Journal Entry For Expenses In Property LeasingNumerous costs and expense are incurred in the operation (leasing) of a property. Depending on the lease agreement, some of these costs/expenses can be recovered from tenants. Therefore, they are sometimes distinguished as “recoverable” and “non-recoverable” costs or expenses. Proper recording of these costs is become more critical and important since not all costs are expensed the year they are incurred—some of these are deferred and amortized over the useful or beneficial periods.

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This post provides guidelines on how to record (make journal entries) for cost and expenses incurred in the operation of property (leasing) business, from the side of the owner of the property—often called as “landlord.” As always, it comes with case examples for you to see the real application on a real property leasing business.

 

Some of the common types of costs incurred in an operating property are: Cleaning services; Security; Water; Electricity; Heating-ventilation-and-air-conditioning (HVAC); Payroll; Insurance; Repairs and maintenance; Leasing costs; Loan closing costs; Management fees; Property taxes; Sales and use taxes; Additional services bill-backs.

 

1. Cleaning Expenses

Cleaning involves the cost of cleaning both inside and outside of the property. This service is either provided by the property owner’s personnel or outsourced to third-party cleaning companies. If it is performed by the owner’s personnel, this cost would be part of payroll expenses. Cleaning cost is a period cost and should be expensed during the applicable periods.

Therefore, the journal entry to record this type of expense would be:

[Debit] Cleaning expense = $xx
[Credit]. Cash or Accounts Payable = $xx

 

However, in an outsourced cleaning scenario, the parties might agree that the owner would pay in advance every six months. In this case, the amount paid in advance would be a prepaid asset and amortized over the beneficial period. Assume the landlord paid $120,000 for cleaning service for the period January 1, 2009 to June 30, 2009, and this amount was paid on January 1, 2009.

The initial and monthly entries would be:

(a). January 1, 2009:

[Debit]. Prepaid cleaning expenses = $120,000
[Credit]. Cash = $120,000
(To record prepaid cleaning for period January 1, 2009 to June 30, 2009)

(b). Monthly starting January 1, 2009:

[Debit]. Cleaning Expense = $20,000
[Credit]. Prepaid assets—cleaning = $20,000
(To record monthly clean expense [120,000/6 = $20,000])

 

2. Security Expenses

Security expenses are payments to security companies for providing their security personnel to the property. The services provided by these personnel could include registering guests entering the building, confirming guest visits with the hosting tenant, issuing security passes (IDs) to tenants, surveillance of the exterior and hallways of the building, and a host of other responsibilities.

The fees paid for these services are expensed during the applicable periods similar to the cleaning service discussed earlier.

The joined entry recorded for the charge is:

[Debit]. Security services expense = $xx
[Credit]. Cash or Accounts Payable = $xx

 

3. Water, Electricity, HVAC (Heating-Ventilation-Air-Conditioning) Expenses

Water, electricity, and HVAC (Heating-Ventilation-Air-Conditioning) represent major expense lines in an operating property income statement. The charges for these items are billed by the utility provider to the property.

In some cases, where there are sub-metering arrangements, these charges can be billed directly to tenants. Sub-metering prevents the allocation of these costs by the landlord using tenants’ pro rata shares of the building. Instead, meters are installed for every tenant in the building.

The entries to record these types of charges are:

[Debit]. Water expense = $xx
[Debit]. Electricity expense = $xx
[Debit]. HVAC expense = $xx
[Credit]. Acquired expense $xx

Note: The “Acquired expense” account, later, will be reversed with “cash” when tenants’ pro rata shares have been properly determined and payment to the utilities’ provider have actually been made.
 

 
4. Payroll Expense

Payroll includes the compensation cost of all the personnel who perform work for the property. It also includes all employees’ employment benefits. Some personnel commonly found at the property include the property managers, engineers, accountants, administrative assistants, and bookkeepers. All compensation to these individuals is recorded as payroll expense.

The entry to record payroll expenses is:

[Debit]. Payroll expense = $xx
[Credit]. Cash or Accounts Payable = $xx

 

5. Insurance Expense

The insurance category represents the cost of purchasing insurance coverage for the property. The amount paid to the insurance company is called the insurance premium. Depending on the insurance company and the arrangement with the property owner, the insurance premiums can be due monthly, quarterly, or annually. Premiums usually are paid in advance.

When premiums are paid in advance, they should be recorded as a prepaid expense and amortized over the coverage period.

Assume the property owner paid $30,000 on January 1, 2009 for insurance coverage for the period starting on January 1, 2009 and ending on June 30, 2009.

The entry to be recorded on January 1, 2009 when the amount was paid would be:

[Debit]. Prepaid insurance = $30,000
[Credit]. Cash = $30,000

 

Therefore, at the end of each month, an entry would need to be recorded to recognize the insurance expense. This entry would be:

[Debit]. Insurance expense = $5,000
[Credit]. Prepaid insurance = $5,000

 

At the end of the first month, the balance of prepaid insurance would be $25,000 [=$30,000 – $5,000].

