Businesses and real estate have some very real requirements for records.
If you’re planning to be a serious business owner and real estate investor,
then plan on keeping track of records as you go. If you don’t have good
records, you might be unable to prove your deductions and then lose
them in a subsequent audit or, if you are sued, be unable to prove that
you really are running the investments like a business. Either way you
lose! Good records can protect you against those problems.
There are three types of record systems that we recommend: (1) temporary
files, (2) permanent files, and (3) financial statement files. A discussion
of each of these types follows.

Temporary Files
There will be income items and expenses for your business or for the
properties you own every year. For ease of use with your accounting system,
keep the backup copies in alphabetical files that are “closed” each
year after your tax return is prepared. Remember that each company will
need its own set of files. For example, Ted’s company will need a set of
temporary files and Ellen’s company will need a separate set of temporary
files. When they begin their real estate investing, that real estate investment
company will need its own set of separate temporary files.
As you pay an invoice, we recommend that you note on your copy
the following information:
Date paid.
Check number.
Amount paid.

We have a rubber stamp that is used to stamp each invoice that has these
three items, each followed by a line. This prompts the accounts payable
clerk to complete each line. The invoice copy is then filed alphabetically
by the vendor name.

If you don’t have a large number of invoices each year, you might
just want to create file folders with “A–C”, “D–F,” and so on. In this way,
you can quickly find your reference information and not have to set up a
lot of files as you go.

Be careful of expenses that end up being capitalized. These are expenses
that actually represent improvements to the property or are assets
to your business. For example, a room addition would be an improvement
that would be capitalized. Invoices representing additions to basis
(capitalized expenses) need to be filed with the permanent files. Another
example would be an asset that you buy for your business that has
use beyond one year, such as a computer. The invoice representing the
purchase of your computer, your business automobile, furniture, fixtures,
equipment, and the like will all be filed with the permanent files.
At the end of the year, begin a new set of file folders and start filing
current invoices in those folders. There will likely be two sets of files—
the past year (for the tax return that hasn’t yet been filed) and the current
year—at certain times of the year. Make sure you have room in a
filing cabinet for those files.

After the tax return is filed, take the invoices, complete with their
file folders, and store them in a separate box. We typically recommend
that you retain these records for five years. However, you may want to
keep them for 10 years in case there is ever a lawsuit. Clearly label the
box with the year so you know when you can shred the documents.

Permanent Files

The permanent files are files that you will keep active long past the tax
year. These are items related to ongoing issues such as the assets of the
company, basis for the property and underlying notes, as well as information
related to the business structures.
The basis files will include documents such as the closing statements
upon the sale of the property, any previous property owned (such as a
Section 1031 like-kind exchange that was performed) that affects the
basis, invoices and contracts for improvements made to the property, .

Financial Statement Files

Most business owners and investors use a software program to track their
income and expenses. We use Intuit’s QuickBooks Pro (available at
Intuit - Personal Finance, Small Business & Tax Software for approximately $300) with many of our clients. This
program allows our clients to securely send their accounting data via the
Internet. We then can look at the financial information at the same time
that the client does. That’s how we work with clients efficiently and accurately
at long distances. In fact, we find that we work better with
clients who are not in our geographic area because it provides the incentive
for all of us to be more efficient.
First of all, consider your computer system files. Consult with your
computer support expert’s advice for backups in your particular case. We
generally follow the grandfather-father-son system of backups. In other
words, we have three backup tapes that are recycled through the series,
so that we always have three days of backup available. We do a weekly
backup as well that is taken and stored off-site.