Cash or Accrual Accounting?

Question

I have read from several sources that RE investors MUST use the cash accounting method.  Our CPA says this is not true.  If the state is important, we are in SC.  Can anyone confirm this one way or another?  To give insight into my concern... Supposedly, when we sell on owner financing, we must claim the full sales price for that year (cash method).  This hardly seems right... why would we have to claim and pay capital gains when we haven't even received the gains?  Our CPA is the only person that will tell me we can use the accrual method.  One in five makes me nervous.  Can somebody please give me a definite answer?

Candace McCutcheon · Answer

That is exactly what the investors have told me, and exactly what our CPA disagrees with.  I feel secure that those in the industry do know what they are talking about.  Perhaps our CPA is not as familiar with this industry, but she will be in time.

Thank you.

Account Closed · Answer

There is one fundamental point I always drive home in a situation like this.

No matter what anyone says or writes, if it in any way is in conflict with what your paid professional is telling you... They are right and we are wrong.

You should absolutely take the advice of the professional you have chosen and pay as a professional, be they lawyer, CPA or in any other professional capacity.

Why? Because they are the ones with the malpractice insurance policy to cover them and you if they give you bad advice and you follow it.

That doesn't mean I would follow their advice, but then I have my own professionals I pay too.

Anyone here can say your CPA is so full of crap their eyes are brown, but that CPA is the ONLY one who can go into an audit with the IRS and explain why they gave the advice they gave and defend the deductions and accounting standards used.

At the Field Guide we always encourage the members to take the materials to their professional with them. If the professional says it is crap, they are right and the SME who wrote the materials is wrong. No debate, no exception. Everyone should take that same approach with anything they read from any site even here at BP.

Dave Toelkes · Answer

Your CPA may have a more comprehensive view of your business than you have given us.  We don't know when you bought these properties, why you bought the properties, and how you used them during your holding period.

I have only given you my perspective as an uninformed casual observer.  Your CPA may have valid grounds for her opinion.

As a general rule, the dealer disposition issue goes to intent.  If you bought the property with the intent to resell it for a profit, then the sale is a dealer disposition and installment sale tax treatment is not allowed.

If you acquired the property with the intent to hold indefinitely for future appreciation, then the sale is an investment sale for which installment sale tax treatment is allowed.

We don't the complete picture, your CPA probably does, so don't completely dismiss your CPA's tax treatment without getting a complete explanation of her rationale..

Account Closed · Answer

I sit corrected, again!

Accrual methods are generally required if you must account for inventory to accurately track your income and expenses.

A real estate investor, yes even a landlord, can choose to use the accrual method of accounting. For the life of me I don't know why a landlord would, but you could.

Ralph S. · Answer

FWIW

Tax Guide for Small Business (Sched C)
http://www.irs.gov/pub/irs-pdf/p334.pdf
Page 12, on Accounting Methods.
No industry, or business type classifications as to who can use what.

Per the use of the trust account, from the description Elliot gives, that is exactly what is happening.  His question pertains to how he should record the income, I only answered that.  As to whether that's the best way....  I've never used a PM.

Candace McCutcheon · Answer

Not a number of experts, a few experienced RE Investors vs- 1 expert CPA.  I wasn't saying the CPA doesn't know the difference; I was saying that she believes we can use the accrual method.  The investors said that we must use the cash method.

We sell only land, so depreciation is not a concern.  However, after reading the posts, I think we may prefer to stick with the cash accrual, but I will talk to our CPA and the IRS regarding deferment of the gains taxes.  We have been paying those in full each year.  It is too much at once when financing 6-12 or more sales each year.

Thanks so much for everyone's input.

Eliott G. · Answer

I was curious about this as well...not for property sales...but for regular monthy rent collection.

Per my management company, I receive January 1st rent on February 15th.  This give the management company time to collect the rents (and late rents), process and send me the funds.  I have no problem with this method, however I run into the following problem...

Decmebr 1st 2009 rent is collected, but not paid to me until January 15th of the following year.  For which tax year do I recognize this rent?

thanks in advance

Ralph S. · Answer

Hate to disagree with Taz, I usually think he's spot on.  But, financing the sale can defer paying capital gains tax.  Either selling on a land contract, or takiing a note can the taxable portion.  In both cases, the sale is recorded, and the gain is determined on the tax return.  Then you claim deferral of the tax to future years.  In both cases, each year you will reduce the amount of the unpaid gain and pay taxes on the principal portion you received, and then pay tax on the interest earned.

As far as the rents, once the rents are collected by the PM, you, as owner, have received the rents, whether they have been passed on to you or not.  The PM, acting as your agent, is only a holder of your funds, and they should be in the PM's trust account.  Think of your money with your PM as a savings account.

As far as cash versus accrual method, that's a declaration you make when starting your company, is Federal in nature (for federal tax purposes), and it is up to you.  I'm sure the feds have a booklet or something at irs.gov that explains in detail, and one for deferring capital gains taxes as well.  Real estate business or anything else, doesn't matter.  If you maintain any type of inventory, then you are pretty much required to use the accrual method.  But, there are other reasons to use one or the other if you have a choice.

The simple difference between cash and accrual is cash is when paid, accrual is when costs are incurred or benefits are received.

I'm confused a little in your post, you've got a number of experts(?) saying one thing, and your CPA telling you another.  Sounds like a Chevy commercial.  I'm sure there isn't a CPA on the planet that wouldn't get accrual vs cash methods of accounting right.  It's covered on about day three of Accounting 101.

Candace McCutcheon · Answer

Thank you very much!  This has been a topic of debate for several months, and I have been shunned a few times for leaning toward the investors with experience as opposed to the tax expert.  With that answer in mind, is one method more beneficial than the other?  At first glance, it would seem to me that paying all the taxes now would eliminate the possibility of paying higher taxes later.

Cash or Accrual Accounting?

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