Receipts? I don’t have them!
If you’re one of those investors who keeps every single receipt neatly organized in 3-ring binders – you can stop reading now. Both of you, actually.
For the rest of us, we’ll discuss receipts. Yes, those dreaded receipts that the IRS will want to see one day. Without receipts, the IRS will torture you and eventually sell you for spare parts to aliens – space aliens, I mean. Without receipts, your CPA will tie you up with his calculator tape and force you to watch Hannah Montana on the Disney channel.
Seriously, do you really need receipts? Yes – if we’re talking about IRS audit. However, if we’re talking about preparing your tax return – then the answer is NO. You heard me right: you do not need receipts to prepare an accurate (and perfectly legal!) tax return.
What you need is accurate numbers for what you spent. But how can you get accurate numbers without receipts, right? Wrong! The trick is to look at the other side of spending. Receipts show where the money went to. Instead, we will look at where the money came from. It is the same number, either way!
Let’s think where the money could possibly come from. Unless you work for the mafia, the money probably came from your own pocket, in one of those forms:
- Bank debit
- Credit card
- Vendor credit
Can we easily track these sources of money? Not if you paid cash. For cash purchases, you either have receipts or nothing. More likely, nothing. And just in case you haven’t heard this before: paying cash is a terrible business practice. Not just from bookkeeping angle, but also from common sense: what if the vendor later claims, by mistake or intentionally, that you have not paid him and demands more money? You better be real good about keeping receipts – which, as we established already, is wishful thinking.
In contrast, checks and bank debits are all listed on your monthly bank statements. So are credit card charges. The best part about bank and credit card statements is that you can very easily get copies of lost statements. Possibly even online, in the middle of the night, during those annoying commercials for male enhancement pills.
Vendor credit is somewhere in between, bookkeeping-wise: you do need to find statements from that vendor. But if they are misplaced, you can ask the vendor for copies.
In any case, the major difference between receipts and bank/credit card statements is: receipts are easily lost; statements are easily available. And they generally give you the exact same information as receipts, with less hassle.
Before we explore my step-by-step process for expense reconstruction, a word of caution. Don’t get me wrong: I am not encouraging you to trash receipts. Quite the opposite: you still must keep all your receipts, in case of an IRS audit. All I am saying is that, for the purpose of tax preparation only, statements give you information easier, faster, and more complete than sloppily-kept receipts.
Now, to the 6-step process.
Step 1. Get all your statements for 12 months.
You need 12 months of everything: each bank account that you used to pay business expenses and each credit card that you abused. In fact, you will need 13 statements, because December-January statements cover two years, and you’re after every transaction between January 1st and December 31st. Not before, and not after.
This is the right time to clarify an often misunderstood concept: when is something considered “paid”, for IRS purposes, if you charged it? The answer is – when you charged it. That’s right: not when you receive your confirmation, not when you receive the statement, not when you make that minimum payment, and not even when you pay off the balance (if you ever do). Each expense is legally paid the moment you charge it.
To illustrate this point, let’s say you picked up a $300 dishwasher at Sears and put it on your Chase Bank Visa card (as of this writing, Sears and Chase both still exist – but please substitute the names once they are merged into Federal government). The moment you swiped your Visa at the Sears counter, Sears got paid. What you have now is a personal unsecured loan from Chase to you. When (or if) you pay Chase has nothing to do with your dishwasher purchase. The purchase is made, and it is OK to put it on your tax return.
Step 2. For bank accounts, get copies of the checks, if available.
There are four ways you may obtain copies of the checks:
- ” some banks include them on their statements or provide upon request
- ” some banks make check images available online
- ” some banks still mail you cancelled checks the old-fashioned way
- ” you can (and I highly recommend you do) use “duplicate” checkbooks that leave you a carbon copy of each check.
Why would you need those if you already collected monthly statements? Because the statements usually do not tell you who the checks were written to. Are you going to remember just from the amount on each check? I don’t think so, either.
