Whether you’re forming a new real estate entity, or whether you’re considering refinancing an existing one, owners and managers of real estate entities should recognize that this is an opportunity to consider changing their financial reporting method. New lender requirements can often be negotiated, and a possible change in reporting method may better fit your company’s circumstances. The majority of real estate companies have a choice on the method they use for financial reporting. The two most common methods include Generally Accepted Accounting Principles “GAAP” or Income Tax Basis Reporting.
In financial reporting for real estate, GAAP and Income Tax Basis Reporting often yield very different financial results. GAAP reporting is required if the real estate entity is a publicly traded company. Conversely, if there is no mandate, real estate owners can choose between the two methods of financial reporting.
While each has its advantages, it can be challenging to determine the best method for each company. The best place to start is by evaluating the key differences and reviewing some key considerations.
Key Differences
[table “1” not found /]Key Considerations for Determining the Best Method
- What does your lending agreement or partnership agreement require? If you’re in the formation stages of your company, a real estate accounting firm can help determine the best method for you and negotiate that into your reporting requirements early in the process.
- What is your exit strategy? If the company may be rolled up into a public REIT in the future, a history of GAAP financial reporting will be required.
- Consider market fluctuations: GAAP financial statements can be affected by market fluctuations, for things such as impairment charges, which may cause repercussions such as debt covenant violations.
- Costs for reporting: It may save money to utilize the Income Tax Basis Reporting method, and only keep one set of books. Some companies report savings of up to 20%.
- User Friendly: Which method will be easier for your investors to understand? Will your users see the income tax basis as more accurately reflecting the economies of your business, or would they prefer the more standard method of GAAP reporting?
While each method has its advantages, there is no “right” choice for reporting. Management should review the facts and circumstances with an experienced real estate accountant to choose the best method for their business and their desired outcomes.
Does your real estate accounting firm provide you with all the options to ensure your business is successful? Contact us today for a free consultation.
Diane Wittenberg, CPA, is a Partner with Haskell & White. She works with many real estate clients, as well as clients in other industries. She provides audit and consulting services to both public and private companies. She can best be reached at 949-450-6334 or dwittenberg@hwcpa.com.