Trust Accounting, Nightmare Stories & More with Alicia McClurg

You need to treat each property or portfolio, depending on the system you're using, almost like its own separate business unit. It has its own income, it has its own expenses, it has its own profit or distributions, and it has to stay within its own contained unit, even though the funds may be put together in a larger trust account. The way that you track it has to be kept completely separate. You know, just because there's money in the trust account doesn't mean that that money is available for any given property or for you. It's not. It's specifically in trust for a specific person, and the state's going to hold you responsible for that.

Hey everybody, welcome back to Peter Lohmann's podcast. Today we have a very special guest. Alicia McClurg from Profit Coach. Alicia, I am very excited to get in a conversation with you today. Trust accounting is actually sort of a hobby horse that I get on from time to time because it's so important for property management. And you're an expert on trust accounting. So we're going to have a fun conversation today. If you're listening to this and you're already bored, you know what? Stick around. I don't want to hear it from you. Trust accounting is really important for property managers, especially if you're doing third party. I'm going to keep this conversation interesting. That's my promise to you. So don't hit stop just because we're talking about accounting today. All right, Alicia, give us a little backstory on who you are, what you're up to today, and sort of how that came, came to be.

Absolutely. Well, thank you for having me on first. This is fun to have the conversation. So a little bit about myself. I have worked with Profit Coach from the beginning of Profit Coach, so I was one of the co-authors of the Financial Controls Guide published as part of the original NARPM accounting standards. I've worked in our trust accounting department, uh, primarily with AppFolio clients and have been the lead diagnostic trust accountant supporting multiple PMs with different business models throughout the country. Often if there's an issue that requires specific forensic detangling, I'm the one digging into it. So. That's an— it's been an interesting way to hone some detective skills as you're going through some of these pieces.

Trust accounting problems can get very hairy. I've seen a few in my day, so that's a perfect jumping off point. I wanted to start by asking you what makes trust accounting different from normal small business accounting? And I see property managers get tangled up here all the time. They start a property management company. And they pull in like a bookkeeper they've worked with before or just a normal, like, small business accounting service to handle their trust accounting. And it gets, it gets messed up very quickly. So what is it about trust accounting that makes it so different?

Yeah, no, that's an excellent question. Part of it is part of what creates the problem is most PMs aren't accountants to start with. And then when they jump in, they're thinking, like you said, the normal small business accounting. PMs are actually signing up for two completely different systems of accounting that they have to maintain separately, but in parallel. One is your normal kind. In this context, we often call that your corporate accounting. This is your business's income, your business's expenses, your payroll, your profitability. Most of your NARPM benchmarks are on your corporate accounting side. What's your profitability? What's your DLR, et cetera? But you have an entirely different system because when you've signed up to manage someone's property, you've always also signed up to manage their money, especially the money that's flowing through those properties. So your owner's rental income, their property expenses, the monthly distributions, this is what we call property accounting, security deposits, the trust accounting. It's called trust accounting because you're managing it in trust for someone else. That money isn't yours. That money belongs to your owner. In the case of security deposits, it belongs to your tenant, and you're making sure that it's being handled correctly on behalf of those individual people. Most of you know that you do need a completely separate bank account for this type of funds. You need one for your corporate account. You need another one for your owner's funds. They're not supposed to be in the same account, but even just having it in a separate account isn't enough. You need to make sure that you know within in that account, how much of that money belongs to this owner and how much to that owner, it needs to be— you, you need to treat each property or portfolio depending on the system you're using, almost like its own separate business unit. It has its own income, it has its own expenses, it has its own profit or distributions, and it has to stay within its own contained unit, even though the funds may be put together in a larger trust account, the way that you track it has to be kept completely separate per statute. You know, just because there's money in the trust account doesn't mean that that money is available for any given property or for you. It's not. It's specifically in trust for a specific person, and the state's going to hold you responsible for that.

Yeah, exactly. And I want to highlight a couple of things you just said there, which I think are really important. One is It's not your money, right? And that's, I think when you first start a property management business, at least for me, this wasn't, this didn't hit home the way it does for me now, which is when you like, say you started like a plumbing company, right? All the money that's coming in from customers and it's in your account and you're paying payroll and rent and everything else, that's all your money. It belongs to your business. In the case of a property management company, you're collecting rent and you're charging a management fee and you're distributing to owners. It kind of feels like the same thing. It feels like you've got revenue there and you've got your profit as your management fee and then sort of your expenses as your owner distributions. That's not correct. That is not your money. It never was your money. And so in the case of a normal small business, the only person who really cares about what's going on with your accounting and your bank and everything is maybe the IRS to make sure that they get their fair share. In a property management company, it's completely different because the money doesn't belong to you. States have come along and said, hey, property management companies, you are dealing with money that doesn't belong to you. And because of that, we take a special interest in what you're up to and how you account for it and how and how often it gets reported on and distributed. So that's the difference. And states can and do shut down property management companies who don't handle this correctly. So that's, that's like really fundamental to what we're up to as property managers. The other thing you pointed out, which I love to reinforce, is every single property that you manage has its essentially its own accounting. The way to think of this is like it's, it's like a micro-business. And there's a great quote, I forget who said it. Every piece of real estate is a micro-business that someone lives in. And like, that is actually the right way to think about it. And the accountant for that micro-business is you as the property manager. So there's a lot going on there and it's really easy to get tangled up. So given what we just said, you work with a lot of different property managers, you've seen a lot of different trust accounts, you've worked with all different sizes. Do you recommend that property managers hire someone full-time in-house to do the bookkeeping, or is this something that a sufficiently motivated business owner could figure out and do on their own? Or do you recommend working with— I mean, I know you work for a service that offers the— a company that offers the service, but if you set aside your sort of employee hat for a moment and think about what you would recommend to property managers, how do you think through that?

