Keeping records up-to-date and accurate

Maintaining complete and accurate records of all transactions is extremely important in the world of property management. Having your records squared away is necessary on four fronts:

• Taxation: You have to report your income and expenses for each rental property on IRS Form 1040 Schedule E to determine your taxable profit (or loss). The IRS requires rental property owners to substantiate all income and expenses by maintaining proper records, including detailed receipts of all transactions to support the accuracy of your tax returns.
• Financial management: If you don’t accurately document all the income streams coming in and the expense payments going out, you won’t be a real estate investor for long. Check out the “Knowing What to Account For” section later in the chapter for tips and information on this key aspect of your rental property. Financial management is also an excellent barometer on the success of your rental property toward providing you with cash flow, equity buildup, and appreciation.
• Litigation or disputes with tenants: Courts typically take the stance that residential tenants (and even small commercial tenants) are merely consumers, so the burden is primarily on the owner to provide any documents outlining the relationship or understanding between the parties. If the owner can’t provide the required records, the tenant almost always prevails.
• Future refinancing or sale: Having accurate and detailed accounting records is important when you look to refinance or sell your property because the amount you can borrow or the sales price you can achieve will likely be based on the Net Operating Income (NOI) that you report. Both a future lender and a buyer will look for stable and predictable income as well as reasonable operating and capital expenses that support the fact that you competently managed, operated, and maintained the property.

Here are a few documentation tips (check out the “Filing made easy” section later in the chapter for ideas on how to store this info):

• Document your income in income journals: Income journals are also called cash receipt journals and consist of the master rental income data collection sheet and ledgers for each individual rental unit or suite.
• Keep all bank deposit records: Although your bank may or may not require a deposit slip with your transaction, or you may have a handy check scanner or even use your smartphone to make deposits, make a listing of all items deposited to keep for your records in case there’s a discrepancy between your recordkeeping and the bank’s records.

• Get a written receipt for all expenses: Even if you write a business check or make an electronic payment for rental property expenses, you must have a receipt to fully document the expenditure. The IRS may not accept a check as proof of a deductible property expense unless you have a detailed receipt as well. Most home improvement suppliers and vendors now provide detailed receipts with specific descriptions of the purchased items, making this much easier than in the past.

  If you have multiple rental properties, develop and assign a one- or two-character code for each property and mark each receipt accordingly. (Indicate the unit or suite number, if appropriate.) When you have information for multiple properties on a single receipt, make photocopies and store the receipts in the folders you’ve set up for your respective properties. This way, you can provide evidence of the expense for each property instead of having to wade through all your folders looking for the information you need.

If you use your vehicle for your rental property activities, be sure to keep a detailed written log of all your mileage. Your mileage is a deductible business expense as long as it’s directly related to your rental property and you have accurate records to document the mileage. Some apps are available that record business expenses. Regardless of your system, make sure that this simple log indicates the date, destination, purpose, and total number of miles traveled. You may be surprised at the number of miles you travel each year for your rental activities — the deductible expense can be substantial.

Here’s a general guide of how long to retain your records:

• Keep all records pertaining to your rental property for a minimum of five to seven years. If you have long-term residential or commercial tenants, it is important to keep all the records for the entire duration of a tenant’s tenancy, plus five to seven years. (For property managers managing properties for others, the time period depends on the legal requirements of the state regulatory commission or department of real estate where the property is located.)
• For tax purposes, records regarding the purchase and capital improvements made during your ownership need to be maintained for as long as you own the property.
• Certain property records such as those concerning injuries to minors should be maintained essentially forever. Although even the IRS has a statute of limitations (except in the case of fraud), the statute of limitations for injuries to minors typically doesn’t begin to run until the minor reaches the age of majority (usually 18). As a litigation consultant, Robert has seen some property owners hit with a lawsuit over ten years after the incident and not have any documents to demonstrate that they had managed the property prudently and it was in reasonably safe condition. In these circumstances, the owner will often be writing a large check, so don’t let that happen to you. Have a long-term, weatherproof, climate-controlled storage space for your most important records.

Filing made easy

Every rental property owner should have a basic filing system with separate records kept for each rental property. You may opt to keep many of the accounting records and files on your computer, especially with the relative ease in the ability to scan and store most documents, but for owners of one to several rental units, a manual system works just fine. Your filing system can be a simple accordion filing box with dividers, kept in a safe place, which you can find at any office supply store. If you own more properties and outgrow the accordion filing box, use a lockable fireproof filing cabinet.

