Property Management 14 mins read

Everything About Trust Accounting for Vacation Rentals (+ Best Tools)

By June 14, 2022 June 22nd, 2022 No Comments
Trust accounting for vacation rental managers

 

Many vacation rental owners choose to have a vacation rental manager. And no matter the range of services these managers provide, and no matter how many properties they oversee, their fundamental role is to make sure funds flow from renter to owner (and themselves) correctly. If managers need to get one thing consistently right, it’s trust accounting. When they do this well, owners probably don’t even notice it. And that’s the way it should be. However, when it’s handled poorly, the stakes are high and the issues even higher.

Plus, one of the biggest red flags during a company audit involves improper handling of trust funds. Therefore when searching for a great property manager, rental owners should pay special attention to the property manager’s understanding of trust accounting and handling funds. As regulations are also state-specific, it is very important to consult your state and local requirements to be compliant. So let’s discuss everything you need to know about trust accounting for vacation rentals.

What are trust accounts?

Each state sets specific rules about how vacation rental property management companies handle business funds and transactions. In some places, an owner’s money must be kept in a separate, federally insured checking account. This account needs to be segregated from a business account and a personal account. This account and the money held there are known as a “trust account.” This money belongs to the rental property owner rather than the property management company. Any money a vacation rental manager receives from a renter must go into the trust account. This includes deposits and rental fees. 

Handing these funds correctly is essential to avoid any legal or ethical ramifications. Some states require that Airbnb property managers state outright how trust accounts will be used and managed, and it is best practice to identify these specifics in the management agreement. That way, everyone knows how their bases are covered.

One Bank Account or Two?

Some state guidelines dictate that property management companies set up two accounts, but other states do not require this. However we do think that two bank accounts (at least) are needed to appropriately manage 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. So 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 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?

Expenses that are the responsibility of the PM should not be paid out of the escrow account. Rental and property-related expenses that are the property owner’s responsibility can be paid out of the escrow account, however this can create issues if the owner does not have enough funds in there to cover the expenses. 

If most or all rental related and property expenses are the responsibility of the owner, then using the escrow account can be considered. However, 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 then bill back the expenses to the owner at the end of each month.

Should I use a Vacation Rental Management app?

Some people feel uncomfortable managing all of this and decide to get help from a Vacation Rental Management app. Vacation rental business owners and managers appreciate many benefits of using an app to help manage the property, including:

  1. Streamlined booking process for guests.
  2. Quick and easy data transfer and booking info into your calendar from multiple booking sites.
  3. Easy and quick processing of payments.
  4. Excellent trust accounting and reporting features that can help make sure everything is being done correctly.
  5. Owner statements/portals and EFT transfer for owner payouts.
  6. Helpful tools for marketing, communications and operations. 
  7. Scheduling for property maintenance, including cleaning, repairs, landscape, etc. 

However, owners and property managers should note that Vacation Rental Management apps do not offer bank/credit card account feeds. And even if they do integration with accounting software such as QuickBooks, they do not pull in owner expenses automatically. 

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

In general, if a vacation rental manager has fewer than five properties, they could get away with only using a VRM app. But it isn’t a great idea. In general, these apps are great for booking, property, and rental management, but they aren’t equally excellent at tracking owner statements. That’s where accounting software comes in.

 

What accounting software should I use?

You have many options for accounting software, but for our purposes, there are three good options for property managers: Xero, QuickBooks Online, and Sage Intacct. You’ll find that both Xero and QBO are intended to run off of one ledger. While you can implement this, we do not generally recommend that you keep trust accounting for owners and managers in the same place. 