Yeah, absolutely. I think as the business owner, it's important to understand what's going on, but you shouldn't be the one doing it. Your time needs to be spent doing other things. In the business, on the business, getting into the weeds of trust accounting is some of the most granular work that you'll be doing. So you need to have an understanding of the concepts and of the principles, but you shouldn't do it yourself as the owner. So I would either hire someone in-house or hire a third party. And there are pros and cons to both. If you've got someone in-house, they often will know your business from the inside. It's easier to understand how all the pieces connect. But it can be easier to introduce things like conflicts of interest, having a sense of, a sense of motivation to commit certain types of fraud if you're dealing with someone in-house, which can be a little bit harder to overcome. And depending on the person you hire, if they're coming in completely blank slate, it can take a little bit to get up to speed on what is trust accounting, how does the system work, what does PropertyWare mean, what does that folio mean by the different pieces, and trying to figure that out. If you hire a third party, you're generally hiring someone who already has experience with trust accounting, already has experience with the system you're in, and there is a much better chance for an effective separation of duties to be able to say, okay, we were able to keep the bill processing over here versus the payment and reviews over here and allow for more fraud prevention pieces that way. There are some cons though, which includes you do need to know who you're hiring as a third party. It's kind of the same either direction, but especially third party, you can have folks that make it sound like they have experience, but then once you get rolling with them, they actually don't know what they're doing, and they will create havoc in the system and put in all sorts of odd transactions rather than come back and admit they don't know what they're doing, or maybe they need to ask questions. So you need to make sure you're dealing with someone who's reputable. Make sure that you, you know who you're working with. And it does require a little bit more intentional coordination and communication with the third party since they're not inside your business. There are going to be certain things that that you take for granted that they're not aware of that need to actually be communicated. So, there needs to be some setup there. But a good third party will take a proactive interest in learning what makes your company, your systems unique, and create some structure around that to be able to make things work.

[Speaker:MICHAEL KRIGSMAN] Love that. And I've tried this all different ways. I did it myself for many years. I kind of limped along with, I— some resources I found really early on, and I'm sort of a— I like learning and I have an engineering background, so I'm comfortable with detail-oriented work and sort of rules and structure. So I was able to get along for a while, but I probably delayed hiring or outsourcing this function longer than I should have. We ended up working with one group for a couple of years. It started out great, but then they swapped out the folks that were actually handling our trust account. And the quality went downhill very quickly. Then I tried bringing it in-house. I made the mistake of hiring someone who had a lot of accounting experience but not a lot of trust accounting experience. That created a lot of problems very quickly. And then there's a lot of confusion when your assumptions are completely traditional accounting.

Yeah.

And then we ended up finding a different group who's been doing a great job for us. So you Don't be afraid to jump around. I know it's painful to switch if you've, if you've experienced that. But if you get a sense that there's issues or problems, you have to jump ship and keep looking until you find— and you'll know when you found a group who's doing a great job. It will be very clear.

It's less painful to switch and find someone good than it is to stay with the person you know is doing wrong.

Right. All right. So one of the important concepts in trust accounting is a triple tie-out. And this is a sort of a special thing that happens specific with trust accounting. Could you explain this? Because I've tried to explain it before and I always forget half of what's actually going on with it.

Sure. So in a typical bank reconciliation, let's say with your corporate accounting, it's what I would consider a two-tie— we'll call it a two-tie reconciliation. You want to make sure that your system, whether that's QuickBooks or whatever you're using for your corporate accounting matches the bank. So you don't have anything, any transaction in the bank that wasn't recorded in your system, and you don't have anything that was recorded in your system that's not accounted for in the bank that at some point is going to clear. So it's a two-way reconciliation, your system to the bank. In trust reconciliation, it's similar. Again, you need the system to match the bank, But you also need to verify— this is the third part of the triple tie— that the balance of your trust account matches a ledger of all of your owners' cash balances that you have on hand for them. Owners plus tenants, if you have security deposits in the same account. So you want to make sure the bank statement matches your bank reconciliation report out of your system. But you also need to produce an itemized ledger of here are all the properties or owners that we're managing for, here are the balances we're carrying for them. That should add up to your bank balance. That's your triple tie.

Yeah. And it, it sounds when you say it like that, you're like, oh yeah, well, of course that would be true every month. How could it not be? But there's a lot of ways that this can get really messed up. So, and just to make this really clear, so The 3 numbers that need to match is one, your bank account balance at the end of the month. So like if I log into chase.com, I go to my trust account, I go to June, how many days are in June? 30. June 30th, you know, closing, closing a balance for that month. It's say it's $100,000. Then I log into my property management accounting software, whether that's Buildium or AppFolio. I pull up my account balance in there. It should also say, you know, exactly $100,000.00. And then this crucial third tie-in is there's reports you can run where I think they call it like rental owner ending balance or property balance. You run that report as of that day and that must also total up to $100,000.00. Again, you're thinking, how could, how could that not be true? There's a lot of ways. And maybe if you could share like a couple of the most common ways that that gets out of sync, like how does that happen?