Organize your records at the property level and the unit level. You’ll have some documentation overlap, but the benefit of having complete, easily retrievable records at your fingertips greatly outweighs the effort involved in making some photocopies. Start at the property level, and construct the following:

• Ownership file: From the moment you take your first steps toward purchasing an investment property, begin storing hard copies of your paperwork in a property ownership file. Keep all the important documents of this transaction, including purchase offers and contracts, the closing statement, appraisals, loan documents, insurance policies, due diligence inspection and pest control reports, environmental reports, and correspondence. You may be tempted to go paperless by scanning and storing everything electronically, but these documents are critical, and you must always keep hard copies because electronic files can be lost. Also keep a photocopy of your deed in the property file and place the original in a fireproof safe or bank safety-deposit box.
• Income and expense files: Each of your rental properties should have its own file section with separate folders for income reports like rent rolls, as well as a separate folder for each of the major property expense categories. Keep copies of all receipts in the expense folders, so that when tax time rolls around, you can easily locate the information you need. Start a new file for each tax year.
• Master maintenance file: We recommend keeping a master property maintenance file for the records and receipts for all maintenance and capital improvements for each rental unit or suite and the common areas. This one-stop source gives you the records you need for all repairs and maintenance during your ownership and can be helpful for your accountant in calculating your basis in the property when you ultimately sell or exchange the property.

Moving on to the unit level, put these files together:

• Tenant file: Create a separate file for each tenant that contains all the important documents for each tenant, including her rental application, lease agreement, the tenant ledger showing all charges and payments, all legal notices, estoppel certificates (see Chapter 11), tenant maintenance requests, and correspondence. Although you can scan and store backup copies of these documents, always keep the original of each document and provide the tenant with a photocopy. You’ll need the signed originals of all pertinent documents should legal action ever become necessary. Individual tenant files are closed out and a new tenant file established upon turnover of a rental unit to a new tenant.

  When your tenants vacate, attach a copy of any paperwork from the termination of their tenancy and bind the entire tenant file together. Transfer it to a separate file for all former tenants, filed alphabetically by rental property.

• Unit maintenance file: We recommend keeping a separate maintenance file for each individual rental unit or suite with the records and receipts for all maintenance and capital improvements. This system gives you a history of the physical condition, as well as the installation date for all appliances or equipment, for each rental unit or suite throughout your ownership. This file remains open even when the tenants change.

Use a system for recording all significant tenant complaints and maintenance requests. This will provide a valuable paper trail if a dispute ever arises regarding your conduct as an owner in properly maintaining the premises. Failing to have good records may well hurt your case should a dispute escalate and end up in court.

Documenting income and expenses

If your tenants pay by check, you can always let the cancelled check serve as the tenant’s receipt, but the best policy is to provide a receipt whenever possible, regardless of the method of payment. Likewise, track your expenses by using checks or credit accounts rather than making cash purchases for which you receive generic receipts, because the legitimacy of generic receipts can be challenged.

Keep your rental property activities separate from your personal transactions. Although the IRS doesn’t require you to keep a separate checking account for each rental property that you own, you need to be able to track the income and expenses for each property individually.

As you add rental units or commercial properties, the accounting becomes much more complex and the recordkeeping more critical. That’s when you must seriously consider hiring a property manager with good recordkeeping and accounting procedures who will create detailed monthly reporting that can be given to your accountant for tax planning and reporting.

Hiring a good tax advisor is a wise investment for even small rental property owners because tax rules are various and complex. For example, certain expenses can be classified as operating expenses and deducted in the current year to reduce your taxable income, but some expenses are considered capital items and must be depreciated or amortized over the estimated useful life of the improvement.

• One of the advantages to owning real estate is that you can deduct all operating expenses from your rental income. These operating expenses include payroll, maintenance and repair costs, management fees, utilities, advertising costs, tenant screening fees, insurance, property taxes, and interest paid on mortgage debt. You also benefit from depreciation, which is a noncash deduction that reduces your taxable income in the current year but is recaptured in the future. Depreciation is discussed in more detail in Chapter 18.

• Capital items typically include your building equipment or components that extend the useful life of the building and have a longer life span or are brand-new, rather than routine maintenance or a repair. Your accountant is usually instrumental in providing guidance as to which items can be expensed versus the items that must be capitalized.

