. With this report, you’ll be able to see any areas where you may be underperforming, where you may need to change, and any growing trends in your books.

Accounting Methods: Cash vs. Accrual

When you first start doing rental property accounting (and most business accounting), you have two methods to choose from: cash and accrual basis. These two methods track your income and expenses a little differently, but depending on a few factors, using one over the other may be more beneficial or even required.

A simple way to think about these two methods is that the cash basis accounting method tracks transactions the moment they actually take place, whereas  the accrual basis accounting method tracks transactions the moment they are scheduled to happen.

Although the difference seems small, it matters in the long run. With cash basis accounting, you have a better idea of how much money you have on hand at a given time, whereas with accrual, you know how much you should have. The latter can be beneficial if you are keeping track of bills that haven’t been paid yet.

There are some stipulations as well. For example, businesses making over $25 million in annual sales over the past 3 years must use accrual. For more information, ask a professional or research whether cash or accrual is the right pick for your business.

Income and Expenses

All accounting begins with income and expense tracking. The basics are as follows:

Rental income is any payment received for the use or occupation of property, according to the IRS. It’s generally considered unearned or passive income, so it’s taxed a little bit differently than money earned from an employer. It can include any money you receive for rent, late fees, rental agreement payments, and more.

Rental expenses, on the other hand, are any expenses incurred on your for-profit rental business, which can include salaries, repairs, mortgage interest, marketing costs, and more. So long as they meet a few requirements, most rental expenses can generally be written off as tax deductibles, which will save you money during tax season.

Capital expenses are a specific kind of expense, as they are long-term investments made to improve the rental property in some way. They can include appliances, company cars, and renovations, but they are not deducted the same way as other expenses. Instead, they are depreciated, meaning you can deduct a portion of the cost each year as the item’s value and lifespan decrease. Correctly reporting your expenses will decrease your taxable income and maximize profits, so getting a good grip on these concepts is vital for growth.

Security Deposits and Fees

As you may know, security deposits (upfront payments made to a landlord before move-in) and fees serve as financial safeguards for landlords. Security deposits, however, are refunded in their entirety upon the lease’s end, given that the tenant leaves with their bills paid and their property in acceptable condition. You won’t track security deposits as income since you’ll be returning them—unless you need to deduct from them for cleaning, damages, etc. Depending on where you operate, you may need to store security deposits in special interest-bearing bank accounts, so it’s important that you research local laws so that you abide by them.

Rental fees are collected for many reasons: applications, screenings, parking, late payments, etc. If you don’t enforce advertised fees, tenants may begin to feel comfortable paying rent late or breaking lease agreements. Ensure that you make penalty and fee enforcement abundantly clear to your tenants so that you don’t feel hesitant to collect them. Property management software can be a great way to ensure the collection of these fees, as it will automate the process for you. Once these fees are collected, they’ll automatically be tracked and labelled in your software for you.

Record Management

Staying on top of your records is one of the most important aspects of rental accounting—for the sake of growth, organization, taxes, and legality. If you find yourself stressing about your record-keeping and organization, here are a few things you can do.

• Make separate bank accounts. By creating separate bank accounts dedicated to your personal and business finances, you won’t struggle to categorize your expenses because it will already be done for you. When it comes time to report rental income and operating expenses, everything will already be in one place. Multiple accounts will also protect your personal assets from legal disputes, as well as simplify your accounting and taxes.
• Be timely. Staying on top of your record management is an extremely important aspect of accounting for rental property owners. It’s best to track transactions as soon as you can and to be as detailed as possible. Save any receipts, bills, or invoices, and generate your own for tenants as soon as you can. Dedicating a few minutes a day will save you from one long, strenuous day during tax season.
• Use bank reconciliation. Do a regular check of your records and your bank accounts to ensure that every number lines up properly. Once again, routinely dedicating a few minutes will save you the hassle of a large pile of records at the end of the year.
• Go digital. Technology has made it increasingly simple to do your record-keeping and accounting online. Using property management software as well as real estate accounting software can securely automate your record-keeping, but it’s a good idea to keep paper records as a backup in case of outages.

