Best Practices for Real Estate Investors: Reviewing Accounting Materials, Including Tax Returns, Prepared by CPAs

Introduction

For real estate investors, financial diligence is paramount. One crucial aspect of this diligence is reviewing accounting materials, particularly tax returns, prepared by Certified Public Accountants (CPAs). These documents provide insights into the financial health of your real estate investments, helping you make informed decisions and optimize your returns. In this blog post, we will explore the best practices for reviewing accounting materials to ensure you get the most out of your CPA's work.

1. Establish Clear Objectives

Before diving into the review process, it's essential to establish clear objectives. Understand what you hope to achieve by examining these materials. Are you looking for tax optimization, risk assessment, or performance evaluation? Knowing your goals will guide your review and enable you to focus on the most relevant details.

2. Choose a Qualified CPA

The foundation of a successful review process starts with selecting a competent and trustworthy CPA. Ensure that your CPA has expertise in real estate accounting and taxation. They should be up-to-date with current tax laws and regulations, as these can significantly impact your investment strategy.

3. Review the Tax Return Thoroughly

The tax return is a treasure trove of information. Start by examining the income statement, balance sheet, and statement of cash flows. Pay special attention to:

a. Rental Income and Expenses: Scrutinize rental income sources, expenses, and deductions. Ensure all income is reported accurately and that expenses are reasonable and justifiable.

b. Depreciation: Verify that depreciation schedules are consistent with IRS guidelines. This can significantly affect your tax liability and cash flow.

c. Capital Improvements: Identify any capital improvements made during the year, as these may impact your cost basis and tax liability.

d. Passive Activity Rules: Understand how the tax return handles passive activity income and losses. Passive activity losses can often be used to offset other passive income.

4. Analyze Financial Statements

Beyond the tax return, it's essential to analyze the accompanying financial statements. Look for key performance indicators (KPIs) specific to real estate, such as:

a. Net Operating Income (NOI): Evaluate NOI to assess the property's income-generating capability.

b. Cash Flow: Determine the property's cash flow after all expenses, including debt service.

c. Debt-to-Equity Ratio: Understand the property's leverage and assess its financial risk.

d. Cap Rate: Calculate the property's capitalization rate to evaluate its potential return on investment.

5. Check for Red Flags

During your review, be on the lookout for any red flags that may indicate potential issues:

a. Unusual Expenses: Investigate any unexpected or unexplained expenses that could impact your investment's profitability.

b. Inconsistent Reporting: Ensure that financial data aligns with the property's operational reality and previous years' reports.

c. Delinquent Taxes: Verify that all property taxes are current, as delinquencies can lead to liens or penalties.

d. Audit Triggers: Identify any factors that could trigger an IRS audit, such as excessive deductions or suspicious transactions.

6. Seek Professional Advice

If you're uncertain about any aspect of your review, don't hesitate to seek professional advice. Engaging a tax attorney or financial advisor can provide you with the expertise needed to navigate complex tax matters and ensure compliance with all regulations.

Conclusion

Reviewing accounting materials, including tax returns, is a critical task for real estate investors. By following these best practices, you can make informed decisions, optimize your tax strategies, and safeguard your investments. Remember that transparency and due diligence are key to successful real estate investment, and a qualified CPA is your partner in achieving these goals.