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Gather’s Trust Accounting Protects your Investment
What comes to mind when you hear the word ‘trust’? For many, it’s the relationship between a trustee and a beneficiary. We often associate it with a family arrangement, where parents appoint a trustee to manage assets for their young children. But did you know you can use trust accounting to manage properties?
Most real estate investors employ property managers. And those managers play the role of a trustee. But unfortunately, not all of them use trust accounting. Is it a legal requirement to use it? And what are the risks of not using it? We’ll discuss these questions in detail, including the benefits to you as a real estate investor. But first, let’s discuss what we mean by trust accounting.
What is Trust Accounting
Trust accounting is an arrangement where a third party holds funds on behalf of another person. For example, the third party in property management is the property manager. And the beneficiary is the property owner. The property manager receives money from the renters in the form of rent and deposit. Part of that money goes to the manager as a commission, while the rest goes to the property owner.
During the distribution process, which might take some time, the property manager holds the funds in a fiduciary position on behalf of the owners. Trust accounting requires property managers to account for the owners’ funds separately. So instead of having a single bank account for all funds received, they maintain a separate account where they deposit all money belonging to the property owners.
Trust Accounting Overview
Trust accounting becomes necessary when the owners can’t manage their assets. It could be due to being underage, incapacitated, unavailable, or lack of management skills. In companies, there are many owners, and it’s not practical to have all of them manage the firm. And as an individual investor, you may not have the time to address your investments. A trustee is necessary in all those cases.
The law of trust crosses many areas. For instance, parents can open a bank account on behalf of their child. If the child is a minor, the parents will have to control the account until that child comes of age. They will set rules for when and how to withdraw the money. Attorneys are in a similar situation. They receive and hold money on behalf of their clients.
The trustee is legally obliged to protect the interest of the beneficiary. Otherwise, any misappropriation can lead to prosecution.
Is Trust Accounting Required by Law?
Many states require trust accounting and recognize it as a legally binding contract. That said, the laws differ from one state to another. For example, some allow property managers to open only one trust account. Others allow two; one for security deposit and the other for operating expenses.
In every instance, the managers must independently justify their spending to the property owner. In addition, they’re under obligation to provide annual reports to the beneficially. Plus, they must present accounting reports upon contract termination and when changing to a different manager.
What are the Benefits of Using Trust Accounting as a Homeowner
After making a considerable investment, the last thing you want is someone mishandling your funds. You want to ensure your investment is in good hands. That’s why you should use trust accounting. Here are some benefits you can expect.
- It secures your funds. Property managers open a separate trust account which banks understand to be different from the manager’s or company’s account. Money from renters goes directly to that account. Also, the trust account has insurance from the Federal Deposit Insurance Corporation (FDIC).
- It enhances transparency. Trust accounts show you all funds coming in and going out and provide clarity on all transactions.
- Peace of mind. Trust accounts give you mental freedom from many points of view. First, you can be sure there’s no misappropriation of funds. Second, they allow you to comply with the law. In case of a legal pursuit, such as a tax investigation, the accounts provide reliable evidence of your income.
- It facilitates auditing. Auditors rely on well-prepared accounts. In case of any discrepancy, the records can facilitate an audit to resolve the issue.
- Less workload. Having a professional maintain your trust accounts makes your work easier. You don’t have to conduct lengthy reconciliations, trying to understand how the manager obtained some figures.
What are the Risks of Choosing a Manager Who Doesn’t Use Trust Accounting
A manager who doesn’t use trust accounting commingles all funds into one account. Whether the money comes as rent, deposit, or commission, it ends up in the manager’s account.
- Legality. It’s illegal to not have trust accounting in some locations. If your property is in a region that requires trust accounting by law, you could fail an audit due to not complying with the law. And for the same reason, the property manager may get their license canceled (or worse).
- Funds accessibility. Another problem with commingling is that the account may become inaccessible if the property manager goes bankrupt or has an unfavorable court ruling. But with a separate trust account, it’s understood that those funds don’t belong to the manager. So any action of freezing accounts won’t affect it.
- Security risks. Commingling funds can deny you the security of having a separate trust account. If the bank suffers economic hardships, FDIC compensates every account under each tax ID up to $250,000. It doesn’t matter the number of accounts under one tax ID; the maximum compensation remains fixed. That means you’d have to share that compensation with the property manager and the other clients. But a fully compliant trust account states each beneficially as a separate person, and the FDIC covers each of them up to $250,000.
Secure Your Investment Through Trust Accounting
In summary, trust accounting is where property managers open separate accounts, one for their business and the other for the property owners. Rent and deposits from tenants go to the trust account, and the brokerage fees go to the business account. Doing this protects your funds from misappropriation and ensures compliance with the law.
Investing in real estate is a huge undertaking. The best way to protect it is through proper accounting. If you’re considering using trust accounting, connect with your local Gather Property Manager to learn more about our services.