Many multifamily property investors love the art of the deal but prefer to leave the accounting and bookkeeping up to accountants or managers. No matter what your preference, you need to choose between two very different accounting methods—cash and accrual—to determine when and how income and expenses are reported, and to help set yourself up for success.
Cash vs. Accrual Accounting Differences
Typically, cash accounting is favored by small business owners due to its ease: income is recorded when cash is received; expenses are recorded when cash is paid out. Those who use the cash accounting method have no control over how investments look ‘on paper’ and can’t use the system to accurately gauge profitability over time. Most investors and property managers, therefore, prefer the accrual method, through which income and expenses are instead recorded when invoices are sent and bills received. Because of the span of time between financing a project—whether it be a new acquisition, development, or repositioning venture—and seeing a return on that investment, accrual accounting provides investors with much more control and a more accurate picture of investment profitability, particularly in the long term.
For example, if you finance a multifamily property project in the third quarter of the year, but don’t expect to receive revenues until the first or second quarter of the following year, accrual accounting allows you to anticipate funds and match income and expenses in the same year, thereby showing on-paper revenue that cash accounting wouldn’t provide.
There are also considerations to note regarding taxation and the time and cost involved in each method:
Taxation: Cash accounting reports income when it’s received during the tax year. Also, if property and services are received, you must include their fair market value as part of income. There may be some instances where there is a delay in receiving income at the end of each year, which could lower the overall taxable income for that year. However, that delay would mean an increase in income in the following year.
With the accrual method, you report income either when you receive payment, the income amount is due to you, when you earn income, or when title passes, whichever happens first. If you are incorporated or you are in partnership with a corporation (other than an S corporation) and record more than $5 million in annual gross receipts from your multifamily property investments, you must use the accrual accounting method. Finally, once you’ve chosen the best accounting method for your business, the IRS requires you to use that method each year moving forward. If you at some point decide to change the method, you must first receive IRS approval.
Time and Cost: Cash accounting is a fairly quick and easy process because income and expenses are recorded in real time as money is received and paid out. Accrual accounting takes more time to manage, as it requires you to keep a separate log of cash coming in and going out to better maintain an understanding of cash flow. The latter method could also cost you more in accounting fees if you don’t manage accounting logs yourself.
While choosing between cash and accrual methods of accounting may seem easy, your final choice will have an impact on your investment strategy. If you are unsure which method is best for you, discuss your multifamily property investment goals with a CPA or trusted tax adviser before making a decision.
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country, and employ a team of experts who can help you hone your investment strategy.
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