TeAm YYePG Digitally signed by TeAm YYePG DN: cn=TeAm YYePG, c=US, o=TeAm YYePG, ou=TeAm YYePG, email=yyepg@msn.com Reason: I attest to the accuracy and integrity of this document Date: 2005.03.17 09:21:22 +08'00' The Landlord’s Financial Tool Kit 01LL-FM-03 7/21/04 3:26 PM Page i This page intentionally left blank American Management Association New York • Atlanta • Brussels • Chicago • Mexico City • San Francisco Shanghai • Tokyo • Toronto • Washington, D.C. The Landlord’s Financial Tool Kit Michael C. Thomsett 01LL-FM-03 7/21/04 3:26 PM Page iii Special discounts on bulk quantities of AMACOM books are available to corporations, professional associations, and other organizations. For details, contact Special Sales Department, AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Tel.: 212-903-8316. Fax: 212-903-8083. Web site: www.amacombooks.org © 2005 Michael C. Thomsett All rights reserved. Printed in the United States of America. This publication may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of AMACOM, a division of American Management Association, 1601 Broadway, New York, NY 10019. Printing number 10 9 8 7 6 5 4 3 2 1 This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data Thomsett, Michael C. The landlord’s financial tool kit / Michael C. Thomsett. p. cm. Includes index. ISBN 0-8144-7235-4 (pbk.) 1. Real estate investment. 2. Real estate management. 3. Rental housing— Management. 4. Real estate investment—Accounting. 5. Landlord and tenant. I. Title. HD1382.5.T5645 2005 333.33'8—dc22 2004006149 01LL-FM-03 7/21/04 3:26 PM Page iv LIST OF FIGURES AND TABLES VII INTRODUCTION: W HAT T HIS BOOK WILL DO FOR YOU 1 C HAPTER 1 THE N ATURE OF REAL ESTATE INVESTING 3 C HAPTER 2 GETTING STARTED IN RENTAL REAL ESTATE 21 C HAPTER 3 C ASH FLOW: THE ESSENCE OF RENTAL REAL ESTATE 51 CHAPTER 4 PICKING THE BEST INVESTMENT FOR YOU 69 CHAPTER 5 BOOKKEEPING BASICS FOR RENTAL PROPERTY 89 CHAPTER 6 KEEPING TRACK OF REAL ESTATE TRANSACTIONS 121 CHAPTER 7 CREATING A TIMELY AND EFFICIENT ACCOUNTING SYSTEM 137 Contents v 01LL-FM-03 7/21/04 3:26 PM Page v CHAPTER 8 HANDLING DEPRECIATION FOR RENTAL PROPERTIES 155 CHAPTER 9 UNDERSTANDING THE TAX RULES FOR REAL ESTATE 179 CHAPTER 10 TAX REPORTING FOR ANNUAL INCOME AND EXPENSE 193 CHAPTER 11 I NCLUDING REAL ESTATE IN YOUR PORTFOLIO 225 G LOSSARY 237 INDEX 241 vi C ONTENTS 01LL-FM-03 7/21/04 3:26 PM Page vi FIGURES Figure 1-1. Sample rental application. 17 Figure 2-1. Average sales prices, new homes. 37 Figure 3-1. Worksheet for cash flow calculation. 55 Figure 4-1. Questions for judging conditions of the real estate market. 74 Figure 4-2. Questions for judging conditions of the rentals market. 75 Figure 5-1. Investment receipts journal. 93 Figure 5-2. Worksheet for loan payments. 95 Figure 5-3. Rental payments journal. 99 Figure 5-4. Year-end worksheet, expense summary. 100 Figure 5-5. Year-end worksheet, expense allocations. 104 Figure 5-6. Sample rental agreement. 112 Figure 5-7. Statement of Condition. 117 Figure 6-1. Automobile log. 123 Figure 6-2. Worksheet for mixed-use expenses. 131 Figure 7-1. Account with subaccounts. 140 Figure 7-2. Account with subaccounts (filled-in example). 141 Figure 7-3. Worksheet for after-tax profit or loss. 150 Figure 8-1. Depreciation limits for passenger automobiles. 167 Figure 8-2. Depreciation limits for trucks and vans. 168 Figure 8-3. Schedule of annual depreciation. 173 Figure 8-4. Schedule of annual depreciation (filled-in example). 174 Figure 8-5. Depreciation worksheet. 175 Figure 9-1. Worksheet for calculating profit on sale of real estate. 183 Figure 10-1. Form 1040. 194 List of Figures and Tables vii 01LL-FM-03 7/21/04 3:26 PM Page vii Figure 10-1a. Form 1040 (cont’d). 195 Figure 10-2. Tax reporting for real estate transactions. 196 Figure 10-3. Schedule A. 197 Figure 10-4. Schedule E. 200 Figure 10-4a. Schedule E (cont’d). 201 Figure 10-5. Form 8582. 203 Figure 10-5a. Form 8582 (cont’d). 204 Figure 10-5b. Form 8582 (cont’d). 205 Figure 10-6. Form 4562. 208 Figure 10-6a. Form 4562 (cont’d). 209 Figure 10-7. Form 4797. 213 Figure 10-7a. Form 4797 (cont’d). 214 Figure 10-8. Tax reporting for capital gains or losses. 215 Figure 10-9. Schedule D. 216 Figure 10-9a. Schedule D (cont’d). 217 Figure 10-10. Form 8824. 219 Figure 10-10a. Form 8824 (cont’d). 220 Figure 10-10b. Form 8824 (cont’d). 221 Figure 10-10c. Form 8824 (cont’d). 222 TABLES Table 3-1. Loan amortization, one year. 59 Table 5-1. Loan payment breakdown, one year. 96 Table 5-2. Impounds accumulated and paid. 97 Table 7-1. Single-entry bookkeeping journal. 143 Table 7-2. Timing differences, impound accounts. 146 Table 7-3. Impound account entries. 148 Table 8-1. Depreciation schedule, 5-year recovery period, 200 percent declining balance. 169 Table 8-2. Depreciation schedule, 27.5-year recovery period. 171 Table 8-3. Depreciation schedule, 39-year recovery period. 172 Table 8-4. Depreciation schedule, 5-year recovery period, 150 percent declining balance. 