QuickBooks Online

Pros:
  • QuickBooks Online (QBO) is a well-known software with straightforward access to advisers familiar with the software, including CPAs and tax professionals.
  • It’s pretty easy to use. With a general working knowledge of accounting, the use of QBO is pretty straightforward.
  • Many time-saving apps easily integrate, including several property management software.
  • Automatic bank feeds help with the effortless recording of transactions and reconciliation of bank & credit card accounts.
Cons:
  • Reporting in QBO can be cumbersome and is not very customizable.
  • While generally easy to use, there are quirks. It is easy to delete information with no audit trail, and knowing how to work the software does take some training.
  • Certain setup considerations and configurations are necessary to account for the short-term rental business properly. Getting these settings correct based on the VRM trust accounting model and your specific business needs requires a certain level of expertise and working knowledge of accounting systems.
  • QBO is intended to be a single entity and single ledger system. Because of this, the best practice is to account for the property manager and owner’s ledgers in two different instances of QBO. This requires duplicate entries when billing back expenses paid on the owners’ behalf and billing property management fees/commissions.

Xero

Most of the pros & cons of QBO are the same for Xero. However, below highlights the most significant differences:

Pros:
  • Xero is a newer software that is generally easier to use with better customer service.
  • Xero offers more robust and accessible custom financial reporting.
  • You’ll enjoy easy upload of transactions, which is not a function of QBO except with the use of third-party apps. This is handy when transferring data from VRM booking apps.
  • It still offers easy integration with many time-saving apps, such as Hubdoc, Bill.com, Expensify, and others to make a bill payment, invoice & receipt data entry, and credit card transactions a breeze.
Cons:
  • Being a newer platform, you may struggle to find all of the assistance you need if you’re new to using this type of platform.
  • Like QBO, Xero may require duplicate entries when billing expenses are paid on the owners’ behalf and billing property management fees/commissions.

Sage Intacct

Pros:
  • Sage Intacct offers robust multi-entity and multi-ledger financial management solutions. This makes accounting for both the PM and trust accounting for owners straightforward in the same system.
  • You’ll have several different dimensions (known as classes in QBO) to tag and track transactions, which makes customizing financial reporting, automating owner statements, reporting per booking/guest stay & reporting, and data analysis powerful, but also quick and painless. 
  • They offer custom financial reporting and dashboards.
  • You’ll enjoy similar easy integration with many time-saving apps.
  • They offer an open API, which allows for custom integration of VRM apps for streamlined and automated accounting of bookings and recognition of rental revenue after guest stays.
  • You’ll like the statistical accounts (i.e. headcount, guest stays, nights stayed, etc.) that allow for robust data and KPI creation and tracking.
  • Easy template uploads allow easy data transfer from VRM/booking software to the back-end accounting system.
  • You can create and send owner statements and supporting documents directly from the accounting software. This keeps the PM from transferring property expenses data back to the PMS to make owner statements.
Cons:
  • A more complex setup requires expertise from a Sage Intacct Partner to ensure the system is set up correctly.
  • While incredibly affordable as a robust financial management solution, the cost might not make sense for small operators.

How do I set up my accounting software?!

Most people choose to use QuickBooks Online, so that is the process we’ll look at below. The Xero setup process is pretty similar to this. Sage Intacct, on the other hand, can only be set up by a certified specialist. 

Note that this is not the only way one can set up accounting software for trust accounting of property rentals, it is generally the recommended setup based on industry knowledge and experience.

  1. Create two instances of QBO or Xero.
  2. Set up an Operating Cash Account for the property manager. 
  3. Set up an Escrow Cash Account in the Owners’ books.
  4. Set up an Owner Payment/Draw Account. Note that this account will be set up as an equity account to track payments to owners.
  5. Owners: set up as customers in the PM and Owner’s books.
  6. Renters: set up as customers. In long-term renter environments, renters can be set up as sub-customers of the owner. But this can create issues with short-term rentals if you have repeat renters that rent out multiple homes with multiple owners.
  7. Classes: You’ll use Class to track location in the PM books and the owner’s books. Ensure that you allow the tracking “byline” instead of by invoice or bill. This can come in handy if you get statements that have expenses for multiple properties on the same bill. Also, having a “top-class” that represents owners and “sub-class” for the property locations is very helpful if you manage multiple homes for the same owner. We also recommend turning on the feature in QBO that warns you when a class is not being used. This ensures that the owner/property always tracks income/expenses. Note that in Xero, classes are referred to as “tracking categories.” Xero has two tracking categories, and each can be assigned by line in invoices, bills, JE’s, etc. The tracking categories cannot have sub-categories, so one tracking category would need to represent the owners and one of the properties.
  8. Billable expenses: Make sure you turn this tracking feature on in QBO. It is an automatic feature in Xero. Note that you would only use this feature in the PM books for expenses billable back to the owner. If expenses that are the responsibility of the owner will be paid out of the escrow account in the owners’ books, the expense will just need to be recorded in the correct account and assigned to the appropriate class/tracking category (i.e., property & owner).

