You’ve closed on a new commercial property or finished refinancing your loan. Congratulations! Now what? Your deposit money went somewhere, and you have a new asset, but how do you translate what you know into QuickBooks?
Have no fear! We’re here to walk you through the recording of the loan, monthly payment entries, what happens at the end of a loan– whether you sold the property or reached the end of the loan term– and a few common pitfalls to avoid along the way.
Please note that all accounting discussion within this document refers to the cash basis of accounting which is most commonly used for real estate. If you are operating on an accrual basis, any income or expense mentioned below should be accrued and written off accordingly.
The information within is provided for guidance purposes only. You should always consult your accountant or tax lawyer for specific advice regarding your situation.
If you paid for appraisals, notarizes, or other such expenses outside of escrow, be sure to take those into consideration when calculating the purchase price of the property. Appraisal fees are often overlooked because they are paid for in advance and sometimes even before the entity has been formed.
There are several different ways to record the monthly payments on a loan. Two of the most common ways are creating one bill that accurately reflects the principle and interest paid each month when it is being paid, or after the bill is paid, creating two journal entries. When utilizing the first method of recording as a single entry when paid, your accounts remain as up to date as possible in your Financial Statements and you eliminate the need to make journal entries. This is the preferred method as outlined below:
The most up-to-date and accurate way to record the loan payment is when it comes in from your bank feed with both the interest expense and loan principle. You can also create a bill payment with the same information. This works best if you have the statement or amortization schedule readily available each month.
The most prevalent problem with this method is that often people put all of the payment into principal or interest because they do not have all the information available when reconciling their bank statements or paying the bill. If you forget to update the allocation each month, this causes the true loan balance to be inaccurate as the amounts for principal and interest change slightly every month if it is not an interest-only loan.
If this method is used when making the payment every month, your loan balance and interest expenses should match the bank at any given time. When using software such as STRATAFOLIO, you are able to pull a report at any given time with the correct loan balances using this method to help secure future loans or to give the information to investors.
Note for any way that you choose to post the payments: make sure you regularly review the loan statement to ensure that your book balance for the loan is correct. It’s much easier to correct an error soon afterward than to try to investigate the issue months (or years) later.
Unless you have a loan that can be transferred when you sell a property to the new owner (which is extremely rare these days), the loan on your commercial property is paid off when you sell the property.
But how does the loan on the property affect the calculation of the gain on the sale of the property? The short answer is that it doesn’t.
Asset Value = Original Purchase Price of Asset + Depreciation – Expenses of Sale
Asset Value – Sale Price = Gain/Loss on Sale
Gain/Loss on Sale = Sales Price – Original Purchase Price of Asset + Depreciation – Expenses of Sale
As you can see here, the loan balance does not enter into the equation. If for example, you sell a building for $1,000,000 that you purchased for $500,000 and have taken $185,000 of depreciation on and pay realtor fees of $50,000 then your gain on sale is $635,000, regardless of the balance outstanding on our loan.
$635,000 = $1,000,000 – $500,000 + $185,000 – $50,000
The closing escrow statement should show the amount being paid off on the loan which will be recorded as a debit to the loan account to bring the account to zero. If the account doesn’t equal zero after recording the settlement statement, you should review the settlement statement for any prorations, fees, or prepayment penalties being charged against the note.
Note for 1031 exchanges: The loan balance on the property does factor into the calculations on replacement property requirements for a 1031 exchange. However, a complete discussion of 1031 exchanges is beyond the scope of this article. But, it is worth noting that if you obtain a new loan in an exchange you should create a new account to track the new loan. Reusing an old account on your books can cause confusion later.
As noted above, all loans should have a unique account in the Chart of Accounts. Creating a new account for a new loan keeps the books cleaner and makes it easier to tie out balances and interest expenses at year-end.
You should consult your accountant if you need help when making changes to your Chart of Accounts or finding the Basis for your asset. This information is provided for guidance purposes only. You should always consult your accountant or tax lawyer for specific advice regarding your specific situation.
With interest rates rising, it’s unlikely there will be more favorable rates in the future which means less chance of commercial loans being refinanced. This means there is a good chance the loans in existence today will be on the books until maturity.
If you have made every payment throughout the life of your loan on time, never made any extra principal payments, and recorded interest expenses correctly throughout the life of your loan, then the final payment on the loan should bring the balance to zero. If that is the case, there’s nothing else you need to do to close the loan. Although at this point, we recommend you make the account inactive in your accounting system to prevent future confusion by posting to the wrong account.
If the loan is maturing because you refinanced the loan, then there are a few steps that you need to take. A new liability account should be created on your books for the new loan. Then follow the same steps as above to record the original purchase of the loan.
If the loan is being assigned to another person, then the balance of the loan should be written off on your books.
If the loan is maturing because it has been written off by your lender, you should make an entry that debits the loan balance and credits “Cancellation of Debt” income on your Profit and Loss Statement.
Loan payment should always go against a liability account, not an expense account.
Even though it feels like the loan payments are an expense, unless the payment is interest only, you should record the principal payment against the liability account. Then the interest will be posted to the interest expense account according to your loan statements. By recording the payment to the interest expense account only, you will have an inaccurate reflection of your profit for the year and will show your business as overly levered by showing a higher debt-to-income ratio.
The interest rate changed and you didn’t update your calculation.
While many commercial real estate loans have fixed interest rates, other types have variable interest rates. If you created an amortization schedule when you first obtained your loan but haven’t been able to match your lender’s balance, check the interest rate to see if it changed and update your schedule accordingly.
Not verifying your account balances regularly.
Any balance sheet account can be regularly reconciled (not just bank and credit card accounts). Verify your liability accounts regularly. You can catch any errors in your principle and interest allocations early on and fix them quickly simply by verifying your balance in your loan statement matches the principal remaining in your account balance. The interest should match the total interest expense for the time period as well.
If you’re ready to see how STRATAFOLIO can help you with your commercial real estate business, contact us today.
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