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Real Estate Accounting – Common Mistakes to Avoid
Finance management in a real estate business is one of the most crucial but challenging processes. The process typically requires one to generate a variety of financial reports, prepare budgets, monitor cash flow, perform audits, and file taxes. All these tasks can quickly become nerve-racking if you, as a real estate business owner, try to handle them on your own.
It is pretty normal to act as an accountant for your own business at times. But this practice can increase the chances of the several financial mistakes that can lead to an IRS audit, penalties, and other costly repercussions. To help you become more aware of the same, here are the most common real estate accounting mistakes you must not make.
Experts’ Views on Common Real Estate Financial Mistakes & How to Avoid Them
1. Expert – Paul Somerville, Editor-in-Chief at ESG
Not Maintaining Financial Records Properly
Most real estate agents and investors do not have enough time to examine irregular bookkeeping data. As a result, it is likely the most prevalent bookkeeping error seen by real estate brokers and investors. In reality, keeping detailed bookkeeping records takes a significant amount of time and effort. Real estate agents and investors, on the other hand, are aware of minor irregularities in the bookkeeping that could lead to an audit.
Real estate brokers and investors can, in any case, use third-party accountants and tax professionals to preserve appropriate bookkeeping records. First, however, as a real estate agent or investor, you need to have an essential awareness of bookkeeping procedures.
For example, to maintain the accuracy of your financial records, you need to be familiar with the categorization of revenue and expenses. Over time, you’ll notice that traditional bookkeeping approaches essentially assist you in maintaining profitability.
Having a Compromised or Poor Back-up
Even real estate brokers and investors must rely on various tools to increase business operations in the digital age. Indeed, technology improvements benefit them by improving their financial structure. However, increasing technology integration equals more IT challenges.
The fear of IT issues is genuine, and they might eventually affect your precious data. To avoid losses, make sure to back up your financial and other essential information. Failure to implement a backup solution can result in the loss of financial data and client information. Modern bookkeeping, thankfully, is digitalized and includes backup solutions. In the blink of an eye, an effective backup system may produce original data and keep scanned receipts.
2. Expert – Erik Wright, Owner & CEO of the New Horizon Home Buyers
Not Hiring a Professional for the Job
When a brokerage is new, it’s common for the owner to hire a family member, a close friend, a young high-school temp, or an unskilled staff member to look through the books. This is a low-cost approach if you’re starting to lay the groundwork for your brokerage. However, in the months and years ahead, these early stages will determine the tone and pace of your company. You want a professional to create a solid structure for those tax deductions you missed, IRS deadlines you missed, and payroll maintenance your employees require.
Additionally, hiring a friend or family member presents its own set of difficulties. It can bring relationship issues into the workplace, sometimes without causing problems, but occasionally with disastrous results. Therefore, if you decide to recruit a friend or family member, make sure they are qualified for the position.
3. Expert – Matthew Dailly, Managing Director at Tiger Financial
Tracking Commissions Separately
Let’s double our efforts and enhance our chances of making mistakes! No businessperson has ever said this. Nobody enjoys redundancy. It’s nearly impossible to tell who owes them money and also who you need to pay if you manage commissions independently from your back office.
Suppose you have numerous agents and are unable to rapidly compute how much the company owes them when a check arrives. It can be challenging for accounting to keep track of how much is owed, and it can be frustrating for managing partners. Unfortunately, this is exactly what you are doing when tracking commissions separately from accounting. Separating these jobs adds to the workload and raises the risk of human mistakes.
Overlooking Data Classification Errors
The commercial real estate agency will fall into chaos if you don’t have a clear categorization system in place. Audit the accounts regularly to ensure that all receipts and payments are properly documented and preserve clear labels for income, obligations, and payments. This ensures that all company ledgers and reports are as accurate as possible.
4. Expert – Nick Jordan, Founder & CEO of Workello
Disbursing Funds Before a Transaction Closes
It’s not good to distribute trust/escrow deposits to any party engaged in a real estate deal before it’s formally concluded, but it happens more frequently than you may expect. This money is not considered commission until the deal is closed, after all of the necessary paperwork is completed, the property is registered, and the keys are exchanged.
Disbursing such funds before the transactions are completed may cause your brokerage to fall out of compliance with your regulatory bodies. Furthermore, any last-minute side agreements that may lower commission payouts would necessitate rewriting checks, wasting time for your office accountant or bookkeeper. Finally, a simple reversal can become a complicated, multistep process depending on your brokerage’s software.
Not Maintaining Separate Bank Accounts
One common blunder in the real estate business is failing to keep personal and business funds separate. In general, most real estate agents will maintain a single account that includes their personal and professional finances. So at the end of the year, when you have to report your company activities for tax purposes, you’ll have a major challenge in unwinding your business costs from your costs.
Keep two sets of records and rely on the requirement to maintain your accounting exchange record. In the short term, it may not seem like a big deal, but in the long run, it might cause problems. Determine your exchanges based on your personal financial situation in this manner. This record can help you manage your expenses and build up a reserve fund.
5. Expert – Jon Kozesky, CEO of J. Thomas Management
Ignoring the 1031 Exchange
The biggest mistake an account can help you avoid is taking advantage of the 1031 exchange. This allows you to “trade-up” for another property at the sale of an existing one and delays any tax implications. You can essentially keep “1031ing” for years or even decades to maximize your portfolio.
In addition, for flippers, an accountant can help you realize the tax savings to sit on your properties for 365 days. There is a HUGE tax benefit to owning the property for one year and one day instead of flipping and selling in the short term. Holding the property for over a year makes the 1031 scenario much easier and more justifiable. This isn’t ideal for those taking advantage of traditional loans or hard money lenders, but it certainly is a major advantage for cash flippers.
6. Expert – Omer Reiner, Licensed Realtor & President of FL Cash Home Buyers, LLC
Missing Tax Advantages
Real estate accountants can help real estate investors take advantage of tax advantages that no other assets can provide. One of these tax advantages that is least optimized is the depreciation of a property. Many real estate investors do not take advantage of this. Hire the right appraisers to determine the depreciation. Real estate accountants can make sure investors take advantage of this and try to receive the highest fair advantage.
Financial management is challenging and takes a considerable amount of time and effort. Unfortunately, many real estate business owners neither have enough time for finance and accounting nor they are professional accountants. Due to this, they might put their business’s financial performance and health at risk by unintentionally committing the above-discussed mistakes. If you think you are also making these or other mistakes, the best you can do is outsource real estate accounting services to streamline your financial accounting operations, reducing or even eliminating the chances of mistakes and errors that can cost you a fortune.
At Cogneesol, we have been helping our client firms in the real estate sector with accounting process optimization since 2008. Our team of skilled, experienced, and real estate specialized accountants can help you establish an effective accounting process, streamline tasks, and reduce accounting costs. We are an ISO-certified firm that maintains complete confidentiality and ensures high-quality services with a fast delivery model. To learn how we can help you, reach out to us today via email – email@example.com or call +1 646-688-2821.
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