Step 3. Mark business expenses on each statement.
I assume that you are human – meaning that you mix personal and business expenses on the same bank account or business card. If you happen to belong to the overwhelming minority of investors who carefully separate business and personal, then you can skip this step. Your business account statement will have only business expenses, and it will have all of them. Congratulations, but do not tick off the rest of us with your bragging. For your own safety, please.
Meanwhile, you will settle into your La-Z-Boy (fitting brand name, isn’t it?) with a stack of statements, armed with either a highlighter or a pencil. I recommend pencil, for the simple reason that pencil mistakes are easily corrected. But if you insist on using a highlighter, make sure to use yellow. Other colors will come out as black stripes when you try to make copies. Trust me – it’s frustrating.
Your job is to carefully (which means slowly) go thru every single statement, line by line, and mark all lines that represent business expenses – as opposed to personal expenses. If you are not sure how to tell the difference, read an article titled “Can I deduct this?” on my website.
It is important to focus on one task only: separating business from personal. Save everything else for the next steps, or you will get distracted and miss some items that could be significant.
One important tip: do NOT mark payments of your credit card bills as an expense. We already discussed on Step 1 that expenses count when charged. Paying your MasterCard bill is simply paying back a bank loan – it is not an expense. Skip over these lines.
Step 4. Sort business expenses by property.
You are now going thru the same statements second time, sorry. And there will be third and fourth time, too. No other way to do a good job if you did not keep day-to-day records. You’re now catching up with a year-long (or life-long) pattern of negligence. About as much fun as sorting out an entire year’s worth of dirty laundry. (If you have a college kid, make it four years.)
On this second run, you are only looking at the business expenses marked during the previous step. Next to each business expense line, mark which specific property it was connected to. To make the process work, you need to assign either a number or some code to each property. I prefer codes, because it’s easier to remember that “SL” represents your Sugar Land rental rather than if it was assigned number 7.
While assigning property codes to each line on your statements, you will immediately run into a common problem: many expenses are general in nature and not specific to any particular property. Examples: tools, RICH dues and classes, computer supplies, books, general marketing, business travel, and so on. The solution is easy: you assign a special “GEN” code to all such expenses. Or, if you designate your properties by numbers, use zero for general expenses.
Step 5. Classify business expenses.
I hope you left some room for additional markings, because you need to step thru your statements one more time and add one more mark. I recommend that you use the other margin of the statement. If you marked on the left margin on the previous step, use right margin now.
You need to categorize each expense, to accommodate various designated lines on your tax return. This could be a little tricky, and your accountant may have specific requirements for categories. I know I do.
Without more detailed guidance from your tax preparer, you can rely on the IRS- designed list of categories. Check out the official IRS Schedule C for general expenses and Schedule E for rental property expenses. You will see “Advertising”, “Insurance”, “Supplies”, “Utilities”, etc. Using these categories is a fairly safe bet.
Tip: if not sure, do not combine. It is always better to use too many categories than too few.
You can invent your own categories, within reason. One of my investor clients once brought me a spreadsheet where one of the business expense categories was titled “Tobacco and alcohol.” Well, at least he was honest and did not call it “supplies” or “business development.”
Step 6. Group and total.
For this final step, you need to prepare several blank pages - one page per expense category. Use the same categories as in step 5. At the top of each page, write the name of the category. Then divide each page into columns or sections, one column per property plus an extra one for general expenses.
If you’re a computer person, by all means use Excel instead of paper. It looks cleaner, it is easier to correct, and no need for a calculator.
Now, you run one last time thru those hated statements and transfer each number onto the right page and the right column. Do not waste time by transferring descriptions and other data – only dollar figures. Just make sure to keep your marked-up statements, so you can trace these numbers back if needed.
Congratulations! You now re-created a complete and accurate set of business expenses, without searching for receipts! Quite an accomplishment, if you ask me.
Guess what’s left to do? You’re right! Total each group of numbers and call your tax accountant for an appointment.