The real estate market was estimated to be worth over $3.8 trillion globally and $510 billion in the United States in 2022, making it the world’s most significant store of wealth. This figure continues to rise year on year.
As the real estate industry continues to grow, evolve, and prosper, the importance of robust accounting practices cannot be overstated. Accurate accounting enables businesses and investors to make informed decisions, identify opportunities for growth, and ensure compliance with regulatory requirements.
In today’s article, we will look closely at how real estate accounting differs from other industries and share some best practices to enable you to benefit the most from your real estate accounting services.
Corporate accounting practices are broadly similar across industries. However, the real estate industry has a number of specific needs connected to cash flow requirements. This means that maintaining accurate and up-to-date cash flow accounting is arguably even more critical in real estate than in other industries.
Real estate accounting has highly specific guidelines around depreciation, property tax, property tax abatement and exemptions, lending, and various tax credits compared to other industries. In some cases, real estate businesses may be eligible for the Qualified Business Income Deduction, commonly referred to as QBI. Real estate companies that have utilized lending may also have banking and leasing covenants that must be met. These items differ depending upon whether the business deals in commercial or residential property as well as upon specific property types. Maintaining diligent records is essential to ensure accuracy and compliance.
While it is not necessarily accurate to say that real estate accounting is more complicated than other types of accounting, the industry has a number of unique considerations, such as those we outlined above. This means that real estate accounting requires in-depth knowledge and a high level of understanding on the part of the CPA firm around capitalization rules, depreciation rules, and the ways in which these can impact cash flow.
Real estate accounting practices fall into one of two categories: cash accounting or accrual accounting. Which method is used will depend upon the size and nature of the business.
Most accounting for small, residential property owners is conducted on a cash basis. This means that financial incomings and outgoings are recorded regularly, when they are actually received or dispensed, and that no future income or expenditure is accrued.
Commercial real estate is more likely to use accrual accounting. Accrual accounting often tends to be used in the cases of large companies with over $10 million of assets or revenue. It is also a requirement for publicly traded companies to use accrual accounting.
Accrual accounting is far more complex than its cash basis counterpart and involves projecting future expenses, inflows, and liabilities based on variables such as lease agreements and loan terms.
There are a number of ways that businesses in the real estate industry can adapt or improve their practices to gain the maximum possible benefit from their accounting services. In this section, we will share some strategies we have identified that are consistently beneficial for businesses operating in this space.
It is essential to create a simple and streamlined process that allows you to effectively track your inflow and outflow of cash. Ideally, the business should have no more than one bank account and one credit card (if required). In general, the fewer touch points there are in your accounting process, the better.
It is also important not to combine personal and business financial affairs. This is a mistake that many small business owners and investors make, and it can have serious implications for your organization’s accounting processes, tax purposes, and any audits.
Finally, do not use physical cash for business expenses unless absolutely necessary, as this makes it more difficult to accurately track and monitor transactions.
Working with your accounting team, create a daily, weekly, monthly, and annual accounting process that makes sense for your business. Everyone, including your team members and any external providers, must know and understand their role and responsibilities in the process and perform them regularly.
Organization and good record-keeping are perhaps the most vital component of a successful real estate accounting strategy. Create a consistent and sustainable system to ensure that even the smallest items are accounted for.
In the modern era, digital retention is the best way to keep accounting records, and we do not advocate the use of a paper-based system. We recommend using a secure online database, shared between you and your CPA, and understanding both your and their document retention policies.
In all circumstances, real estate transaction records must be kept for at least four years to comply with federal and state statutes. In some cases, it is appropriate to keep records for up to seven years. CPAs are automatically required to keep records for seven years.
Perhaps the most important aspect of successful real estate accounting is planning. It is important to understand from the beginning the accounting basis your business will utilize, the processes and systems you will adopt, the legislative and regulatory requirements to which you must adhere, and the ways in which you will collaborate with your accountant or CPA. It is always preferable to understand these vital elements in advance as opposed to attempting to resolve them after the fact.
Here at Levine, Jacobs & Co, we have been supporting clients in the real estate industry with their accounting for decades. If you would like to learn more about how our experienced and knowledgeable team of real estate CPAs can assist you, please contact us.