Why Trust Accounting is Critical for Property Managers

No matter what range of services they provide or how many properties they oversee, one of Vacation Rental Manager’s fundamental roles is to make sure funds flow from renters to property owners (and themselves) correctly. And one of their go-to methods to get this consistently right is trust accounting.

With a great system of trust accounting in place, your vacation renting business is on firm footing to succeed. However, trust accounting can be tricky to set up correctly and draining to keep up with regularly. If you underestimate this obligation, accounting issues can cause frequent headaches for an otherwise prosperous business.

One of the biggest red flags during a property management company audit involves improper handling of trust funds. To properly (and legally) handle owner and tenant funds, a property manager must understand the basic principles of trust accounting. Trust accounting regulations for property managers are state-specific, so it is very important to consult your state and local requirements to be compliant.

Frequently Asked Questions about Trust Accounting?

What are Trust Accounts?

There are specific rules about how business funds and transactions are handled by a property management company. Trust accounts for property managers are typically used to keep tenant deposits and rent payments separate from operating capital.

Some states require that all owner funds be maintained in a separate federally insured checking account. This account and the funds within, also known as a trust account, must be separate from your business and personal bank account(s). These funds are considered to be client funds (or rental property owner funds) and not funds of the brokerage(property management company).

Both rents collected on an owner’s rental property and security deposits collected from tenants are considered trust funds and must be placed into a trust account. Please keep in mind that rent collected on behalf of another person must be deposited into a trust account. Some believe that this only applies to security deposits/tenant deposits but that is not true, trust accounts are for all funds received on behalf of another for a real estate transaction.

The proper handling of these funds and accounting is important to avoid commingling of funds, which is illegal.Some states require property managers and owners to specify in the management contract exactly how trust accounts will be used. Even if your state has specific regulations for trust account use, it is always good practice to identify specifics in your management agreement.

One or Multiple Accounts?

Depending on your state guidelines, a property manager can set up one aggregate trust account of separate accounts for each owner. If not regulated by the state, it is up to the property manager to decide between one or multiple accounts for accounting and tracking purposes.

Some property management companies choose to set up two accounts- one account established as an operating trust account and one serves as a tenant security deposit trust account. This is good practice so you don’t accidentally spend the security deposit funds.

Check with your state guidelines to determine if you can hold trust funds in an interest-bearing trust account. Remember to reconcile all your accounts on a timely basis to avoid any future discrepancies.

One Bank Account or Two?

There is not much of an option here. Two bank accounts (at least) are needed to appropriately administer trust accounting. One of the most basic requirements of trust accounting as required by law is that there be no commingling of company funds and property owner funds. While trust accounting is not required in every state for short-term rental property managers, trust accounting and separate bank accounts are the best way to track owners’ and PM’s funds. The first account is typically an operating account, which holds funds that belong to the PM. The second account is an escrow account that holds rental & security deposits and rental revenues owed to the owners not yet paid out.

Should you use the operating account or escrow account to pay for a property and rental-related expenses?

Under no circumstances should expenses that are the responsibility of the PM be paid out of the escrow account. Paying rental and property related expenses that are the responsibility of the property owners could be paid out of the escrow account, but this can create issues if the property owner does not have enough funds in the escrow account to cover the expense. If most or all rental related and property expenses are the responsibility of owners, using the escrow account can be considered. If responsibility varies greatly based on type of expense and agreement with the owner, the best practice is to use the PM operating account and bill back the expenses to the respectable owner at the end of each month.

Should I use a Vacation Rental Management app?

Vacation rental management apps like Hostaway offer many advantages, including:

• Streamlined booking experience for your renters
• Automatic data transfer and booking into your calendar from multiple online booking sites
• Fast and easy payment processing
• Most offer some sort of trust accounting or general financial reporting features
• Owner statements/portals and EFT transfer for owner payments
• Marketing tools & apps
• Most offer property management scheduling (housekeeping, maintenance, etc.)

One big shortcoming of VRM apps is that they don’t offer the bank/credit card account feeds and even if they integrate with Revenue management software and accounting software, such as QuickBooks Online, they don’t pull in owner expenses automatically. This creates the manual entry of expenses in the VRM app for complete owner statements, which is usually a duplicate entry because expenses have already been recorded in the accounting system and are being used concurrently.

Can I just use a VRM app or should I also use accounting software?

Small VRM’s (usually 5 or fewer properties) may be able to get away with only using a VRM app, but its not recommended. A shortcoming of VRM apps that offer accounting functionality is they are clunky at best and reporting and functionality is poor. Best practice is to use VRM apps for the booking, property and rental management, and tracking owner statements functionality in conjunction with an accounting software.

