Real Estate – Record to Report – Financial Accounting

Real estate accounting in the U.S. refers to the specialized financial management practices for businesses and individuals involved in the buying, selling, leasing, or managing of real estate properties. This includes real estate developers, property managers, real estate investors, and brokers.  

A strong foundation in accounting best practices paves a smooth path for your business to flourish and win new clients. In this short article, you’ll learn the fundamentals for taking control of the accounting side of your real estate business. 

Key Real Estate Activities 

The real estate market in the United States offers diverse opportunities, from property flipping and wholesaling to earning rental income. Here is a brief about each of them: 

1. Property Flipping: 
   • Acquiring undervalued properties, improving them, and selling at a profit.
   • Requires careful tracking of acquisition costs, renovation expenses, and sales revenue. 
2. Wholesaling: 
   • Securing properties under contract and assigning the contract to an end buyer for a fee. 
   • Involves monitoring contract costs and revenue recognition from assignment fees. 
3. Rental Yields: 
   • Generating steady income by leasing properties to tenants. 
   • Involves managing rental income, operating expenses, depreciation, and financing. 

Documents Required for Accounting

1. Bank and CC Statements:
   • For reconciliation and verification of transactions. 
2. Closing Documents:
   • Settlement statement (HUD-1 or Closing Disclosure) for sale and purchase. 
   • Title insurance policy. 
   • Property deed. 
3. Loan Documents:
   • Mortgage agreement. 
   • Promissory note. 
   • Loan amortization schedule. 
4. Lease Agreements:
   • Contracts with tenants detailing rent terms, lease duration, and other conditions. 
5. Rental Payment Receipts:
   • Documentation of tenant payments.
6. Operating Expenses:
   • Utility Bills: For electricity, water, gas, and other utilities. 
   • Maintenance and Repair Invoices: For services like plumbing, landscaping, and cleaning. 
   • Insurance Policies: For property and liability coverage.
   • Property Tax Bills: Annual or semi-annual tax assessments.

Below is an overview of key aspects of real estate accounting in the U.S 

Separate Personal and Business Finances 

• Use a dedicated bank account for real estate transactions. 
• Avoid mixing personal and business expenses to maintain accurate records and simplify tax filings. 

Maintain an Accurate Chart of Accounts

Create a tailored chart of accounts: 

• Assets: Property inventory, investment properties, accounts receivable. 
• Liabilities: Loans, accounts payable. 
• Equity: Owner contributions retained earnings. 
• Income: Sales revenue, assignment fees, rental income. 
• Expenses: Renovation costs, operating expenses, interest 

• Create accounts for booking the property related expenses as COGS expenses which are a part of the Gross Profit. 
• Other Non-COGS expenses should be a part of the P&L following the Gross Profit forming a part of the Net Profit. 
• Create WIP accounts (Purchase, rehab, closing costs, holding costs, etc) under current assets account to account for the properties that have been purchased and listed for sale. 
• Use subcategories for detailed tracking (e.g., separate property taxes, utilities, and maintenance expenses). 

Use Appropriate Accounting Software 

• Software that are designed for real estate, like QuickBooks, Xero, Buildium, or Yardi, for streamlined tracking and reporting can be chosen for easing the process. 
• Use tracking features like (Classes, tags, etc) to book all property related expenses and revenues so that detailed reports can be easily fetched to see the profits from a particular deal. 

Record Income Correctly 

• Rental Income: If rent is received for any property then it should be recorded when earned. 
• Sales Revenue: Recognize income upon closing the sale.
• Other Income: Commissions received or brokerage fee received can be recorded as other income. 

Track Expenses Accurately 

• Direct Expenses: Include property repairs, maintenance, property taxes, utilities, insurance and closing costs during sale and purchase. They are accounted under COGS. 
• Indirect Expenses: Marketing expenses, payroll expenses, vehicle expenses, office expenses and other miscellaneous expenses are a part of indirect expenses and are accounted as Non-COGS expenses. 
• Loan Payments: Separate interest (expense) and principal (liability reduction). 
• Purchase of Property: When a property is purchased, its expenses are accounted under the WIP (Inventory) accounts in the balance sheet until the property is sold. After the sale of property, its purchase expenses are moved to the COGS accounts in P&L.  
• EMD: Earnest Money Deposit in real estate refers to a sum of money that a buyer provides to demonstrate their serious intent to purchase a property. It should be recorded as a current asset in balance sheet. It can later be either refunded or adjusted during the purchase against the actual purchase price. 

Reconcile Bank and Credit Card Statements 

• Perform regular reconciliations to ensure records match bank accounts. 
• Identify discrepancies, missing transactions, or errors promptly. 

MIS Reporting 

Create various reports for better insights into the business. 

• Cash Flow Statements 
• Property wise profit report 
• Commission calculation reports 
• Budgeted Vs Actual revenues and expenses 
• Dashboards for various ratios and expenses 

Prepare for Taxes 

• Track deductible expenses year-round to simplify tax preparation. 
• Maintain proper vendor names while accounting to make it easier to collect data to file Form 1099-NEC for payments to contractors over $600. 

Conduct Regular Reviews and Audits 

• Periodically review financial reports for accuracy and completeness and address inefficiencies or discrepancies in real-time.