  Rental property expenditures for capital items must be accounted for separately and are capitalized when their cost basis is depreciated or amortized over multiple years rather than deducted as an operating expense in the current year. This means that you are able to reduce your taxable income by the full cost incurred but by a prorated amount over several years. Your accountant will generate depreciation or cost recovery schedules indicating the amount that can be deducted each year. Also, your accountant can keep you informed about changes in the federal tax code that affect depreciation deductions of certain capital expense items. See Chapter 18 for federal tax law changes that are positive for rental property owners and allow them to decrease their taxable income through immediate expensing of property upgrades and improvements.

• Some costs of financing, such as loan fees or points paid at the time of the loan, can’t be taken as an operating expense and must be amortized (taken incrementally) over the life of the loan. However, if you refinance or sell the property and pay off the loan, then you can take a full deduction of remaining unamortized loan fees in that tax year.

Be sure you accurately record the payment of a tenant’s security deposit. These funds aren’t typically considered income; instead, they’re considered a future liability that is owed back to the tenant if the tenant honors the terms of the rental agreement. The security deposit may become income at a later date if you apply any portion of it to cover delinquent rent, cleaning, repairs, damages beyond normal wear and tear, or other charges after the tenant vacates the rental unit or suite.

Creating a budget and managing your cash flow

Every rental property should have a budget, which is simply a detailed estimate of the future income and expenses of a property for a certain time period, usually one year. A budget allows you to anticipate and track the expected income and expenses for your rental property.

Many rental owners neglect to allocate and hold back enough money for projected expenses, so when it comes time to make a repair or capital improvement, for example, they don’t have the money set aside to cover it. If you set up a budget, you’re better able to anticipate your expenses.

Although the budget for a single-family or rental condo is fairly simple, a proper budget for a newly acquired multi-unit apartment or commercial building can require some careful planning. That planning includes a thorough review of past expenses and the current condition of the property. Trends in expenses, such as utilities, can also be important when estimating the future cash flow of a rental property, so be sure you don’t overlook them. Check out the income and expense categories we cover in Chapter 12 — the process is essentially the same whether you’re formulating a pre-purchase income/expense pro forma or the annual budget for ongoing operation of the property.

Many owners rely on cash flow from their rental properties not only to cover their expenses but also to supplement their personal income. But particularly if you’re a small rental property owner, you need to have a built-in reserve fund set aside before you start taking out any rental income funds for personal reasons. Maintain a reserve balance large enough to pay your mortgage and all the basic property expenses for at least two to three months without relying on any rental income. When you don’t have long-term leases with stable tenants or the local rental market has low demand for your type of rental property, it may make sense to increase your cash reserves to an amount that allows you to sleep at night. Also, remember to allocate funds to cover semiannual and annual expenses such as your property taxes (if not impounded by your lender) and potential income tax due on your rental property net income.

Set up a bank account where you set aside money for anticipated major capital improvements. For example, you may own a rental property that will need a new roof in the next five years. Rather than see your cash flow wiped out for several months when it comes time to pay for that new roof, you can begin setting aside small amounts of money into a capital reserve account over several years. Lenders on large residential and commercial type properties often require the monthly funding of a capital item reserve and replacement account (called CapEx). For large apartment projects, this expense can be from $200 to $500 per unit per year. The owner can periodically submit requests (with copies of paid invoices) for reimbursement of qualified expenditures such as appliances, floor and window coverings, roofing, exterior painting, paving, and other capital items.

Recognizing the value of professional accounting software

However, as good as these programs are, they lack the specific rental property features and reporting that are invaluable to effective property management. If you have more than ten scattered site rental properties and/or over 25 total rental units, we strongly recommend purchasing a professional rental accounting software program. These programs typically offer the following:

• Complete accounting (general ledger, accounts receivable, accounts payable with check writing, budgeting, and financial reporting)
• Tenant and lease management, including online applications, rental agreements and leases, and virtually all standard rental management forms
• Tenant communications via email and text for service requests and feedback, maintenance scheduling, and reminder notes
• Additional services such as marketing and advertising, prospective follow-up, budgeting and forecasting, electronic payments, prospective resident screening, payroll, utility billing, and even package management for all of your resident’s online purchases!