Sure. Well, one way that gets out of sync that's actually normal is if you have checks issued out of the account that haven't yet cleared. You could actually have a bank balance if you log into Chase and you see it says $100,000, your system balance may actually show lower than that because it's already accounting for the checks that you've cut that haven't actually cleared. So you may not see an exact match to your bank balance there, but the system should help you say, okay, given that bank balance and accounting for the transactions that we know are outstanding, here's the number we're going to tie to. And so it'll adjust the bank balance a little bit and say, this is the number we're aiming for. And then that's the one you'll tie the property ledgers back to. One of the ways that that can go off is if something has been changed in the system. If you've had a transaction, often what can happen is you'll have a transaction that was booked in the system in a previous month that for some reason someone went back in and edited. Sometimes it's a check that didn't clear and they can't— they cancel the check and they reissue it. That can make a little things a little bit bumpy. Sometimes there are things that you're like, why are they messing with the accounting that's supposed to be you know, settled, but for one reason or another, they've made a change. And then that comes back and your system says, oh, now we're expecting this instead of here. Often it's because the adjustment was made incompletely. It was half done. There was another half that needed to happen. It didn't quite happen. And so things, things start looking off. But There's a number of, a number of ways. If you're— one other thing that can happen that actually doesn't look like a problem at first, because your balance can still tie out, is if you pull that property ledger and you have one of your properties at a negative balance, your ledger might still tie out. But what that means is you've actually taken money from a different property and you've used it for this property's benefit. So the state's going to look at that as if you stole the money from the funds you had in trust. That's going to be a problem. So your triple tie isn't necessarily going to catch that, but that's something that you need to look at as you're looking at that ledger. Is anything showing it negative? We need to make sure that that gets corrected fast.

Yeah, that the issue of a specific property owner having an overall negative balance, I think that's one of the very first things that an auditor is going to look for when they're taking a look at your trust account. It's a very common thing and it's easy for that to happen in the course of property management. So for example, let's say you have 100 properties under management and some duplex that you manage, the AC goes out in the middle of August and the tenants are screaming. They have young babies, the, you know, they have health concerns, asthma. You've heard it all. So you being a good property manager, you take a look at your PMA, you see that you're authorized to you know, approve emergency repairs in such and such situations, temperature above 95 degrees, heat index, blah, blah, blah. So you go ahead and approve the AC repair. The guy goes out there, he says, this is a 20-year-old unit, you need to replace it. You say, go ahead, I have approval to do that. So then he sends the bill the next day because they're anxious to get paid. You cut the check and you're thinking, oh wow, I handled this so well. I got the tenant happy. I got the You know, maintaining the asset for my property owner per the management agreement. Well, what you forgot to do there is ask for an owner contribution from the property owner such that there was enough funds on hand to cover the cost of that AC repair. Just because the check you wrote to that AC or that the HVAC vendor, just because the check cleared doesn't mean you're good. Of course, the check cleared because there's 100 other property owners funds in there, but that specific property owner is now negative $3,000. And if you were to print that out on a spreadsheet, just like you were saying, that money actually was made up by other property owners' balances. And so if you were to like take a snapshot of that, freeze it in time, you could be accused of basically stealing funds from your other owners. So there's a few ways you can handle that. You can either never like pay a vendor until you have the funds on hand for that specific property owner. You could refuse to even issue the work order until you have the funds on hand. Something that other people do is they will pay the vendor out of the corporate account, like you as the property manager pay that vendor and then pay yourself back from the property owner once there's enough funds in there. Or maybe you charge some interest. Like there's a lot of different ways you can handle this and still be in compliance. But what you really don't want to do is just write checks and worry about it later. Like, that's a, that's a bad idea. And I won't say I've never done that, by the way. And if you're an Ohio auditor and listening to this, everything I'm about to say is purely for illustration purposes only. But the reality is when you're running a property management business and you're like, all right, it's like $200 negative, the rent's coming in 3 days, like this tenant's been there for 3 years, they've never been late, this isn't going to be a problem. Like, I get that. As a property management business owner, I hear you. My job is to inform you that you were technically out of compliance for those 3 days. And if you were to get audited, you could get in big trouble. Now, do with that information what you will, but I want everyone who's listening to be informed. Mm-hmm.

That's something to make sure you're aware of so that you're making an informed decision when you're faced with that kind of a catch-22 situation. So obviously you don't really want to front the money from corporate if you can help it, because that's a drain on your business. But if you do write the check and you have other— you're essentially asking the other property owners to front the cost for you. The state's not going to be happy with that. And yeah, you just need to be aware.

Yeah, it's— this is a typical property management situation and this is very— this is one of the things that makes this business really hard is sometimes there's no good solution. So we just outlined a couple of bad ideas. But if you do nothing to stay in compliance, well, now the tenant is screaming and they're going to report you to the health department and they're going to report you to the Board of Real Estate and blah, blah, blah for an unsafe, you know, unsafe dwelling for, you know, not keeping up with repairs. And then, you know, what are you supposed to do if the owner's on vacation, they're out of the country, you can't get a hold of them, you're sort of stuck between a rock and a hard place. So it's a big challenge. What are some of the worst problems you've uncovered? I want to hear some of the horror stories of trust accounting, the stuff of nightmares. Let's, let's, let's give our property managers a little heartburn. Those who are listening, what can go wrong here?

