In a people-centered business like property property management, the last thing you want is to be stuck crunching numbers and untangling accounts. There are some well-established property management accounting best practices that can save you time, but often that’s not enough to fully understand where your money’s going and whether you’re staying compliant.
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This post takes a look at one of the most important parts of accounting, setting up a trust account for property management. We’ll explore why you need one, common mistakes to avoid, and how to set up a trust account the right way.
What Is Trust Accounting?
Put simply, a trust accounting is when a third party holds funds for the benefit of (in trust for) a beneficiary. In the case of property management, the third party is the property manager and the beneficiaries are the owners that manager works with.
Think of trust accounting as a bank vault filled with safe deposit boxes, each designated to a specific property owner. Although everyone’s money is kept in the same vault, each person’s stash is separate. Likewise with trust accounting, even though everyone’s money is held in the same bank account, each owner’s money is tracked and accounted for separately.
Why Use Trust Accounting for Property Management?
As a property manager, you’re handling other people’s money on a daily basis. That’s a lot of responsibility, and it can also mean a lot of headaches. Managing that money in a single trust account makes the job much easier. You’ll end up spending less time spent opening new accounts and reconciling each one on a monthly basis. You’ll be able to separate and distinguish your revenue from that of your clients more clearly, avoiding the potential chaos of keeping all the funds passing through your business in one place. If you’re using the right software, the whole process becomes even easier.
The trick is setting up your account the right way.
What Makes Trust Accounts Tricky?
Legally-compliant trust accounts are essential, not just to avoid a failed audit, but also to protect against other, more common risks. Knowing these risks ahead of time will help you get all the benefits from creating a trust account, while still safeguarding your business.
It can be hard to tell whether a trust account is set up correctly, even for an auditor. Auditors can only verify what they have visibility into, so if the account is listed as “trust” or “escrow,” they might not be able to identify red flags in how the account is structured. This all means that, just because your accounts may have passed an audit, doesn’t mean you have a legitimate trust account established at the bank.
Let’s take a look at those red flags and the procedures that the bank must perform in order to set up a proper property management trust account.
Common Risks of Incorrectly Setting Up Trust Accounts
What are the biggest risks when you go about establish a trust account the wrong way? In an earlier post, we asked Allison Disarro, Senior Vice President of Enterprise Bank to share her thoughts on what you should look out for when setting up a property management trust account. Here’s what she had to say:
Many banks may not be familiar with the property management industry, how property managers hold funds and the requirements for the type of bank account needed. When we hear the word “trust,” we often think of Irrevocable, revocable, payable upon death trusts, etc.—the types of trust accounts that an estate would form for their families, businesses or other assets. These types of trust accounts are often prepared by an attorney and come with several pieces of documentation such as notarized trust certification, estate rules, etc; None of which applies to a property management business!
Many times when a trust account is not created correctly, it’s simply setup as a business account with the nickname of “trust.”
As you might imagine, that detail is superficial. Having a nickname on the account provides no additional protection to the account than if it were called something else, such as “payroll.” This nickname can be changed at any time.
If there is any question in your mind about whether or not your trust accounts are set up right, it is important to communicate with your banker about the requirements. Help your banker understand what type of account this is, what it is intended for, and reiterate that these funds do not belong to you or the company.
Here are some suggested questions to make sure you have your accounts correctly structured as a trust:
- How much is my trust account or trust accounts, insured for in total—separate from the other company accounts?
- If the bank were to receive a letter of intent to lien from the IRS, would the bank freeze the assets in my trust accounts?
- Does the bank have a record of the beneficiaries whose funds I hold in my trust accounts?
Depending on the answers, these are usually telltale signs that the account is or is not structured correctly. If the answers are not clear, ask to speak to a compliance department agent for clarification or confirmation. If all else fails, ensure that you are protecting your clients’ funds and find a bank which specializes in and thoroughly understands these types of accounts.
What Else to Watch Out For
- Lack of Sufficient FDIC Insurance on Trust Accounts: The standard FDIC Insurance for deposits at a bank (assuming that bank subscribes to FDIC) is $250,000 for all funds per entity/Tax ID #, no matter the amount of accounts held under that entity. Do you know that a true, legally-compliant trust account should actually be insured up to $250,000 per beneficiary, in this case the property owner, within that trust account? In the event of a bank failure, this is critical, especially for those companies who manage more than $250,000 combined in their accounts at any given time.
- Governing Entity Lien or Lawsuit/Judgement: In the event of a governing entity lien against the company from the IRS or FTB (or an unsuccessful lawsuit in which funds need to be garnished), the bank is required to freeze the necessary amount of assets held under the Corporate Tax ID# reference on the lien order. If the trust account is set up correctly at the bank, the bank should not consider the trust account as available funds, because even though they are held under the company owner/broker TIN, the broker is acting as fiduciary agent meaning these funds explicitly do not belong to the company under review.
- Loss of Broker’s License: If any of the events occur and you were in fact somehow able to recover the funds, you would still be at risk of losing your broker’s license after reporting the incident.
Getting Started: The Dos and Don’ts of Property Management Trust Accounting
With these risks in mind, it helps to how to get started with a trust account for property management. Here’s what Allison advises:
- Name all 3rd party accounts as trusts: A trust account is not just for security deposits. An account that accepts rents must be structured as a trust. This cannot be named just “operating” just because it is used as an “operating trust.”
- Monitor who signs: Ensure all signees are either broker, agent, or bonded employees.
- Keep your beneficiaries updated: Update your bank account every 6 months to 1 year with the beneficiary information for them to keep with depository records.
- Allow ineligible users to have ACH, billpay, or wire access to the client funds: Giving this type of access to non-eligible or trusted employees is giving them permission to release funds from the accounts at any time. Remember, the broker is held liable for all trust activity!
- Facsimile stamps/electronic stamps: When signing a bank agreement to have a signature stamp be an accepted form of authorization, you are agreeing that any checks signed with this stamp are legal, authorized signatures. You cannot claim fraud if an employee or others use your stamp for unauthorized activity.
Clean Accounts, Clear Benefits
With a property management trust account set up properly and effective software that simplifies accounting across your business, you’re already set up for success. The next step? Figuring out how to spend all that time you’re saving.Read more on Accounting & Taxes
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