Another advantage to using the computerized rental property accounting software packages is the ability to have your mortgage and other bills deducted electronically. Or you can work with these software packages to pay your bills online. If your tenants pay their rent electronically as well, you can decrease the time you spend handling rent collection and accounting.

In the last decade, the accounting and management software options for real estate investors and property managers has greatly expanded with an impressive array of online features that take advantage of today’s technology. Many property management accounting packages are available for a nominal investment, but don’t be penny-wise and pound-foolish. Many of the less expensive systems may work in the short run, but if something goes wrong, you may be left stranded without technical support or help. If a software firm is relatively new and only has a few hundred users in place, you’re in for a much higher risk of program bugs or incompatible system errors or incorrect results. The software may not even be updated or supported years down the road. Your financial investment, and all the timesaving and other significant benefits of computerized accounting, may be lost if the software package isn’t backed by a solid company. While there are many competitors in this space, we only will comment on some of the main long term players who have been and likely will be around as your real estate empire grows.

When you use a management company, you typically receive several important accounting reports within a couple of weeks after the end of each accounting month. If you review these reports regularly, they can provide you with a good understanding of your rental investments and give you the opportunity to inquire about or suggest changes in the operations. But if you manage your own property and do your own accounting, it’s important to actually review and analyze the financial reports in the same manner as you would if you had entrusted your investment to a property manager. You may think that you know everything you need to know about your rental property, and setting aside those monthly reports until tax time may seem harmless, but they’re great tools for improving your management results if you use them properly.

You can customize the financial reporting offered by software programs to meet your needs. Monthly reports often contain income and expense information compared to the monthly budget as well as year-to-date numbers.

The language and terminology can be confusing to the novice, but most property management software is offered as either desktop or cloud-based. Of the cloud-based software offerings, the most popular and Robert’s recommendation would be SaaS (Software as a Service), which is centrally hosted and available by subscription. The continued challenges with data security and identity theft makes SaaS the best solution for rental owners and property managers who aren’t interested in spending time becoming an IT expert.

Identifying some of the better programs

Each of the many program types available has its own strengths and weaknesses. In recent decades, there has been an impressive improvement in the capabilities of the software offerings for rental owners and property managers. Unfortunately, with so many software solutions to choose from and subtle differences from one to the next, finding the right software for you will require some careful research and patience.

Following are a few programs that we highly recommend for the entry-level rental owner or small property manager:

• Buildium: This property management software system is easy to use, is cloud-based, and caters to small rental property owners. This software is popular with small-time residential property owners who self-manage and want the basic property management and rent collection accounting, but also can offer their residents online rent payments and service requests through a tenant portal. While this software can handle any number of separate properties and a large number of rental units, its sweet spot (based on features and pricing) seems to be for owners and property managers with up to 100 rental units. The current pricing model for the basic core product is a sliding scale monthly base fee based on the number of units, with 1–20 units being around $50 per month or just over $150 per month at 100 units. More information is available at www.buildium.com.
• Point2 Property Manager (P2PM): P2PM, the entry-level product for industry leader Yardi Systems, is geared specifically toward the small multifamily manager and is an easy-to-use property management and accounting software-as-a-service option. P2PM is easy to implement as well. The current pricing model is $1 per unit per month with a $50 minimum. Simply go to the P2PM website at www.point2propertymanager.com, sign up and begin using.

• Quicken Home & Business: Quicken has discontinued their standalone Rental Property Management product and incorporated all of its features into its best-selling Quicken Home & Business software. For many rental property owners, this very popular software is already being used by them and it follows the same conventions, format, and protocols they already understand. However, even for new users, this is a quick and easy study with a large variety of training resources available to allow users to quickly understand and streamline their property management accounting.

  If you have a modest real estate empire of fewer than ten separate properties, you’ll find that the affordable Quicken Home & Business is the right software package for you that’s one step up from manual systems or user-customized computer spreadsheet software.

  Unlike many of the specialized software programs included in this list, Quicken Home & Business is primarily an accounting package and doesn’t offer any of the advanced features that are becoming mandatory — online tenant portals for rent payment and service requests or marketing/advertising coordination and vacancy management.

  One of its best features for the more entry-level real estate investor is you can prepare your federal 1040 Schedule E to hand to your accountant or import directly into TurboTax if you prepare your own tax return. For information on Quicken Home & Business and other related products, go to www.quicken.com.