There's a good amount that can go wrong. I think one story that comes to mind is someone that I didn't actually work with, but I looked, I did a deep dive into their books as I was looking at potentially working with them. And this particular client had used a different third-party service for about 15 months to do the reconciliation. But prior to that, they had tried to handle it themselves and had more or less ignored it for a couple of years and then had hired this other service to come in. And that service came in and was trying to do patchwork where they're like, here's the transactions that match in the bank and in the system. We still have a gap of like $50,000. They would plug in a $50,000 transaction just so that the bank rec page would look good on the system. That's $50,000 of either prop owner or tenant funds that are being completely unaccounted for. Where did that go? We don't know. But this service would do that month after month. So by the time we're looking at it, we've got at least 15 months of wrongly reconciled accounts, that's building on a foundation of several years of not having actually paid attention. We were seeing potential evidence of trust funds being transferred over to the corporate account without any particular reason. And maybe there was a reason that I didn't get to, and we were digging into it. But we ended up coming back and— saying if we're going to work together, we're going to have to do some massive cleanup. And the cleanup was going to be more than the owner wanted to pay for right at the moment. But I was, I was getting pretty concerned as I was looking at that. What happens if the state comes in and starts looking at this? There's no way to be able to demonstrate that you've been properly managing these funds. I'm not sure where a lot of those were going., but as the accountant, I'm looking at these, you know, 5 and 6-figure plug entries. I'm like, I can't believe that we're doing this. Like, this is not good.

Have you seen just blatant fraud, like where property managers will take money from the trust account to pay salaries, or maybe like a specific employee, like got ahold of the trust account checkbook and set up a fake vendor, like anything like that?

Yeah, we've, we've had clients who had disgruntled employees who had full access to the system. So they had the ability to enter a vendor, enter a bill, approve the bill, push it through for payment. And then I think it was just the last step where we as a third-party service were reviewing the payments and just happened to notice, wait, that's the employee's name. Why is this going out?. And so in this case, they kind of defeated their own purpose by using their own name. But you could put— someone could put a fake name in there. But if you don't have the right separation of duties on that, you could have someone that has full access to the system plug in. We've had— we've seen that go almost all the way through, and then we flagged that and sent it back. We've had clients who, before we came there, have lost like high six figures through things that could have been prevented if someone with context was reviewing what payment is going out to who for how much, and they would have had the knowledge to say, hey, that doesn't— that's not in the normal course what's going on here.

That's a really crucial sentence you just said. Someone with context reviewing what's going out and to who. And that gets so crucial. It's easy to kind of— there's two ways you can kind of mess this up, in my opinion. One is The person with context is the same person who's entering it in the first place. And that's kind of what you're describing here, where the same person who gets the bill is the same person who enters the bill, is the same person who pays the bill, same person who approves it, potentially even the same person who's reconciling it at the end of the month, which makes for a very efficient workflow, but it opens you up to a ton of vulnerability. Yeah, that's a classic, like, small business accounting fraud like attack vector is not having that separation of duties like you mentioned. The other way I see this get messed up is you kind of swing too far the other way where you say, all right, the person like the property managers are going to be the ones receiving and entering the bill, but we're going to have someone completely unrelated to them reviewing and paying. Well, if the person who's reviewing and paying is just your RTM in Indonesia, who knows nothing about who your vendors are, who your property owners are, what's a normal amount to pay for an AC repair, anything like that. And they're just greenlighting everything. That's— you might as well just have nothing in place there because they don't have any of the context to understand, oh, what's this weird new vendor? I never heard about it. I don't see their paperwork in our system. Or what's this like duplicated vendor that's off by one letter that like— there's a lot of ways that this can get really messed up. So it's This is kind of heavy, right, for a property manager who's listening and you're sort of mentally checking off now all the things that you're worried about in terms of compliance. I feel you, like, this is hard stuff. And that's part of the reason I want to bring this conversation and have this conversation today is because I want folks to at least know what's going on and know what is possible to, to get wrong here.

Yeah, it's, it's definitely important to be aware of the types of things that can go wrong and then to realize that there are ways of accounting for that, of mitigating those vulnerabilities. Do make sure that different, no one person has access to the full flow of being able to enter and pay a bill, but like Peter was just saying, make sure that it's someone with context who's reviewing, who knows what they're looking for. So it's not simply, yeah, we broke it up and they're different people, but this person number 2 is just rubber stamping everything that came through. That's not going to do it. But it doesn't take a whole lot for— let's say even you as the business owner, may not be something that you want to spend some time on, but it shouldn't take too much time in a given week to just do a quick review of, do I recognize this name? Does that amount look reasonable? And if we're all good, you don't necessarily have to dig into the details. And we're good. But if something comes across, it's like, who is that? Why is it $100,000? That should be, you know, $350,000. Just making sure that things are there. It doesn't take— it shouldn't take a ton of work to make sure some of these things are preventable. Often it's just taking a little bit of thought and making sure that you put, you put those safeguards in place, you put a couple reviews in place that you yourself are taking care of, or someone that you trust is taking care of, and you should be, you know, that, that right there will take care of a lot.

I want to talk about property management software for a second. So there's a bunch of different property management accounting softwares that folks are using: Buildium, Appfolio, Propertyware, Rentvine. I know you've probably taken a look at a bunch of these. I'd love to hear some of the pros and cons of, of the different softwares, specifically from a trust accounting perspective. Like, what are some of the strongest areas that you see where these specific softwares are really doing well? And what are some areas that specific softwares are kind of weak in or you'd like to see improvements?

Yeah, it's a good question. And I'll just say upfront, I've only had direct experience running trust accounting within AppFolio. So I can't speak as much to some of the others. I've been in and out of PropertyWare, in and out of Rentvine. Um, I do recommend AppFolia from what I've worked with it from a functional perspective. Um, when I switch over into PropertyWare, the interface feels unfriendly and there are certain pieces that are good to keep an eye on that AppFolia will bring up that I don't see a way in PropertyWare to get quick visibility on. But that could just be my unfamiliarity with the software. AppFolio has its quirks, but there are ways of making sure that you have visibility on everything once you know what you're looking at.