What accounting software should I use?

There’s A LOT of accounting softwares out there, but generally there’s three good options for most PM’s, Xero, QuickBooks Online, and Sage Intacct. A big shortcoming of both Xero & QBO are that they are one entity & one ledger systems. While it can be done, trust accounting for property owners and accounting for the PM’s books in the same instance of QBO or Xero is very difficult. I walk through the suggested set-up of your accounting software in more detail below, but if using QBO or Xero, my recommended setup includes keeping two sets of books, one for the PM and one for property owners.

How do I set up my accounting software?

As you are likely to set up your system on QuickBooks Online, that is the system I will focus on below. Sage Intacct would only be set up with a certified specialist and Xero has a very similar setup to QBO. Note that this is certainly NOT the only way to setup your accounting software for trust accounting of property rentals, but is generally my recommended setup based on industry knowledge and experience.

First, below are the key setup configurations:

• Two instances of QBO (or Xero)
• Operating Cash Account
• Escrow Cash Account
• Owner Payment/Draw Account
• Owners – Set-up as customers, both in the PM books & Owners
• Renters – Set-up as customers
• Classes – Use class to track location in both the PM books and Owners’ books. Ensure that you allow the tracking “byline” instead of by invoice or bill.
• Billable expenses – You will want to make sure that this tracking feature is turned on in QBO. It is an automatic feature in Xero.

How do Trust accounting transactions flow?

You will need a general understanding of accounting to properly account and track both your owners’ and your own PM company’s books. But hopefully, this will give you a general understanding of the flow.

Rental & security deposits accompanying bookings, which usually occur in advance of the actual guest stay, should be recorded as rental deposits and deposited in the escrow account. With some online booking sites, payments for the rental are not received until after the guest departs.

If using a VRM app, the tracking of these bookings is very automated and helpful. Because no money is received, generally there is no transaction to record; however, either creating a future dated estimate or invoice in your accounting software on the date of the booking makes accounting for the receipt of the money after the departure much easier. I also recommend creating the future dated estimate or invoice even when a deposit is received (in conjunction with recording a deposit) to make the recognition of revenue, sales tax, etc. automatic after the date of the guest departure.

After the guest stay and usually at the end of the month, rental management commissions will need to be calculated and recorded. A VRM app becomes very useful in tracking and calculating the rental management fees owed per rental. These fees should be recorded as invoices to the owners in the PM books and recorded as bills in the Owners books. Using the upload feature in Xero is very helpful to batch create these invoices and bills. You can use an app like “Transaction Pro” or Bookingtrust to perform a similar upload in QBO.

Expenses paid on behalf of the owner will depend on whether you decided to pay for those expenses out of the Owners’ books (escrow account) or your PM operating account. If you paid via your PM operating account, you will want to make sure these expenses are marked as billable when first recorded. Upon the creation of the rental management fee invoices, you can simply add the billable expenses to that invoice and subsequently record them as a bill on the Owners’ books. The downfall of this process is the duplicate entry on the PM & Owners’ books.

Every month, after rental revenue has been recognized, owners’ expenses, and rental management fees recorded, it’s time to process transfers out of the escrow account. The PM will transfer the rental management fees owed to itself from the escrow account and rental revenue less expenses and rental management fees should be transferred to the owners.

There are still other considerations, such as returning security deposits, paying sales taxes, and whether you require a retainer balance for future property expenses, but hopefully this provides an outline to follow to properly account in a trust accounting environment.

How to account for PM & Owners’ books in the same instance of QBO?

Owner payable account should be created in the balance sheet. I recommend creating a top level account in QBO, with sub-accounts “Owner payable – rental revenue received”, “Owner payable – owner expenses paid”, “Owner payable – rental management fees,” & “Owner payable – owner payouts”.

As rental revenue is recognized, it should be reversed out of rental deposits and into the “Owner payable – rental revenue received” account. Similar with owner expenses.

As bills are received or expenses are paid, they should be recorded in the “Owner payable – owner expenses paid” account.

Rental management fees will need to be recorded as journal entries, with credits to rental management fee income and debits to the “Owner payable – rental management fees” account.

Payouts to owners should then be recorded in the “Owner payable – owner payouts” account.The balance of the Owner Payable accounts combined should always represent the amount owed the owners.

This is not very conducive to automating the creation of owner statements without the use of a VRM app; however, expenses paid on behalf of the owner will need to be manually recorded in the VRM app to ensure the owner statement is correct.