Explore the essentials of escrow accounting for anyone managing investment properties. It is good practice for navigating escrow numbers and continuous compliance. Simplify the process to improve fund management and grow your real estate portfolio.
To account for cash held in escrow properly,let's first trace the path the cash takes through your business. A third party holds money in an account on behalf of two other parties while they complete a transaction. The neutral party may hold assets, such as cash, securities, or funds, until both the buyers and sellers have fulfilled their responsibilities.
The escrow account manager may be a lender, escrow company, escrow agent, or mortgage agency. In real estate transactions, the escrow agent or company may be the same as the title company.
Now that we have the path, let us map your Chart of Accounts using QuickBooks Online (QBO).
What you'll learn...
Is the escrow account an Asset? Or is it a Liability?
You close on a single family with $3,500 of escrow. This covers $291.66 per month of property taxes and insurance. Escrow Accounts may either be cash that the business expects to receive or cash the business must pay out. In this case, the escrow is a prepayment for expenses and is an asset. The escrow is for the next 12 months and is a current asset.
To set up an escrow account in QBO, you can create a Bank or Other Current Assets. They have the same effect on your Income Statement and Balance Sheet. It comes down to personal preference. Let us use the current asset account.
I opened a session using QBO's Sample Company. Use it to evaluate new bookkeeping techniques. Head over to the left side menu and select Chart of Accounts from the Transaction center.
To begin the escrow account setup, select the New button to create the new account.
To create an Other Current Assets account, select the Asset parent account, and in the Save account under, select Other Current Assets. The Tax form section, also called detail type, determines how the transaction will be applied to your Schedule C tax form when set up as a sole proprietor in QBO. It does not change anything else other than tax account mapping.
Select the best description for your escrow account. Investment - Mortgage/Real Estate Loans and Prepaid Expenses both are suitable options. I am not sure of the detail type, so I will just choose Investment - Mortgage/Real Estate Loans for now. The escrow is a current asset so I will name the account Current Escrow.
Find the +New button on the top right and select journal entry.
Create a new journal entry and add your new asset to QBO.
Going back to the Chart of Accounts, the Current Escrow account now has a $3,500 balance mathcing Journal Entry #1.
As you use your escrow, create an expense to match the HUD. The prepaid expense asset is now an actual expense reducing your tax liability.
What's actually happening here? The insurance and rent expense accounts are going up. Your available escrow is going down by the amount of the expense. The escrow balance is now $3,208.34.
If you enter the account register to see all the transactions, you will find the initial journal entry to log the asset and the expense to log the escrow payment.
As you add more assets to your books, you may need to update the escrow account information. Create a system for adding and updating accounts, including naming conventions and tax treatment.
In this case, I thought it would be better to change the Account name to something more descriptive by replacing Current with Insurance & Tax. I also decided to select Prepaid Expense as the detail type since it is more accurate.
Add another payment for the following month, keeping the reference numbering consistent. It makes asset reporting easier.
Bookkeeping is all about mapping your physical business activity to the digital world. The transaction is happening between the lender, lessee, and leaser. The escrow and the other related accounts map the physical activity to QBO.
Escrow is restricted cash
Escrow is one form of restricted cash. Any cash reserved for a specific purpose qualifies as restricted assets. For example, if you set aside revenue to pay dividends to shareholders or expect to lose a lawsuit and reserve cash to pay the judgment.
Although escrow is part of your financials as a cash on hand asset, and available to you, you are not supposed to use it for anything other than its intended purpose.
Horacio Bermudez