 

6. Repairs and Maintenance Expense

Repairs and Maintenance are costs spent to keep the property for its intended use. Examples include repair of broken windows and doors, repair of toilets stoppage, replacement of light bulbs, maintenance of the heating system and air conditioner, maintenance of elevators, and so on. Numerous bills fall into this type of expense. Repairs and Maintenance expenses are period costs and should be expensed as incurred.

The entry to record the cost is:

[Debit]. Repairs and Maintenance expenses = $xx
[Credit]. Cash or Accounts Payable = $xx

 

7. Leasing Costs

Leasing costs are the costs incurred to lease the premises to tenants. The most common leasing costs are broker’s commissions and legal fees. Broker’s commissions are paid to brokers for securing a tenant who leases the premises:

  • In a residential lease, the commission is typically paid at lease signing and the payment obligation varies between the landlord and the tenant.
  • In commercial leases, the broker’s commission payments are typically spread over the length of the lease and are specified in the commission agreement between the leasing broker and the landlord.

 

The most common commission agreement entitles the broker to a portion of the commission upon a tenant’s signing of the lease; the remainder is paid over the term of the lease. Sometimes the landlord and broker may agree that the broker is entitled to an additional commission if the tenant renews at the end of the original lease.

The accounting journal entry to record broker’s commission is different from how some of the other costs described above are recorded. The total commission is recorded as a prepaid expense and amortized over the length of the lease.

 

Case Example

Assume the broker and landlord agree that the total broker’s commission for a 5-year lease with a commencement date of January 1, 2009 and expiration date of December 31, 2013 is $600,000, of which $300,000 is paid upon lease signing with the remaining $300,000 paid on January 1, 2011. Assume the lease was signed on November 15, 2008.

The entry to be recorded upon signing the lease and payment of $300,000 to the broker would be:

[Debit]. Prepaid broker’s commission = $600,000
[Debit]. Accrued broker’s commission = $300,000
[Credit]. Cash = $300,000

 

Thereafter, during the lease period (January 1, 2009–December 31, 2013), the monthly entry to record the amortization of the prepaid broker’s commission would be:

Total commission            = $600,000
Number of months          :              60
Monthly amortization      = $  10,000

 

Therefore, the journal entry is:

[Debit]. Amortization expense:
              broker’s commission              = $10,000
[Credit]. Accumulated amortization:
              broker’s commission              = $10,000

 

Then at January 1, 2011, when the remainder of the broker’s commission is paid, the entry would be:

[Debit]. Accrued broker’s commission = $300,000
[Credit]. Cash = $300,000

 

Legal fees are the fees paid to an attorney for drafting the tenant lease agreement. In most leases the legal fees are paid upon signing the lease. Regardless of when they are due or paid, the amount should be capitalized and amortized over the term of the lease.

 

Case Example

Assume that for the same lease transaction just discussed, the landlord paid $60,000 in legal fees. The entry required upon signing the lease would be:

[Debit]. Prepaid legal fees = $60,000
[Credit]. Accrued legal fees = $60,000

 

When the legal fees are paid, the required journal entry would be:

[Debit]. Accrued legal fees = $60,000
[Credit]. Cash = $60,000

 

Each month during the lease term, the amount of legal fees to be expensed is calculated as:

Total legal fees         =  $60,000
Number of months    :            60
Monthly expense      = $   1,000

 
And, the journal entry is:

[Debit]. Amortization expense—legal fees = $1,000
[Credit]. Prepaid legal fees = $1,000

 

8. Loan Closing Costs

In a real practice, the purchase of real estate in most developed economies is mostly financed with debt. Debt financing involves costs such as application fees, origination fees, administration fees, and syndication costs, among others. These costs are called “Loan Closing Costs.

These costs should be capitalized and amortized over the life of the loan. Assume debt was used to finance a real estate asset purchase and the total loan closing costs were $500,000 on a 10-year debt financing.

The entry to record the loan closing costs is:

[Debit]. Loan closing costs (assets) = $500,000
[Credit]. Cash = $500,000

 

The monthly amortization of this cost during the loan period would be:

Total loan closing costs = $500,000
Loan period in months  :            120
Monthly amortization   = $4,166.67

 

The monthly journal entry would be:

[Debit]. Amortization expense—loan
             closing cost                                      = $4,166.67
[Credit]. Accumulated amortization—loan
              closing cost                                     = $4,166.67

 

 
9. Management Fee

In some cases the owner of a real estate entity hires a professional real estate management firm to manage the property. These firms provide the staffing, interface with the tenants, lease vacant space, procure supplies, and collect rents, among other responsibilities.

Management fees are recorded as assets when paid and amortized over the engagement management period unless the amounts are paid periodically over the management period.

 

 
10. Property Taxes

Generally property taxes are billed by the city or municipality where the property is located. Property tax is a major source of revenue to local governments and a major expense line on a property’s income statement. The amount of taxes paid on a property is assessed by the government taxing agency. The importance of this cost is very evident upon review of a property’s financial statement. It is usually one of the largest costs of operating a property.

