After speaking with hundreds of real estate investors about their bookkeeping, I’ve identified one common mistake that most house flippers are making.
To understand the mechanics of this mistake, it helps to have a basic understanding of accounting. When classifying bank feed transactions, one overarching question needs to be answered: Should this cash outflow be classified as an EXPENSE or should it be CAPITALIZED? The answer determines which financial statement it gets reported on. If a transaction is expensed, it will appear on the Income Statement. If it’s capitalized, it will show up on the Balance Sheet.
Real estate accounting involves many nuanced rules about capitalizing versus expensing costs. For house flippers, the rule is straightforward: all expenses for a flip property must be CAPITALIZED (as inventory) until the property is sold. When the property sells, the balance in the asset account is then reclassified to Cost of Goods Sold on the Income Statement.
This includes expenses such as insurance, interest, and taxes. When reviewing a house flipper’s books, I often see these items expensed on the Income Statement. This approach can work if the property sells by year-end. However, what if the property doesn’t sell and carries over to the next year? In that case, these expenses roll into Retained Earnings on January 1st of the following year. If your tax accountant overlooks these items, you might lose the deduction when the property finally sells.
The best way to avoid this mistake is to capitalize all flip property expenses into a single Current Asset account titled with the property’s address. By default, QuickBooks Online (QBO) tends to suggest expensing transactions to the Income Statement, which is what most house flippers do.
Keep in mind, QuickBooks Online (QBO) isn’t specifically designed for real estate investors. It’s tailored for small business owners who want to maximize their business deductions. House flippers often use QBO incorrectly when tracking their investments. This is one of many reasons why having a knowledgeable accountant with real estate experience on your team is invaluable—they can guide you through these common pitfalls.
