When it comes to accounting for real estate investments, most independent rental property owners choose cash-basis accounting.
Cash-basis accounting means that accounting is done at the time transactions are completed, regardless of when that money was due or invoiced. This is the simpler method of accounting compared to accrual accounting, where accounting is done at the time of invoicing, which may not always be an accurate picture of your rental business’ financial standing.
With cash-basis accounting, you simply record all income and expenses when they are actually received or paid. The main advantage of cash-basis accounting is that it is easier to track and manage your finances. The downside is that it may not always show a true picture of your profitability, since your business’ current or future liabilities may not always be accounted for.
Common mistakes in cash-basis accounting
When it comes to real estate, there are some common pitfalls that can come with cash-basis accounting. Let's take a look at some of these mistakes so you can avoid making them in the future.
Marking building purchases as an expense during escrow. While you want to be accounting for mortgage principal, land value, building value, and escrow, you don’t want to be accounting for these items before the deal is closed. This is a common mistake and can be costly, especially if that transaction is accounted for around the new year.
Not putting the exact date of rent collection. If January rent is due on 1/1/23, but your tenant pays you on 12/31/22, then it counts as 2022 revenue and cannot be moved to 2023. Making sure your transactions are categorized at the time they are completed vs. when payments are owed or initiated is important to understanding your real-time cash flow and for tax purposes.
To maintain accurate reports, follow the above cash-basis accounting best practices, and consult your CPA if you have any questions about specific situations for your rental business.
Disclaimer: This content has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for accounting or tax advice.