• Rent Manager: Like all the software we mention, Rent Manager by London Computer Systems has everything you need, starting with a strong financial accounting package that includes a general ledger with accounts receivable and accounts payable, budget management payroll import, and financial reporting. The property management tools include rent collection (even an optional check scanner), tenant lease management, contact management and word processing (for correspondence and all types of notices), VoIP phone integration, as well as a work-order module.

  Rent Manager is offered in a stand-alone or cloud-based version, and the current pricing model is a flat fee. Visit www.rentmanager.com for more details.

• Yardi Breeze: For small to medium residential and commercial property owners and managers (100 to 1,000 units), Yardi Systems also offers a fully integrated, Windows-based product called Yardi Breeze that has much of the same basic functionality as Yardi Voyager but with less sophisticated reporting capabilities and fewer features and configuration options. Like Yardi Voyager, Yardi Breeze includes all the basic features of prospect and tenant management, fully integrated accounts receivable and accounts payable, a general ledger, and cash management. It also allows ready access to information, elimination of duplicate entries, and spontaneous delivery of reporting.

  Current pricing is $1 per unit per month with a $100 minimum. See www.yardibreeze.com for more information.

But, if you have a medium to large portfolio of scattered sites or several large buildings, then we believe the choices are easier: AppFolio, MRI, Real Page, and Yardi are the major options and we discuss each one:

• AppFolio: A web-based product that claims to be an all-in-one, user-friendly property management software solution from marketing and leasing, to maintenance and reporting. Some of the AppFolio standard features include online tenant and owner portals, online applications and leasing, built-in screening, maintenance requests, mobile inspections, bulk text messaging, plus the usual accounting and reporting.

  This software is for residential, commercial and association managers with at least 200 units and is available for a per unit fee (currently $1.25 per unit). For more details, visit www.appfolio.com.

• MRI: Another property management software option that has had a loyal following for many years. A series of major acquisitions makes MRI a comprehensive and flexible technology platform that can be customized. Like RealPage and Yardi Voyager, MRI is for the medium to larger rental property owners or property management companies. (More information on this cloud-based accounting and investment management system is at www.mrisoftware.com/.)
• RealPage: Billed as the property management solution that does it all, RealPage offers rental property owners and managers with larger portfolios their OneSite^® property management software with a comprehensive suite of integrated options, including accounting, marketing and lead management, resident screening, renters insurance, utility management, and expense control modules. Following an industry trend, RealPage acquired Rent Roll, Inc. in 2017, and also has made additional acquisitions to offer an even broader range of data management and online payment services. (See www.realpage.com.)
• Yardi Voyager: For rental property owners or property management companies with portfolios of 750 or more rental units, we recommend the Yardi Voyager asset and property management software suite. Robert’s property management company uses this industry-leading software, and he has been impressed with its ability to provide real-time daily and weekly reporting to effectively manage properties. Yardi Voyager also offers detailed monthly financial reports, which allow his company to provide a greater level of service to clients and outperform the competition. This product has been an industry leader for many years, but be sure to check out the newest features of Yardi Multifamily Suite, RENTmaximizer (to ensure you are getting top dollar) and RENTCafé if you want the top-of-the-line property management software for all types of residential (conventional, affordable, student, seniors, condos/HOAs/co-ops), as well as commercial, industrial, and retail modules. Robert uses the Yardi RentCafe Suite as his all-inclusive marketing, leasing, resident services, and accounting system for everything from websites and social media, to vacancy advertising, applicant screening, and online leasing, plus a resident portal for online payment and service requests. (See their full product line at www.yardi.com.)

When evaluating different software packages, gather as much info as possible. Be sure to talk to actual product users, preferably people in your area with comparable rental properties and similar accounting needs. Determine what features a program offers, how easy it is to operate, its computer hardware requirements, the availability and cost of technical support, and the strength and reputation of the company backing the product. Obtain a demo or trial version of the software that you can use before you buy, just to make sure it’s truly what you want.

Just like with any technology product, another factor to keep in mind is not just whether the product meets the current standards but whether it incorporates or has the ability to upgrade and include the latest trends. The current trends in the rental housing industry software that you should look for include cloud-based or web-based Software as a Service (SaaS), subscription-based software, automatic posting of vacancies on various websites, integrated hosting and management of websites, electronic maintenance work order requests, electronic rent collection and bill payment, and integrated credit checks and applicant screening.