One of the things that really strikes me here is that despite these software packages being really built on a heart of accounting, they are accounting software at their core. That's sort of what they're originally designed to do. It still feels like it should be a lot easier to manage my trust accounting, whether it's Buildium or Appfolio or Rentvine or any of them. Um, for example, the, what we were just talking about, the triple tie, like there is no report I can run in Buildium. I'll speak to Buildium because I'm familiar with them. There's no report I can run in Buildium to get a triple tie report for the previous month. Um, and that's just, that's a, that's a basic critical part of trust accounting. And there's a bunch of other scenarios where it's like, Here's another common one that comes up. A tenant moves from one unit I manage to another and they want to transfer their security deposit, or a roommate moves out. Like, there's all these, like, really common things that come up when you're dealing with security deposits and you're dealing with rental units, common, common accounting scenarios that require many, many, many steps that are error-prone. Another one is like a property owner wants to move, move balances between properties that they own. That's another one that's like, that's a multiple times per month request. And it's just not— there's no like wizard to walk me through how to do that. I have to like go to some arcane help article and record a $0 check and like it's all these weird things that you have to do. So this is kind of my plea to our industry. Like, let's get— let's refocus on some of these core common scenarios that we're dealing with as third-party property managers. And let's try and make that a little bit easier for, for us and for you who are, who are in the books every day.

Yeah, that would be great. AppFolio does have a lot of, a lot of pieces like the transfer funds between properties. That's simple in AppFolio, but even AppFolio doesn't have a like a triple tie report. Their bank rec view looks like it might give you a triple, but it actually doesn't give you that property ledger readout. So we've developed our trust account audit package report where we're pulling multiple reports out of that folio, cross-checking things in and around, and we can get there and it's good, but it's not a one-stop shop. You kind of have to know where you're going and know what the pieces are to pull together.

So yeah, it's so, it's so frustrating. There's all these little things that as you've been managing property for years, there's little mistakes that can happen that if you don't know where to look in what report to check, you would never find it. I'll give you a couple examples. One of them is, well, one of them is properties with negative balances. Of course, we kind of talked about that already. And I have what I call my iron law of trust accounting, which is Your client must never owe you money. You must always owe your client money. Like, that's another way of saying don't let that account go negative. That's like my iron law of trust accounting. So another one is you'll end up— if you do this long enough and you have enough units, this is going to happen to you. You'll end up with a lease that's ended. The lease is over, but there's a, there's a balance there. And I don't mean the tenant owes money. I mean, there's a positive balance. On the lease ledger. And that happens because somehow you either forgot to issue the security deposit or some sort of credit was applied after the fact, or you did issue the security deposit, but they never cashed it. So if you haven't done this, you need to go in and run a report and look at all of your ended leases and look at those account balances. Another one that can happen is a property that you've already de-managed potentially years ago. Somehow we'll have a positive or a negative balance and it won't be zeroed out. That's another one that's really easy to do. And there's like, there's a few more of these where you almost need to like once a quarter, like run a little mini audit to catch some of these things that won't show up on a triple tie. They won't show up on some of the normal rent roll reports that we're looking at frequently.

Mm-hmm. I think another one that comes to mind too is it's Depending on the way your system is set up, it can be fairly easy to accidentally have your security deposit funds held in the wrong account. If you have a separate account, especially, but it's, it's easy to accidentally get the security deposit funds mixed up with the rental income, and then those can accidentally get paid out. And then when it's time to pay the security deposit out, you, you don't have the funds. There are ways to check that. But again, that's something that it's easy to assume. We got the check-in for the amount of security deposit, we're good. And we're not actually making sure that the system is keeping it separate, that it's in the right place in the bank. And then we actually have that when we need it.

I want to ask you about where we can learn more about trust accounting, but first I have to tell a story about security deposits and what you're describing, what you just talked about. So We bought a book of business from another property management company years ago. It was like 130 units, so pretty significant size. And the owner of that management company was a great guy. We were very friendly. It was an easy transaction, no problems at all with the actual closing and transfer of everything. We got, you know, all the information for the property owners and the residents and all that good stuff. So we started getting everything set up in our system.. And at the time when we, when we closed, I noticed that there were not security deposit funds in the trust account. And so I went to the business owner. I said, hey, what's up with the security deposit? So those in a separate account or something, like, will we get a separate check for that? And he goes, oh no, those are the owners have those. We, we went ahead and anytime we got the security deposit, we would issue it to the owner just so they would have it because I think he probably said something like, usually we withhold it anyway because of damage. So it's just easier to just send it along. And I was like, oh, okay, I guess that makes sense. That's not how we do it, but okay. So we finish onboarding and we start operating this portfolio of properties. And then we have our first few move-outs. So tenants move out, we do our move-out inspection, walk through, and it just so happened that these first few properties were in really good condition. And so we, We wanted to issue, we, we have a policy where we try to issue the security deposit in full if it looks like the tenant has made like an A effort, like, you know, they've cleaned and there's no junk left behind and they've, there's no obvious damage. We try not to ding them for little stuff. Like we want to just keep a good relationship. So we ring up the owners and we say, hey, good news. The tenant's moved out. We're working on getting the unit turned over and finding you a new tenant. But the tenant actually left the property in pretty good shape. We would like the security deposit so that we can issue it to the tenant. And the owner said, what are you talking about? And we said, you know, the security deposit that we issued, that the previous property manager issued to you during the last, you know, when this tenant moved in, kind of was probably during the turn. And they said, no, that, what are you talking about? We never got that. And so we really, we started digging into this.. And we've— what we found is that the owners did receive the security deposit, but they didn't know it because basically they just applied it as a balance to the property account when the property account was kind of already in the negative from all the turn costs and everything coming in. So the owners did get the security deposit as like basically a credit to their account, but it was never made clear to them. It was never explained. It was never like separately transferred. And so for the next 2 years, every time we had a move out, we would have to have this hard conversation with these property owners of like, yes, you need to send us a security deposit. Yes, you did receive it. We'll send it. We would send like screenshots of like the transaction from the previous property manager. We would like have to dig through their accounting software, which was different from our accounting software. It was a big mess. So yeah, don't do that. Hold the security deposits. Do not send them to the owners. It can cause a lot of problems.