DIY or Bookkeeper?

In terms of books management, you essentially have two options: doing the rental property bookkeeping yourself or hiring a professional to do it for you. Lucky for you, hiring a bookkeeper isn’t a necessity (though it does have its perks!) thanks to modern technology.

Bookkeepers

Accountants and bookkeepers can be a great option for landlords with large rental property portfolios and many complex moving parts. They can be costly, however, as hiring an employee will mean forfeiting some of your income for their pay. You can hire a general accountant, who will likely have an accounting degree and/or experience in managing finances, or you can hire a Certified Public Accountant (CPA).

The main difference? In addition to their education, CPAs must pass rigorous exams in order to earn their certification, whereas accountants and bookkeepers do not. CPAs additionally have extensive tax experience and can help you understand your property taxes or increase your deductions thanks to their formal training and tax code knowledge. For this professional help, however, you should have some room to spare in your budget, as their average annual pay as of October 2024 in the US was $73,405.

Rental Property Accounting Software

Another popular option, rental property accounting software, is significantly less expensive, averaging around $15-70 per month. With this option, you won’t get the same kind of in-person help or personalized tax advice, but some software platforms will offer complementary round-the-clock customer support, whereas most CPAs will not. Additionally, it will automate a lot of processes for you, making it easier to stay organized when tax season comes around.

With this option, everything is stored online in an easily accessible cloud, and most of your bookkeeping can be automated. By securely syncing your bank accounts (in the case of Ledgre, with Plaid) you won’t have to manually track most transactions. Bank data will automatically be pulled from your account and imported into your rental property accounting software, making it simple to keep all of your records in one place. For landlords who prefer to be more in control of their finances, rental property accounting software is a fantastic option.

Budgeting

To keep your real estate accounting on track, you’ll need to establish a budget and stick to it. This is another aspect of accounting that is often overlooked, but it’s vital to your success. You must have a clear idea of how much money you are allocating to different aspects of your business so that you can decide exactly where you need to cut back spending.

When setting up a budget for your rental property business, you’ll need relevant data, including all financial statements, data on rental income and expenses for the past 1-5 years, as well as data on prior vacancies, evictions, and market trends. With all of this information pooled together, you’ll need to assess your past financial health and adjust your budgets accordingly. This is a complex process, so do some reading on setting up a basic budget before you dive right in.

Since you will likely have budgets and categories for certain aspects of your business, rental property accounting software can be a helpful tool. With customizable software, you can create, track, and edit budgets online so that you can simplify the process while still keeping a watchful eye on them.

Metrics, Reports, and KPIs

Once you get into a groove of things, it’s a good idea to keep a close eye on your rental business’s health via regular financial reporting.  It’s important to be aware of a few methods to measure your success and stability.

Basic financial reports such as rent rolls, profit and loss statements (P&Ls), and pro forma statements give you quick and reliable financial health insight. Rent rolls keep a snapshot of your rental income with tenant details, rent amounts, payment histories, and more. Similarly, P&Ls (also sometimes known as rental property income statements), provide broader financial data for a shorter period of time. They’ll typically include your sources of income, expenses, and more details that showcase your flow of cash. Pro forma statements, however, focus on the future and are used to predict potential income, expenses, and overall profitability based on past data and trends.

Other real estate accounting metrics and Key Performance Indicators (KPIs) can also help to monitor and foster your business’s growth. Your cash flow, for instance, is a metric that subtracts your debt service and expenses from your NOI (your Net Operating Income, another accounting metric). This will essentially show you how profitable your business is and whether or not you’re breaking even. There are many other important metrics and KPIs that all landlords should know, so when assessing your financial health, it’s best to get comfortable with as many as you can.

Conclusion

Equipped with this information, you’ll now be more ready to effectively handle your property management accounting. And whether you choose to outsource your bookkeeping or not, it’s good to have a solid grasp of the concepts mentioned above so that you can stay in touch with your properties’ financial health at all times.