This guide details how to make a property purchase journal entry based on your closing disclosure. These instructions are specifically for properties purchased this year or in your current accounting period.
Properties that you purchased earlier and have already filed taxes for should be entered using these instructions, as their basis and depreciation schedule will have already been established.
This is an important and advanced transaction, as it sets the property's basis and, therefore, its depreciation schedule. You will need your closing disclosure from the property purchase. You may also need the property's most recent tax assessment to help you calculate the property's Buildings/ Land value ratio (more on that below).
Want REI Hub to take it off your plate completely? We charge $100 to analyze your closing disclosure and create the property purchase journal on your behalf.
Not every investor will need or choose to make property purchase journal entries or track their fixed assets and depreciation in REI Hub. If your accountant, tax preparer, or tax preparation software manages these items on your behalf, then you may not need or wish to enter them into REI Hub. Not sure what's best for you? Our customer service team is happy to chat through your individual situation.
Create the Property Fixed Asset and Loan Account
1) Create a fixed asset for the property
Navigate to the Fixed Assets page, found under the Organization tab in the left side menu. Click Add Asset.
Select 'A Property' from the first screen.
Give it a name. The property address is fine, or '123 Main St Fixed Asset.'
The placed in service date is when the property was first listed for rental. You can also leave it blank for now and fill it out later.
2) Set up the loan account from the Loans page
Navigate to the Loans page, under Accounts, on the left side menu. Click Add Loan in the upper right.
Click to learn more about loans and the loan payment template.
Skip this step if you did not finance the purchase.
Calculate the Property Basis
First, you need to calculate the effective sale price or total basis of the property. This is the the purchase price of the property, minus the amount of any credits the seller provided at closing (which will be on the closing disclosure), plus the sum of the closing costs, which can be capitalized (described below). Written as a formula, it would be:
(Purchase Price - Seller Credits + Capitalized Closing Costs) = Effective Sale Price or Total Basis
To get this number, you need to sum up your capitalized closing costs, as many of your closing costs should be capitalized and depreciated over time. These include:
Title fees and insurance, surveys, recording fees, legal fees, and transfer taxes.
Most costs associated with obtaining a loan should be capitalized, including loan origination, processing, underwriting fees, purchased points, appraisals, credit reports, etc.
Additionally, anything you pay on behalf of the seller (such as unpaid taxes or real estate commission) can also be capitalized.
Now that you have the effective sale price or total basis of the property, you need to determine how much of it is depreciable and how much is non-depreciable. The total property basis includes both buildings (sometimes called improvements or structures), which are depreciable, and land values, which are not depreciable.
This information is on the property's tax assessment and can typically be found through the tax assessor's office or your local government website. The tax assessment provides the current assessed value, broken down by Land value and Building value. The tax assessment value is likely different than the purchase price, but it is the ratio of Buildings to Land value you need.
Determine the ratio of buildings to the total property value, and then apply it to the effective sale price or total basis to get your Building's value (the depreciable basis of the property). The remainder of the total basis will go to Land (the non-depreciable basis of the property). Land and Buildings values will go in the debits section of the manual journal, as described below.
Example: You purchase 123 Main St for an effective price of $100,000. The most recent tax assessment showed the property worth $90,000, with the land valued at $15,000 and the Buildings/Improvements at $75,000. Therefore, $75k of the $90k is the Buildings value, for a 0.833 ratio. Multiply that ratio by your effective price ($100k), and you get $83,333 for the Buildings value and $16,667 for the Land value.
Create a Journal Entry
Property purchases are complicated transactions that touch multiple accounts. The 'Manual Journal' transaction type is a blank journal entry that allows you to select any account and add as many lines as needed.
1) Click Add Transaction and select Manual Journal
You can find Add Transaction buttons at the top of the left side menu or in the property fixed asset you just created
2) Enter the purchase date, property, description, and fixed asset.
3) Enter the debit lines
Buildings: This is the property's depreciable basis, calculated as described above.
Land: This is the main account for the non-depreciable basis of the property.
Any tax-deductible closing costs present on your closing disclosure are entered individually into the specific expense account. These can, but don't necessarily include:
Taxes
Insurance
HOA fees (which can be created as a sub-account of Other as it is not a default expense category)
Mortgage interest
Your closing disclosure may also show adjustments for expenses prepaid by the seller and/or unpaid by the seller. Prepaid expenses should either be added as a new debit line or combined (increasing the value) with the existing value in the same expense account. Unpaid expenses should either be added as a credit line or reduced to the existing debit for the relevant account.
Escrow account prefunding (if applicable). If your loan is escrowed, an escrow account was automatically created when you set up the loan.
You don't need to worry about any individual line items here. If present, they are estimates. Enter the total transfer or prefunding amount.
4) Enter the credit lines
The loan account: Enter the total initial loan balance.
If the property was not financed, omit this line.
The bank account: select the account that funds came from, the Down Payments account if you have previously funded it, or choose Owner Funds. Enter the amount of your cash paid at closing.
Earnest money deposits:
If you have not previously accounted for earnest money, select your bank account or Owner Funds and enter the amount of your EMD.
If you have previously entered your earnest money into REI Hub, select the Earnest Money Deposit account and enter the amount.
5) Optionally attach an electronic version of the closing disclosure and save the transaction
Optional Advanced Tracking
Some investors who finance a property purchase may wish to separate out their specific capitalized loan closing costs into a separate fixed asset to track and depreciate. This may be done for two reasons:
Capitalized loan closing costs depreciate over the lifetime of the loan, typically 30 years. Since rental property depreciations on a 27.5 year timeline, the property asset and loan asset don't perfectly match up.
Many investors refinance or sell before the end of their initial loan. At that time, you can expense any remaining capitalized loan costs if you have tracked them.
To do this, you will set up separate fixed assets, one for the property and one for loan closing costs. You will make one journal entry for each asset. Unlike the above:
You will separate out capitalized closing costs that apply to the property asset (title fees and insurance, surveys, recording fees, legal fees, and transfer taxes) and capitalized closing costs that apply to the loan asset (loan origination, processing, underwriting fees, purchased points, appraisals, credit reports).
The Auto Balance account is a default equity account that is used here to break the property purchase and loan origination into two assets and journals. Using offsetting debits and credits to the Auto Balance account in the two journals nets out to zero while still properly recording all the other information.
As an important note, if you received any rebate on your loan in excess of your loan closing costs, you have nothing to depreciate; therefore, a second asset and journal entry is not required.
Want REI Hub to take it off your plate completely? We charge $75 to analyze your closing disclosure and create the property purchase journal on your behalf.
Still have questions? Reach out to our Support Team via email at [email protected] or call us at (888)939-6865.