Have you ever wondered how much a landlord can charge for rent or while buying a rental property? Or why is the IRS involved with small businesses? Or how to calculate depreciation, or what the term Gross Rent Multiplier means, or what the difference is between value and market rent? If any of these questions sound familiar, then this article is just for you! Simply follow these simple accounting tips for landlords and soon your worries will be a thing of the past.
The two ways landlords account for income are either by deducting from expenses or by adding to revenue. What are some common expenses that landlords subtract from their income when they account this way? Some examples are repairs and maintenance costs, insurance bills, mortgage interest payments. What is revenue that comes in from rent payments? Some common examples are pre-paid or deferred rent, and unearned income.
Many landlords don't think of the expenses and revenue when they sign a lease, because it is not until they begin getting monthly bills that they realize the payments will be deducted from their own pocket. Most landlords feel: "If a tenant bills me more than I collect, then I will pay it from my pocket. I should get paid for services rendered." Although this might sound like a great deal, in actuality it is an unfair method used by many landlords because they are forced to account for their expenses rather than investing the money on capital improvements.
If a landlord charges more than he or she collects in rent, then the landlord will realize a loss on that property. To make up for the loss, the landlord can either add it to the total amount of rent due in arrears (for example, if you are 6 months behind on rent then you would owe 6 months of rent) or accrue it and sort at the end of the year. By simply adding all of your expenses together, any landlord can see how much they overpaid for services rendered. Any property management fees or commissions do not have to be accounted for because these costs are already factored into what you pay in rent and therefore they cannot be subtracted from revenue.
The IRS Form 1065 asks many of the same questions as the landlord's accountant, but at the end of the year, you don't necessarily have to pay taxes on it. The landlord must pay taxes on money that has been accrued but not sorted; this method of accounting is not recommended since it is more difficult to manage.
For landlords who choose to add their expenses to revenue, do so by listing your income and expenses in an account book (or if you'd prefer, use a computer program) on a monthly basis. List how much rent was collected (or billed), and then list how much rent went toward utilities; how much went toward property management; and how much went toward any other valid expense. The net of this all amounts to gross receipts. That is the amount of money that is left in your pocket.
You can now take this amount and deduct it from your expenses if you decide to deduct any expenses. This is where Gross Rent Multiplier comes in handy; after calculating your expenses, you can multiply the amount by 1.2 or 1.35, depending on the cost of living in the area where your property is located. This will give you a market multiplier for that particular area.
To understand how Gross Rent Multiplier works, first you must know the difference between gross rental income (GRI) and net rental income (NRI). GRI is what the landlord gets from all of his or her tenants. It is not always a percentage of their rent; it can be a flat amount. For example, if a tenant pays $100 per month as rent, and the landlord collects $240 per month in revenue (as a percentage), then the landlord has gross revenue of 0.6 times Rent. In this case, GRI is 60%.
Total GRI is also used in calculating Gross Rent Multiplier. This is the sum of the net rent multiplied by 1.35 (or 1.2 depending on your market). To calculate how much money comes into a landlord's pocket from total gross revenue, divide Total GRI by Total NRI. The result of this calculation will be how much money was left for the landlord after all expenses were paid.
Using Gross Rent Multiplier, a landlord can calculate how much he or she can charge before incurring any loss on the property. If you are an investor and you purchase a property with $100,000 dollars of equity, then everything depreciates over time on average about 5%. Therefore, if you are going to rent the property out and you would like to have a maximum of $120,000 in gross revenue per month before your regular expenses, then you will have to charge $1.20 per "gross" dollar (or $100,000 divided by 1.20).
Every landlord has different expenses that they may incur. The most common type of expense is managing the property: keeping the building in good condition for your tenants. It might include landscaping flowers, painting walls, replacing broken appliances/furniture/etc., fixing leaks, molding windows and doors not to mention cleaning up after tenants. These are all valid expenses for the tenant and landlord.
It may be difficult to decide what to deduct from GRI. Is it better to rent the unit at a lower rate if you incur additional expenses? The bottom line is that subtracting extra expenses from gross revenue will not affect whether you make a profit or a loss, as long as your monthly gross revenue totals more than your monthly expenses.
A typical formula used by landlords in calculating Gross Rent Multiplier is:
A = Total GRI; B = Total NRI
A - C - D - E = B * 1.35 or A = B * 1.2
(B - E)*1.35 = C
B = C
A = B * 1.2 (or 1.35)
*The numbers in parentheses indicate the figures that can be calculated using a calculator or your computer. For example, you could use either equation (1) or (2). I suggest that you use equation (2) if you want to know what the business will look like in the future. If you want to know how much money is coming into your pocket, then use equation (1) for a quicker answer.
If you are going to rent out your property to invest in property, then you will want to make sure that it has a high market price. The more money that comes in from rent, the less money you will lose on your initial investment.
Include in your calculation whatever taxes you have or will owe. The larger the cap rate on your property, the larger percentage of income you can legally deduct from gross revenue before incurring a loss on this property. For example, if the cap rate (i.e. rental income divided by expenses) is 5% (or $900/month), then you legally cannot deduct more than $20 per month of expenses from gross revenue. However, if the cap rate was 25%, then you could deduct $100 per month of expenses from gross revenue before incurring a loss.
The IRS will allow deductions for property management costs and maintenance not to exceed 15% of GRI. If the actual amount you incur in capital expenditures exceeds 15%, your deduction can be reduced if there is a decrease in GRI due to depreciation expense.
To calculate Gross Rent Multiplier, use this formula:
Gross Rent Multiplier = NRI/Rentable Area * 1.35 (or 1.2)
NRI = total rent collected; Rental Area = rental area's gross annual rentable area
If you spend a lot of time on the phone with other landlords and are tired of hearing from some of them that they want to pay their taxes quarterly, It'll save you a trip to the mailbox. There is no reason to pay your taxes quarterly; if you do file quarterly and pay before April 15th each year, then it will only cost you for postage ($1.00-$1.50) and filing fees (approximately $30). All you have to do is wait until April 15th when the government throws away roughly $40 of your hard-earned money on you just because it can.
If you are going to invest in rental property, then consider taking credit courses offered by real estate seminars to learn how to minimize your taxes. Through these courses, you may be able to save a few thousand dollars per year on taxes if you are careful about where and what properties you buy as well as how much of each property that you own and rent out (part of the time).
This is all about real estate accounting that you need to know if you are willing to invest in a property. Though if you need any professional help with the same, then you can consider getting help from Better Capital and get the best help from them.
For more information, you can visit Real Estate Calculators.
