Rental property owners have a lot to keep up with, so bookkeeping often falls lower on the to-do list, gets set aside, and is rushed through once it can’t be put off anymore. But procrastinating, then hurrying through the bookkeeping process leads to mistakes. REI Hub is one of the leading providers for rental property accounting software, so we’ve seen a thing or two when it comes to real estate accounting. Use this list of the top five errors associated with rental property bookkeeping to double-check your property’s books.
#1 – Commingled Accounts
A common error with rental property bookkeeping is combining bank accounts. This mistake can have several forms, from combined personal and business accounts, to combined accounts for multiple legal entities, to combined accounts for operating costs and security deposits.
Even if you run a small real estate investment business with just one unit or property, have a separate business bank account for your rental property. Tracking your deductible costs for your rentals is easier when you have a separate account for the rental business (or potentially even for each property). With combined personal and rental bank accounts, you can easily miss transactions, which affects your bottom line. Plus, sorting through each additional transaction costs you time!
Furthermore, some states require rental property owners to keep security deposits in a separate bank account. Even the interest generated from those security deposits must be returned to the tenants, according to some state laws. If you keep your security deposits in an interest-bearing account along with other funds, you must either calculate the interest amount related to those deposits or risk having to give up all the interest earned. Failure to follow your state and local laws regarding security deposits can trigger hefty fines and penalties.
If you have commingled bank accounts, speak with your tax adviser and lawyer about what the requirements are for your area and what’s the best way to divide your accounts.
#2 – Doubling up on Deductions
Every expense is a deduction for your business, so you certainly want to make the most of the expenditures for your rental units. Unfortunately, many property owners unintentionally double up on their deductions in a few key expense categories.
Mileage vs. Auto Repairs and Fuel
If you use your personal car for business travel, the IRS lets you expense your mileage. Although the mileage rate may vary from year to year, it’s always based on the fixed and variable costs of operating a vehicle. So your mileage expenses already cover your fuel and maintenance costs for your vehicle. If you record mileage along with fuel and auto maintenance costs, you’re doubling up on those deductions. That’s a red flag for the IRS.
When your business owns a vehicle, then you can expense the associated fuel and maintenance costs instead of taking the mileage deduction. But if you use your personal vehicle for business travel, keep a mileage log and take the deduction.
Full Deductions for Meals Instead of 50 Percent
For the past few years, businesses could deduct 100 percent of certain business meal costs. However, that 100 percent deduction was temporary, and as of 2023, the deduction is back to 50 percent for some meal charges.
50 Percent Deductible
- Meals while traveling for work
- Meals at a conference
- Food items, like snacks, coffee, or sodas, for employees
- Business meals
100 Percent Deductible
- Food for company-wide recreational employee events, like holiday parties, summer picnics, and team-building events
- Snacks or coffee for customers
- Meals for clients or customers
Most of the meal-related outlays for rental property owners fall into the 50 percent category. If you deduct the entire cost of something that isn’t in the 100 percent deductible category, that’s a tip-off for the IRS.
When the IRS believes your tax return has errors, they can ask for proof of your deductions. If your supporting documentation doesn’t match the information on your return, you may need to file an amended return, which could affect your refund or amount due. The IRS may also assess penalties for incorrect tax returns. Save yourself time, money, and stress by reviewing your deductions related to auto and meal expenditures.
#3 – Repairs vs. Fixed Assets
Determining what counts as a repair and what is a fixed asset is a common source of confusion for real estate investors. Expenses are property-related costs necessary for managing and maintaining your business. Expenses are deductible for the year in which they occur.
Fixed assets, or capital improvements, add value or extend the useful life of your rental property. According to the IRS, we can’t deduct the entire cost of the improvement within the same year, unlike expenses. Instead, property owners recoup the cost through depreciation over a set period. When you pay for the fixed asset, only a percentage of the cost is deductible that year.
If you incorrectly categorize an expenditure, whether it’s a repair when it should be a capital improvement or if it’s a fixed asset that should be a repair, the effect on your books is significant. This error alters your bottom line for the year because it affects when the expenditure is deductible.
For a full discussion on fixed assets and repairs, see our related resource article, “Are the Repairs at Your Rental Property an Expense or a Capital Improvement?
#4 – Skipping Reviews, Reports, and Reconciliations
Two of the most important parts of the bookkeeping process are reconciling your bank accounts and reviewing your reports regularly. Unfortunately, these steps often get delayed or skipped altogether.
Reconciling your bank accounts ensures that your book balance (in your accounting software) and your bank balance match and the same transactions are in each. Addressing any discrepancies as soon as possible is always best, so add reconciling your accounts to your monthly schedule.
Reviewing your financial reports each month helps you keep track of how your business is doing. Monitoring your cash flow, income, expenses, assets, liabilities, and equity means you can make informed decisions regarding your rental properties. Can you afford to buy a new property? Is your current unit profitable? Do you have enough cash flow to cover a capital improvement? Do you need to raise the rent after a tenant moves out? If you don’t review your balance sheet, profit and loss statement, or cash flow statement, you may not be able to answer those questions.
Looking at a month-to-month comparison, like REI Hub’s Net Income by Period report, helps you spot trends occurring within your business. Are your utility costs creeping up, or are they significantly higher than this time last year? If so, is there a leak in your rental unit, or is it time for some energy-efficiency upgrades? Reviewing your reports each month will help you identify potential issues and see where to make corrections.
Use the arrival of your bank statement as a reminder, or set up a recurring event on your calendar each month so you’ll already have the time set aside to reconcile your accounts and review your reports. And at the end of each year, schedule an annual review of your accounts. Be sure to include REI Hub’s Tax Time Double Check and the Tax Review as part of your yearly review process!
#5 – Reporting Revenue
Underreporting income can lead to IRS penalties. In instances of significant understatements, the Accuracy-Related Penalty is interest plus 20 percent of the tax due on the understated amount from the tax return. Rental property owners can misreport their income if they only report the rents received.
Rental income includes not only the normal monthly rent but also payments made for canceling leases. Advance rent payments count as well, even if the rent wouldn’t apply until the following year (assuming you file taxes in cash basis, as most real estate investors do). And if your tenant covers a property-related invoice you would normally pay, that counts as rental income too. This error is particularly prevalent with utility reimbursements. When property owners pay utility bills, then the tenants reimburse the landlord, the IRS considers the reimbursement as reportable rental income.
When your tenants provide property or services in lieu of rent, determine the fair market value of the property or service, and record it as income. If your tenant doesn’t meet the lease terms, and you keep some or all of the security deposit, the amount you keep counts as income. However, if you’re holding deposits that are refundable once the leases end, those deposits aren’t reportable income.
Takeaways
For rental property owners, a single bookkeeping mistake may not seem like a big deal. However, all the errors listed above are common sources of trouble for real estate investors, and even one of these mistakes can have a significant impact on a business. If you’re not sure how to account for something on your property’s account books, ask your tax preparer how to record it properly. If you need assistance recording a specific type of transaction in your REI Hub account, contact us! We’re here to help. Just remember to review your account books regularly to double-check for these common errors. The time you spend cleaning up your books is an investment that will help strengthen and protect your rental property business.
