Rich in Real Estate

Easy Accounting

for

Real Estate Investors

(5th Ed)

A Note from the Author

In my CPA practice I found that many of the creative real estate investors had trouble finding the help and advice they needed for the new methods of buying, holding and selling real estate. And, once they do find an accountant or bookkeeper who is willing to work with them in creative real estate, questions then began arising on how to keep the financial records.

That’s how Easy Accounting for Real Estate Investors came about. In fact, I've often suggested to clients that they lend or purchase an additional copy of Easy Accounting for their CPA or bookkeeper, to use as a reference guide to booking some of the more creative real estate transactions that are out there.

You will find real life practical examples of accounting short-cuts for today’s creative real estate investors.

Updated for changes in today’s new economy, I hope you enjoy this latest reincarnation of Easy Accounting. This product is near and dear to my heart.

Warmly,

Disclaimer
Information Only – Not Legal Advice

This publication is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. That’s because each individual’s legal, tax, and financial situation is different, specific advice should be tailored to the particular circumstances. For this reason, you are advised to consult with us, your own attorney, CPA, and/or other advisor regarding your specific situation.

The information and all accompanying material are for your use and convenience only. We have taken reasonable precautions in the preparation of this material and believe that the information presented in this material is accurate as of the date it was written. However, we will assume no responsibility for any errors or omissions. We specifically disclaim any liability resulting from the use or application of the information contained in this book.

To ensure compliance with requirements imposed by the IRS, we inform you that any US federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and it cannot be used for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. Always seek advice based on your particular circumstances from a qualified independent advisor.

Any disclosure, copying, or distribution of this material, or the taking of any action based on it, is strictly prohibited.

Easy Accounting for Real Estate Investors (5th Edition)

Copyright 2016 by Diane Kennedy and Virtual Marketing & Sales Series LLC. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopied, recorded, or otherwise, except in the case of brief quotations embodied in critical articles or reviews, without the prior written permission of the publisher. For more information, write US TaxAid Series, PO Box 158, Sparks, NV 89432.

Table of Contents

Introduction, or "Why Keep Real Estate Records?"

Section 1 The Basics for Building Real Estate Wealth

Lesson 1 – Basic Bookkeeping

Basic Bookkeeping You Need to Know

Balance Sheet

Income Statement (also called the Profit & Loss Statement)

Statement of Cash Flows

Balance Sheet Terms for Business Structures (also known as Business Entities)

Adjusting Journal Entries

Summary Questions

Lesson 2 -Record-Keeping Requirements

What to Keep and Why

Temporary File

Physical Record-Keeping

Electronic Storage

Do You Need a Security Compliant Site?

Online Storage Organization

Permanent files

Financial Statement Files

Real Estate Professional Back-Up

Summary Questions

Section 2 Personal Residence

Lesson 3 - Personal Residence Tax and Accounting

The Misunderstood Principal Residence Tax Break

Calculating the Two Year Holding Period Prior to 2009

Calculating the 2 Year Rule After 2009

Qualifying Use vs. Non-Qualifying Use

Calculating Excluded and Non-Excluded Gain on the Sale of a Home

Calculating the Time Period of Non-Qualifying Use

Do You Need Accounting Software?

Reporting the Sale of a Principal Residence

Record-Keeping for Principal Residences

Length of Time Required for Record-keeping

Business Use of Your Home

Personal Conversion to Rental

Depreciation Set-Up

Summary Questions

Lesson 4 – Personal Residence Bookkeeping Short Cuts

Accounting Requirements

Adjusting Journal Entries

Adjusting Journal Entries When You Sell

Tax Forms to be Filed in the Event of a Property Sale

Summary Questions

Section 3 Accounting for the Buy

Lesson 5 – Creative Real Estate Buying Strategies

5 Property Buying Methods

Accounting Methods for Purchases

Leasing

Optioning, or Rent-to-Own

When Did You Buy?

Buying or Leasing?

Buying without Transferring Title

Accounting Considerations

Summary Questions

Lesson 6 – Leasing from Seller

Leasing a Property

Summary Questions

Lesson 7 – Buying Property

Buying Property

Outright Purchase

“Subject To” Purchase

Seller Financing

Some of the Money Came From Another Source

Amortization of note

Land versus Building

Calculating Land Value

Calculating Personal Property Value

HUD-1

Summary Questions

Lesson 8 – Section 1031 Exchange

Like-Kind Exchange

Definition of Like-Kind

Exchange Rules

Basic Like-Kind

Receiving Boot

Multiple Properties

Determining Your AJEs

Summary Questions

Lesson 9 – Special Developer/Dealer Issues

Dealer or Investor?

Capitalization

Capitalization – Indirect Costs

Summary Questions

Section 4 Accounting for the Hold

Lesson 10 – Creative Real Estate Leases and Sales

What Are You Going to Do With the Property?