And if you do send them to the owners, make sure it's clearly documented and clearly communicated. And yeah.

Wow. That, that sounds like a nightmare. To make it worse, when we realized what was happening, I want— I drafted an email to send to all the owners to let them know about this so that they could be ready when they had to move out. And the email said something like, Dear Mr. So-and-so, and it was like a mail merge thing. Um, just so you know, we, we don't have your deposit. Um, you actually have your deposit. We sent it to you shortly after you moved in, and so when you move out, we're going to be asking you for that deposit. So we, you know, put this on our letterhead and we did the mail merge thing in our accounting software. Boom, sent it out to all the owners. And I was expecting a little bit of pushback, uh, but, um, I wanted to start the conversation early. But what happened was I accidentally sent it not to the owners, but to the tenants. And so every single tenant at these properties got an email saying, we don't have your security deposit. You have it. You need to send it to us. Oh, that was one of the worst days in business. Of course, they immediately started calling and emailing back. What the hell are you talking about? You know? Oh, it was such a nightmare. And so You know, careful with mail merge, make sure you're selecting owners, not tenants, and vice versa when you're, you know, depending on what you're, who you're trying to communicate with. So yeah, that was a, that was a bad day.

The impact of a single button click.

For folks who are like, all right, you've got my attention. I need to know what's going on here. Even if I don't necessarily want to do it myself, I need to learn more about this topic. Where could they go? What resources are available? Books, courses? Websites, PDFs, like how could a property manager learn more about trust accounting?

That is a really good question. A lot of states have certain like guides that they try to put out to give you an idea to how to follow the regulations, but they're not going to be super helpful. A lot of it comes down to the specific software that you have and making sure that you know how to use that software, but then understanding the logic behind it. When I was learning, it was a matter of just jumping in, following processes, making things happen, making mistakes, fixing the mistakes, and then starting to pick up the logic of the software and then the logic behind the software. It's like, software is doing this and it's not letting me do that. Why would it be that way? And starting to put the pieces together. So for me, it was a lot of learning by doing. You need an experienced person there to tell you what it is you're looking at. But in terms of specific resources, I would say start with your own software, your software's help resources. If you're in AppFolio, they've got a lot of help center documentation and taking the time to walk through that, play around in their practice site, and start actually thinking through where is the money going when you do this. Have you done it in both the system and in the bank? You know, with thinking through it, that's probably the best way I would, I would say. I'm sure the other softwares have other ways of working through things as well. But I would say start by, start by getting super familiar with your particular software and be thinking not just what is the software doing, but why was it set up that way? There was a reason someone thought that was necessary to code it that way. And often that ties back to a trust accounting principle or regular, you know, regulatory piece that you're looking at. That's more or less, more or less the way that I ran.

Yeah, it's really— I feel like there's an opportunity here for a course, a textbook, an e-book, something along those lines, because this truly is something that property managers need to have a handle on the basics of. And I remember like 12 years ago when I was just getting started in the business, I came across a PDF. I think it was put out by Buildium about like basics of accounting for property managers or something like that. I think I remember that digging up for it a couple of years ago and it's still out there. Maybe we can find a link to that. But yeah, this is a tough thing because you're right, that's kind of how I learned is just like you were describing, I would just try things. I'd be like, why wouldn't it let me do this? And then I would like, read the help articles and like look at this PDF and maybe ask around. So, um, man, I— if you're listening and you have any type of like an education background or you're looking for a piece of content for your, um, software or your vendor in our industry, I think this is a big opportunity. If you know of anything, please reach out, let me know, and I'll probably link to it in my newsletter or something. Because this is something that— I mean, it's truly like the, the foundation of our business is trust accounting and there's just not a lot out there.

It's kind of sad. Yeah, totally would agree with that. The few courses I'd run across were very, very skeleton in nature and were almost unhelpful in the degree that they did not get into the, the detail of things. There's just, yeah, there's, there's a huge, a huge opportunity there. And I would say Yeah, we need the basics, but we also need what I like to call— we need the 101 level, trust accounting 101. We also need 102, 103. It's easy to find resources that are very, very basic. What do the terms mean? And then it's easy to find resources that are at the super expert level. It's like if you already know everything about AppFolio, here's, you know, a couple things that you can do, you know, with this and that, but finding things in the intermediate levels where it's like, let's lay the foundation, but let's actually build on that and get you up to speed.

Those are rare. Mm-hmm. Yeah, that's a great point. Let's talk about 1099s for a minute. So part of what we deal with as property managers at year end is 1099s. It's kind of a pain. So what, what is a 1099? Why am I having to deal with this as a property manager? Has anything changed with 1099s recently that I need to know about? Like, let's, let's like park on this for a few minutes.