176 Table 10-1. Summary, rental income and expense. 207 Table 10-2. Supplemental schedule, depreciation expense: straight-line (SL) method (deductible portions in italics). 210 viii L IST OF F IGURES AND T ABLES 01LL-FM-03 7/21/04 3:26 PM Page viii The Landlord’s Financial Tool Kit 01LL-FM-03 7/21/04 3:26 PM Page ix [...]... for the investment While different lenders employ many variations of the basic strategy, they all look at the numbers in the same way They calculate your net monthly income (your take-home pay) and then take a percentage of that as the maximum obligation they will accept for your mortgage payment (The “obligation” usually includes mortgage principal and interest, property taxes, and insurance.) If the. .. Neighborhoods can change for the worse, the local economy can fall apart, or a large employer may close down or move away Another potential problem area involves dealing with tenants The landlord-tenant relationship is usually amiable and fair It is occasionally emo- 03LL-Ch01-03 10 7/21/04 3:01 PM Page 10 THE LANDLORD’S FINANCIAL TOOL KIT tional or illogical As a landlord, you accept the risk that some tenants... lenders may also require higher loan points and other fees, just to offset their higher risks The standards are higher, and for good reason What the Lender Might Require If your credit rating is less than perfect, you may have to meet a series of extra requirements These could include: 03LL-Ch01-03 12 7/21/04 3:01 PM Page 12 THE LANDLORD’S FINANCIAL TOOL KIT ❑ Higher down payment requirements, so that... cover their mortgage payment The bad news: If you do not keep the property rented every month, you have to make the mortgage payment from your other funds The good news: If you keep the property occupied, then tenants’ rental payments are used to make those mortgage payments In this situation—and given no unexpected extra expenses the property pays for itself When you purchase properties at the right... tenants This is the first step in checking whether tenants can provide the basic information you need—employment verification, current landlord’s name, a bank account reference, and monthly salary verified with copies of recent pay stubs Use a form such as the one shown in Figure 1-1 and require all applicants to complete it 03LL-Ch01-03 16 7/21/04 3:01 PM Page 16 THE LANDLORD’S FINANCIAL TOOL KIT Some applicants... and limitations These are the three attributes that make real estate a sound investment 21 04LL-Ch02-03 22 7/21/04 3:01 PM Page 22 THE LANDLORD’S FINANCIAL TOOL KIT 1 Location, of course, is the central defining element of a “good” real estate investment The vast difference in land values between 400 acres of Texas scrubland and a quarter acre in downtown Dallas make this point Whereas the scrubland... 7/21/04 3:01 PM Page 16 THE LANDLORD’S FINANCIAL TOOL KIT Some applicants will fail to fill out the form, meaning that they know they cannot refer you to their landlord, that they do not have a bank account, or that they have no income Any of these problems disqualify the person based on even a cursory review Therefore, requiring a written application is a necessary first step Key Point: Look for applicants... information the applicant has provided to you There is no way to ensure that employment will continue into the future, and this step is intended only as a fact-checking phase If the applicant is self-employed, you cannot verify income in the same manner You will need to get a copy of the person’s bank statement for the past two or three months to ensure that deposits are going into the bank There is no... wait out the market The situation is far different when the market for rental units goes soft If there are more rentals in town than there are people wanting them, you could face a more immediate problem: the loss of rental income If you believe your investment is not growing quickly enough, or if you experience higher than expected vacancies, you should keep open the possibility of selling There is... emphasis in this book Other choices (e.g., raw land speculation, commercial and industrial properties) are much more advanced and beyond the interest of most investors The residential housing market can be easily studied in any given area You can readily find information about the local population, employment, 3 03LL-Ch01-03 4 7/21/04 3:01 PM Page 4 THE LANDLORD’S FINANCIAL TOOL KIT rental occupancy . email=yyepg@msn.com Reason: I attest to the accuracy and integrity of this document Date: 2005.03.17 09:21:22 +08'00' The Landlord’s Financial Tool Kit 01LL-FM-03 7/21/04 3:26 PM Page. is required, the services of a competent professional person should be sought. Library of Congress Cataloging-in-Publication Data Thomsett, Michael C. The landlord’s financial tool kit / Michael. 3:26 PM Page viii The Landlord’s Financial Tool Kit 01LL-FM-03 7/21/04 3:26 PM Page ix This page intentionally left blank 1 Real estate investing is a practical alternative to the stock market for