 

How do Trust accounting transactions flow?

You will need a general understanding of accounting in order 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.

Before a stay begins, guests will pay rental and security deposits. Property managers should record these as rental deposits and deposit them in the escrow account. Some online booking sites do not release payment until after the guest departs. Using a VRM app, tracking these bookings is automated. Because no money is received, generally, there is no transaction to record; however, creating a future dated estimate or invoice in your accounting software on the booking date makes accounting much easier. We also recommend creating future-dated estimates or invoices once a deposit is received to make the recognition of revenue, sales tax, etc., automatic after the guest’s departure date.

Rental management commissions should be calculated and recorded after a guest’s stay and at the end of the month. A Vacation Rental Management app can track and calculate the rental management fees owed per rental. These fees should be recorded as invoices to the owners in the PM books and as bills in the owner’s books. 

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 the PM’s operating account. If a property manager paid for expenses on behalf of the owner, they will want to make sure these expenses are marked as billable when they first record them. Upon creating the rental management fee invoices, they can 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 and owners’ books.

Every month, after recognized rental revenue, owners’ expenses, and rental management fees are recorded, process transfers out of the escrow account. The PM will transfer the rental management fees owed from the escrow account. Rental revenue (minus 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?

When choosing to account for PM and Owners’ books in the same instance of QBO, there are some steps property managers will want to take to keep track of and bill everything appropriately. Begin by creating a top-level account in QBO and sub-accounts labeled thusly: “Owner payable – rental revenue received,” “Owner payable – owner expenses paid,” “Owner payable – rental management fees,” and “Owner payable – owner payouts.”

  • Rental revenue should leave rental deposits and be put into the “Owner payable – rental revenue received” account as it becomes actual revenue. 
  • When bills are received, or expenses are paid, record those in the “Owner payable – owner expenses paid” account.
  • Management fees should be recorded as journal entries, crediting the rental management fee income to the “Owner payable – rental management fees” account.
  • Owners’ payouts must be recorded in the “Owner payable – owner payouts” account. The sum of those owner payable accounts represents the total owed to the owners.
  • In the VRM, manually record expenses that are paid on behalf of the owner to ensure that the owner’s statement remains accurate.

Key challenges with trust accounting

As with anything else, even trust accounting has features you should be aware of that are different from the typical business’ bookkeeping.

Be careful not to co-mingle funds

The very best choice a property manager can make is to keep separate bank accounts for property owner funds and property manager funds. However, this can make things more complicated. Even still, best practices often take more time to get things done right. 

Preserving your ethical responsibilities

The vacation rental manager holds a significant fiduciary responsibility to their vacation rental owners. Do not take this responsibility lightly. Ensure a high level of transparency at the beginning to gain and preserve trust. 

Following state laws

Since every state seems to have its own rules for trust accounting, it falls to the property manager to ensure that everything is being followed appropriately. If these rules are not followed, it will only lead to expensive and difficult headaches down the line. 

Know your state of affairs

Best practices exist so that people can make the best decisions with the most accurate information on hand. Following these best practices will ensure that property owners and managers can do just that. Co-mingling funds clouds the financial picture of a rental. That is the last thing a quality property manager wants for their clients. 

This is an updated guest post from Jesse King Ehret, Founder and CXO at Ximplifi. If you want to learn more about how technology can simplify your vacation rental accounting, check out their website.