Well, I'll start with a disclaimer that I'm not a tax attorney and there are a lot of complications around this. So if you need specific advice, please consult your tax attorney. That being said, the 1099s as a PM that you're probably going to end up running into are two different types. Potentially 3 depending on your space. The one is the 1099-NEC, which stands for non-employee compensation. That goes to contractors, vendors. You're probably issuing those from your corporate accounting space as well as your trust accounting space. Vendors that you've worked with that are unincorporated that you've paid more than $600 to in the year. That's an oversimplification, but it's pretty close. The other, another type of 1099 you're going to need is the 1099 Miscellaneous. This goes to your owners. Your owners each need a 1099 for the rental income received that year. And one of the common hiccups that I've seen is how do you deal with prepaid rent? A lot of times your owner's going to get the 1099 and they expect that to be, this is the income that I received for this calendar year. What the IRS actually requires is that you, you report prepaid rent on your 1099 in the year it was received, not the year it applies to. So if your tenant has prepaid rent in the last, last week of December 2024, but it's supposed to apply to January 2025, you actually need to include those funds on your 2024 1099 that you send to that owner because the funds were received in 2024. That's something that gets confusing, um, for a lot of property managers, for a lot of owners, but it is something that can be communicated upfront and should help to reduce the questions you receive. Quite a few folks will also send out an annual statement along with that 1099 to explain here's You know, here's where we're getting that number from. Here's why it's accurate. Do, do note that your 1099s being accurate depends on having your trust accounting fully up to date. You need to make sure everything is up to date, reconciled through the end of the year. Otherwise you could have deposits of prepaid rent that weren't accurately recorded or applied at the time. You can have all sorts of pieces that haven't rolled the right way if you haven't updated the trust accounting by the end of the year before you issue the 1099s. The other type you could run into, and I don't have direct experience with this, but some of our clients are in markets where you are required to collect and disburse interest on various pieces. You might end up being responsible for a 1099-INT in that case to report interest paid. But I'm not aware specifically of new regulations on 1099s. I'm sure, you know, the IRS changes things every year. I would check with your tax attorney on that. But I would say, you know, you've got these different types in mind. You want to make sure you're able to file on time. It does become pretty critical to receive the W-9 form from each new owner or vendor that you're working with so that you have that tax information upfront. When it hits January, you're not following up with 75 people trying to get them to send you the information before the deadline. So a little bit of pre-thought on the process there will save you a ton of grief when it hits January.

Yes, this was something I definitely messed up early on as I wasn't collecting W-9s from vendors or property owners. In the first few years of doing business. And then when I— just like you said, when it came time to run 1099s, I was contacting all these owners and vendors. So lesson learned, and this is a great best practice, is we actually attach the W-9 to the back of our PMA. And so when they sign the PMA, they also have to fill out the, the W-9. That way we have all of that data. It goes right into our system. Same thing with contractors. We won't start working with a new contractor or vendor unless we have a completed and signed W-9 on file for them. That's a pretty easy thing to insert into the process that saves you a lot of headache down the road. Great idea there. Yeah. I want to highlight something that you just mentioned, which is like, don't issue your 1099 if your trust accounting is not right. That, that brought up something that I wanted to highlight, which is you should think about your accounting cadence. And I think about this on a monthly and also an annual basis. So for us, we have an accounting cadence that goes like the reconciliation and triple tie needs to be done within like the first 8 days of the month. And then we do our owner reporting and distributions on the 10th. Excuse me, on the 10th. And that's really important because you need to make sure that all of the accounting stuff is cleaned up and done and cleared out. For that month before you issue funds to your owner. Otherwise now you're like correcting things after the fact and their statement won't match the balance and, and stuff like that. And so also on the annual cadence, the, you have to issue your 1099s. I think it's by the end of January. And so again, the, the importance of getting all of your like year-end accounting work done before you issue 1099s, which you mentioned. Is, is an important thing. So I think one of the— I'm a big fan of like cadences. And once you have a cadence, you can sort of add things and move things and document it and put it on calendars and stuff like that. So this is a great way to help yourself get organized, help your business get organized so that you don't miss stuff that we've been talking about for the last 45 minutes.

So you don't miss stuff and so that you don't run into panic mode when you realize at the last minute You needed this, but now it— now you're on the line for it. If you're— if you've planned for that, you've set up your cadence to account for, I'm going to need this, so I'm going to collect it ahead of time so that by the time the crunch moment hits, I've got it. You save yourself a lot of stress as well as making sure you've got the right things in play to keep yourself in compliance.

All right, so I want to talk about Profit Coach for a little bit. So you, you've been with Profit Coach from the beginning. You, you were— you mentioned earlier your involvement in a lot of the great work that Profit Coach has done for the industry. So one of the things that I'm, I'm most excited about when I think about all the contributions of Profit Coach to advancing the state of our industry is the Chart of Accounts. So the NARPM accounting standard, you guys collaborated with NARPM on basically putting together a standard chart of accounts for the corporate side of our books. And that's something we implemented years ago. You guys helped us do that, and it's been a game changer for us in terms of getting visibility into important metrics in our business and helping us understand, you know, what money's coming in, where is it going, our unit economics, and a lot of our key metrics. Um, my question for you though is that is the corporate side, we have a great standard chart of accounts there. On the trust accounting side, there is no standard chart of accounts and every property manager has this set up differently. All the different property management accounting softwares have kind of their default chart of accounts that they start you with. A lot of times that's set up to sort of mesh with the IRS forms. I forget what the, what the form is that they're sort of trying to align with, but it really doesn't do a lot to help property owners and property managers get clear on the property level finances and especially on the expenses? Like, what do you see here? What do you recommend? Like, how should we be thinking about this?