Creative Real Estate Dispositions

Accounting for Rent-to-Own Programs

Initial Option Payment

Ongoing Option Credits

Impound Accounts

Surrender of a Rent-to-Own Property at the End of an Option Term

Partial Option Reimbursement to Tenant

Exercising the Option

Summary Questions

Lesson 11 – Rental Bookkeeping Shortcuts

Rental Property

Traditional Rental Accounting

Standard Financial Statements

Rental Accounting

Amortization

Impound Accounts

Customer Deposits

Depreciation

Repairs vs. Capitalization

Summary Questions

Section 5 Accounting for the Sale

Lesson 12 – Sale

Sale – How Do You Get Your Money

Basis

Inherited or Gifted Property

Calculate Gain

Sample Accounting Entries

Summary Questions

Lesson 13 – Installment Sale

What Qualifies?

Installment Treatment Versus the Dealer Status Issue

Depreciation Recapture for the Installment Method

How to Calculate the Tax Installment Method

Reporting Requirements

Impound Accounts

Accounting for the Installment Sale Method

Summary Questions

Lesson 14 – Foreclosure Accounting

What Happens When They Won’t Pay?

Rent-to-Own

Installment Sale

Summary Questions

Section 6 The Chart of Accounts and Using QuickBooks in Your Real Estate Investing Business

Using QuickBooks® in your Real Estate Investing Business

Introduction

Traditional Property Rental

Property Management Business

Real Estate Contractor (Construction)

Wholesales and Flips

Lease/Option Program

Procedures for New Businesses Not Set Up on QuickBooks:

Section 7 Questions and Answers

Frequently Asked Questions

Where Do All These Questions Come From?

Appendices

Appendix A –Adjusting Journal Entries

Appendix B – Amortization Schedules

Appendix C – Accounting Glossary

Easy Accounting for Real Estate Investors (5th Ed)

Introduction, or "Why Keep Real Estate Records?"

If you don’t properly record your expenses and purchases, you will likely lose the ability to deduct them on your tax return. That means that you’ll pay more tax. Plus, if something happens to your property and you are sued, you will need to provide good documentation for your own protection or risk losing everything.

But, the question always arises as to what kind of records to keep, how to properly account for transactions for tax purposes and how long to keep records. Those are the questions that “Easy Accounting for Real Estate Investors” will answer.

Throughout the book you will find examples of Adjusting Journal Entries (also called Journal Entries, AJEs or JEs). An Adjusting Journal Entry is an entry used in a double entry bookkeeping system.

There is a good chance that you won't be doing your own books, even though you're reading this manual. That's one of the early decisions that all business owners and real estate investors face: when to do it yourself, and when to use experts to do the work. If you're very new to bookkeeping or to using QuickBooks or other accounting software, then your time may be better spent getting your business up and running and doing the things that you're good at.

However, don't let that stop you from reading this manual. Even if you don't choose to do your own bookkeeping, as a business owner you owe it to yourself to have at least some accounting knowledge. Otherwise, how will you really know how your business is doing?

If you aren't doing your own books, make sure your bookkeeper reads through the Manual, especially the AJEs and JEs (or buy a second copy - it makes a great Christmas gift!). But remember, it's ultimately your responsibility to provide your bookkeeper with the information he or she needs to make the calculations and adjustments. That information will be covered atthe beginning of the lesson. Read it and follow it. You’ll have better information, more deductions, and a lower accounting bill!

Let's get started.

Section 1The Basics for Building Real Estate Wealth

Lesson 1: Basic Bookkeeping

Lesson 2: Record-Keeping Requirements

Lesson 1 – Basic Bookkeeping

After completing this lesson, you should be able to:

1.Identify a balance sheet, income statement and statement of cash flows.

2.Explain what an adjusting journal entry is, and why you (or your bookkeeper) would use one.

3.Match the following description with the appropriate financial statement (Balance Sheet, Income Statement, Statement of Cash Flows):

Snapshot of the assets and liabilities of the company at a given date

Statement that shows the flow of profit for a period of time

Financial statement that shows where cash is coming from (or going to) within the business

Explain how a company can be making money and yet not have any cash. Which statement would provide the early warning sign of that occurring?

Understand that different business structures use different terms for ownership.

Basic Bookkeeping You Need to Know

Financial literacy is simply not taught to most students. In fact, unless you have a business degree, you probably never learned about financial statements. The purpose of this section is to give you basic information about financial statements. We don’t want to try to turn you into a bookkeeper or accountant so we’re not going to discuss the specifics of debits and credits, only the basics. There is an Accounting Glossary inAppendix C if you’d like a refresher of a specific term.

There are three types of financial statements. These are:

Balance Sheet

Income Statement

Cash Flow Statement

In some cases when you are reviewing an investment you might be presented with an income statement only. The income statement is only one part of the financial statements. You MUST see all of the financial statements in order to get a full sense of the investment potential. Read on for the analysis points of each financial statement.