Most taxing authorities give property owners the right to challenge the assessment value used in determining the property taxes.

Attorneys and other professionals specialize in helping owners to obtain a fair assessment of their property and thereby reduce their property taxes. Most of these professionals are paid on a contingency basis based on the successful reduction of the taxes. In some cases, their fees can be up to 30 percent of the annual tax reduction. This can be a very profitable profession, especially in cities where property taxes on commercial properties are in the millions a year.

Property tax billing varies between cities. Some cities bill monthly or quarterly while some others bill semiannually or annually. However, regardless of how often the property taxes are paid by the owner, the cost should be expensed over the applicable tax period.

For some municipalities, property taxes are paid in advance; for others, they are paid in arrears.

 

The bill should be thoroughly reviewed to ensure that the amounts are expensed during the correct period. Assume that a municipality bills property taxes in advance semiannually. In this case, the payment by the property should be recorded as prepaid property taxes when paid and expensed pro rata over the six months.

 

Property Tax Case Example

If on January 1, 2009 the property owner paid $600,000 for property taxes for the period January 1, 2009 through June 30, 2009, the initial and subsequent monthly journal entries would be:

(a). On January 1, 2009:

[Debit]. Prepaid property taxes = $600,000
[Credit]. Cash = $600,000

(To record property taxes paid for period January 1, 2009 through June 30, 2009)

 

(b). Monthly starting January 1, 2009:

[Debit]. Property tax expense = $100,000
[Credit]. Prepaid property taxes = $100,000
(To recognize property tax expense for the month)

 

(c). At the end of the first month, the prepaid taxes balance would be:

Original prepaid property taxes                 = $600,000
Property taxes expense in January 2009    (-)$100,000
Prepaid taxes balance at January 31, 2009 = $500,000

 

Assume instead of in advance, property taxes for the period of January 1, 2009 through June 30, 2009 are due and paid on June 30, 2009. In this case the property owner would still have to recognize property tax expense each month by recording an accrual each month. The required monthly journal entries would be:

 

(a). Monthly journal entries starting January 31, 2009:

[Debit]. Property tax expense = $100,000
[Credit]. Accrued property taxes = $100,000
(To accrue monthly property taxes due June 30, 2009)

 

(b). Journal entry on June 30, 2009:

[Debit]. Accrued property taxes = $600,000
[Credit]. Cash = $600,000
(To record payment for property taxes for January 1, 2009 through June 30, 2009 due on June 30, 2009)

 

These entries ensure that the property’s financial statement appropriately reflects the property tax expenses every reporting period.

 

11. Sales and Use Taxes

Sales tax is a state tax on the retail sale of tangible personal property or services. Sale taxes are normally collected by the seller from the purchaser on behalf of the state. The seller in this capacity acts as the custodian for the state in collecting these taxes. Use tax is a government tax on the use or consumption of tangible personal property or for services where sales tax was not charged by the seller at the time of the transaction. Generally, goods used in a manufacturing capacity are tax exempt because they are part of inventory.

Use taxes arise because sometimes, during the purchase, the purchaser has not decided whether the goods would be consumed by the purchaser or used in the production of a final product. If the purchaser ends up using or consuming the goods, the purchaser has to pay use tax to the state.

A purchaser is subject to sales or use tax on tangible personal property if three conditions are met:

  • There is transfer of title or possession.
  • There is transfer of the right to use or control.
  • There is transfer of consideration such as credit, money, or extinguishment of debt.

 

Note: Sales and use taxes are not required on intangible personal property; however, services are subject to sales and use taxes. Care should be taken to differentiate between intangible personal properties and services.

Certain purchasers and products are exempt from sales and use taxes. Examples of exempt purchasers include government agencies, religious organizations and societies, educational organizations, and charitable organizations.

Some products exempt from these taxes include donations to nonprofit organizations, publications, research and development, and tangible goods used in the manufacturing, processing, or production of inventory for sale. It is also important to note that different states have different rules on exempt purchasers and products.

Rental income is also exempt from sales or use tax. Landlords’ charges for overtime freight elevator service, overtime cleaning, heating, air conditioning services, and electricity are also exempt from sales or use tax because tax rules consider them as incidental to the rental of the premises.

 

12. Additional Services Bill-backs

In some cases tenants may require additional services above and beyond the normal level of service agreed to on a lease. These may include requests for HVAC after normal work hours, additional security, or cleaning during certain events. These types of costs are billed back to the requesting tenant and not included as part of operating expenses billed to all tenants.

These additional costs are recorded differently depending on whether the books and records of the property are kept on a GAAP or federal tax basis:

  • On a GAAP basis, the additional billing to the tenant is included as revenue with the corresponding cost recorded as expense.
  • On a federal tax basis, this additional billing is not reported as revenue unless there is a profit earned on this transaction by the property, which would then be reported as revenue.