It's a good question and it's an angle that, to be transparent, we haven't dug into very deeply. As you said, most softwares have their default COA and there are different IRS pieces that can play into setting things up. Like you said, that doesn't necessarily help with in terms of understanding the performance of your units and how things are rolling. The one thing that I would keep in mind, um, that can be a little bit confusing when you first look at it is with your trust chart of accounts, it's set up from your owner's perspective, not yours. So in your corporate accounting, if you're getting income, that's going to the income account. In the trust accounting, if you are getting income, it's an expense because it's an expense to your owner. So keeping that distinction in mind is helpful when you're thinking about how you're setting that up. But in terms of specific categories of, you know, similar to NARPAM in terms of like, here's the category of expense you need to track, we haven't done a lot of analysis that direction. I think if I took a gut-level approach to that, I would probably be thinking in terms of having, you know, the rental income and then other sources of income, keeping those separate. For the owner, I'd have the management fees as something of a cost of sales category, most likely. And then having larger categories in terms of utilities, large repairs, small repairs, potentially breaking some of those further down. Depending on what, what would be valuable to track. There's also the question of the fees that are owed to the management company but are paid from the tenant. In an AppFolio setup, those end up being a net zero on your property accounting because they come in from the tenant and they go right back out to the management company. But you still have to account for them on the chart of accounts somewhere, but they actually shouldn't be impacting your property accounting. They shouldn't be impacting your owner. So there's, there's some, some setup to think about that direction as well. I would probably categorize those still in the cost of sales section, but with an understanding that if the owner is seeing a balance in these certain sections, that's a problem. And we're needing to make sure that that gets zeroed out.

For what that's worth. And a lot of the, a lot of the property accounting softwares have the ability to suppress those accounts so that they're not showing up on reports and causing confusion for the property owners. So when you are working with a client on their trust account and doing either a cleanup or just an ongoing reconciliations and, and categorizing the transactions. You're not recommending changes to the chart of accounts, you just sort of whatever they, they have set up, you work with that as opposed to the corporate side where you're kind of pushing hard for a specific chart of accounts.

Right. At this point, that's, that's pretty much the way it's run. We'll, we'll take what they've got set up. We'll make sure that we understand what they're meaning by what's set up. If we see there are you know, there's unnecessary duplication, we may help to try to merge things. But in terms of a systematic understanding and approach, we don't have anything parallel to the NARPM Chart of Accounts for the corporate side.

Okay. And I know that on the multifamily side, I've seen— I feel like the multifamily side has some kind of a standard here because I've seen like occasionally when I'm helping a property owner underwrite like a potential purchase of an apartment complex, they'll send me like the income, uh, the income statement or the, the T12 for the, for the multifamily property. And the chart of accounts is massive. They've got like, seems like hundreds of these different accounts. Uh, it's very, very, very granular. And I feel like maybe there's some standard there on the multifamily side, but it wouldn't make sense to just import that into our world of mostly single-family residential because it's just too complex and it has all these categories for like, you know, fire servicing the elevators and the fire suppression system, like all these things that just don't make sense for us.

There's a lot of assumptions in multifamily that don't carry over to single.

But I wonder if there's something there that we could start with and pare it down. I don't know. It's, it's maybe a challenge for another year, but so sticking with Profit Coach for a minute, what are you guys up to over there? I've heard something about a operational standards effort that's underway.

I'd love to hear sort of what's the latest there. Yeah, absolutely. So yeah, we are definitely pretty excited about the, the operations standards idea there. So the thought is similar to the way that the NARPIM accounting standards were defined so that we know where to look for financial tracking and guidance. There's a similar need for something along those lines in operations where we have the ability to identify what the metrics, what the milestones, what the standards are for operations, and have the ability to introduce something of a data-driven process design that allows you to design what you're doing, your workflow, according to the data-driven best practices. And not having to rely on processes you inherited or a hand-me-down feel, or it's just your best guess of the way to run it. If you're able to actually define and measure and benchmark what needs to happen in operations, then this actually will increase your value to your owners, your residents. It increases your team performance, gives them a better track to run on. And it also plays into practical items like the trust accounting we were talking about here. If you've got your processes dialed in to make sure you have that cadence set up, you've got your key control checks completed, you're collecting the fees you're actually supposed to collect— you'd be surprised how often that's an issue— your security deposits are processed accurately on time with the deadlines, etc., you actually have the ability to line those out because now you have a standard to look at and say these are the best practices to make sure are included. We're working on defining those standards. You'll be hearing more from Profit Coach over the next couple of months with that, especially the Profit Power Hour webinar on August, I believe. Forget the exact date, but it'll be the fourth Wednesday in August. There's going to be some, some exciting updates coming on that. This is something that we're aggressively working on over the next couple of months here, and we're excited to keep everyone posted as that, that comes forward.

Awesome. Yeah. And I've said before, I've put my full weight behind this. I'm a huge proponent of what you guys are up to and any type of a standardization around process or workflow or metrics or KPIs. I'm all in on that stuff because that's what's going to let our, let our industry level up and continue to deliver better results for our property owners and our residents and, and run more sane businesses and help each other. So huge fan of that. Awesome. Thank you so much for coming on today, Alicia. Where can folks learn more about what you're up to or what Profit Coach is up to?

How could they follow along there? Yeah, no, it's been fun. Thank you for having the conversation. I think if you want to keep up with what Profit Coach is doing, the best way would be to register for our monthly Profit Power Hour webinars. There will be a mixture of just good informative content and also different updates on the new projects that are coming through. That's probably your best way to stay in touch is to register there and then you'll be, you'll be in the know as new things come through.

Okay, great. And we'll, we'll find a link and drop that in the, in the show notes. So thanks again.

This was awesome.

Awesome. Thank you. If you like the show and want to get connected to the community, you can follow me on Twitter @PSLohmann and subscribe to my email newsletter on my website, peterlohmann.com. I try to share as much valuable property management content as I can on a regular basis. Thanks again for listening and have a great week.