The distinction comes down to donor intent. Unrestricted donations (formally called “without donor restrictions”) can be used for any organizational purpose. Restricted donations (“with donor restrictions”) come with conditions attached. The donor specifies how the money must be used, when it can be spent, or both. Your job is to honor those conditions and prove you did.

Every donation needs to be classified at the moment it comes in, not weeks later when you’re trying to remember. When a donor gives $5,000 for your after-school program, that’s restricted to that program. When someone drops $200 in the general fund, that’s unrestricted. The classification happens once and drives how you track and report the funds going forward.

In QuickBooks Online, the cleanest approach is using classes or tags to distinguish between restricted and unrestricted funds. Set up a class for each restriction category that matters to your organization. “Building Fund,” “Scholarship Fund,” “Youth Program” and so on. Every transaction tied to restricted money gets tagged with the appropriate class so you can run reports showing exactly how much was received and spent against each restriction.

You also need a system for documenting donor intent. Save the grant agreement, the donation letter, or even the email where the donor stated their wishes. If a donor gives verbally and says “use this for the food pantry,” note it in your records. Without documentation, you’re relying on memory, and that falls apart when board members or auditors ask questions a year later.

Releasing restrictions is where many nonprofits get tripped up. When you spend restricted funds on their intended purpose, you need to record a release from “with donor restrictions” to “without donor restrictions” on your books. This isn’t automatic. It requires a journal entry that moves the amount from one net asset category to the other. Skip this step and your Statement of Activities will overstate your restricted balances and understate your unrestricted activity.

For time-restricted gifts, the release happens when the time condition is met. A donor gives $10,000 to be used in the next fiscal year. On January 1 of that fiscal year, you release the restriction. Purpose-restricted gifts get released when you actually spend the money on the stated purpose.

Your financial statements need to show net assets in two categories: with donor restrictions and without donor restrictions. The Statement of Financial Position breaks this out on the balance sheet side, and the Statement of Activities shows revenue and expenses separated by restriction category. Donors, grantors, and board members rely on these reports to verify funds are being managed properly.

The biggest mistake is treating all donations the same and sorting it out later. That creates a mess that takes hours to untangle, especially during an audit or when a grantor asks for a spending report. Getting the classification right upfront takes seconds. Fixing it after the fact takes much longer and risks errors that erode donor trust.

If your tracking system feels unreliable or you’re behind on properly categorizing donations, working with bookkeeping services experienced in nonprofit accounting can get your records straight and build a process that keeps them accurate going forward.