Sometimes you will be handed a set of projected financial statements. The term “projected” means “my best guess” or “I sure hope this is true” or “I wish this was true.” A lot of the problems that have occurred with publicly-traded companies happened because someone read a projection and believed it was an accurate reflection of the company. A projection is simply an estimate based on suppositions that may or may not occur. That projection (or guess) is only as good as the assumptions. If you review a projection or pro-forma, ask to see the assumptions.

Balance Sheet

The balance sheet is a snapshot of a company. It shows the assets, liabilities and equity (net worth) of the company at a given point in time. The equity is the value of the assets minus liabilities.

Balance sheet assets might include:

Account / Analysis Points
Cash / Typically the amount is correct, if the bank statement has been reconciled.
Accounts Receivable / Watch for “old” accounts receivable that have gone bad and are likely uncollectible.
Fixed Assets / This should reflect the basis of the property – its historic value, not the current fair market value of the assets. It will also include the capitalized improvements to the property.
Accumulated Depreciation / Most assets are depreciated over time. The depreciation is an expense, but the cumulative effect of the depreciation is shown as a negative balance in the asset accounts. This accumulated depreciation reduces the basis of the assets.
Investment in ABC Co. / Many companies invest in other companies. The “Investment In” account shows what they have invested in or possibly a goodwill value of the asset.
Other Assets / If you have financed your real estate property, chances are there is an Impound Account, which would count as an Other Asset.This is an asset that increases as you make monthly payments and decreases as the lender makes payments for property tax, insurance and other items authorized to be withdrawn from the Impound Account.If your property has been refinanced or the loan sold to another company, verify that the Impound Account is accurate.

Creative real estate investors will have unique entries to the asset portion of their balance sheet based on the way in which they have taken control of the property and when the purchase is actually deemed to have occurred. This will be covered in greater detail in Part III – Accounting for the Buy.

The Balance Sheet also has liabilities. These liabilities might include:

Account / Analysis Points
Accounts Payable / These are current debts that the company has. This is frequently the first indicator of a problem. If there is a lot of debt that must be paid within the next month, the company must have enough cash flow to cover it. It doesn’t matter how much money the company makes. It matters whether it can pay its current bills.
Customer Deposits / Deposit Money that the company (or real estate venture) has collected from customers or tenants is a liability. At some point, this must be paid back. This is also another potential ticking time bomb. An example of this would be a security deposit that you have taken from a tenant. You may need to pay that back when they move out.Another form of Customer Deposit will be Impound Accounts that you collect from property you have sold and financed.If others are paying you a monthly fee that you hold on deposit, it is a liability to you.
Accrued expenses / An accrued expense is another form of accounts payable. The company owes someone else money. However, in the case of accrued expenses there will be very significant debts – payroll taxes, interest and property taxes. These are monies due to people that can take away assets. These need to be currently paid.
Mortgages Payable / A mortgage payable is typically a long-term debt. For purposes of cash flow analysis, you need only calculate the monthly payments required on the mortgages payable UNLESS the mortgage has a clause that requires it to be paid sooner. The mortgage payable will be decreased each month ifprincipal is paid on the loan. (Some loans are interest only. In this case, there will be no reduction in the mortgage amount)

The balance sheet also has an equity section. A simple explanation of the equity section is that it shows the total assets minus liabilities. This is a correct statement, because in order for the balance sheet to balance, the sum of liabilities and equity must equal the amount of assets. Following is a list of some of the accounts found in the equity section. The biggest differences occur in the equity section due to the type of entity. Corporations have shares, whereas LLCs have membership interests and LPs have limited partnership interests.

Account / Analysis Points
Stock / Every corporation should have a value in the stock account. If they don’t, the accounting is suspect.
Treasury Stock / Treasury Stock refers to stock that the company has purchased from stockholders. Generally this is a positive sign that the company is expecting the value to increase.
Paid in Capital / Not much to analyze here.
Partner Capital / This is used in a partnership (or LLC taxed as a partnership). This will tell you how much you and others have invested in the company.
Distributions / This account is used only in the case of an S Corporation. It will tell you how much the
shareholders have taken out of the company in the current year.
Retained Earnings / The retained earnings account shows the current and past accumulated earnings of the company. This can be an interesting account to watch when a company “turns around.” Look for the current change to this account to see what the trend for the company appears to be.

Following are a series of Balance Sheets. As you go through these, notice the difference in presentation and terms that are used to describe the ownership. The key differences will be within the equity portion of the Balance Sheet. You should be able to tell the type of entity simply by looking at a balance sheet. For example, the first example is Good Tenants Management Company. This company is operating as a C Corporation. The second example is still Good Tenants Management Company. However, in this case, the company is operating as an S Corporation.