Property Management Accounting: Security Deposits
Handling security deposits can become unexpectedly contentious upon move-out or the sale of a property that currently houses renters. This is because although you, as the landlord, hold the funds, the money belongs to the tenant until such a time as the property is surrendered back to the owner. How you account for the security deposit matters well before move-out!
Keep It Separated
The easiest way to manage the security deposit is to keep it separate from other funds. This means setting up an account specifically for the security deposit. If you manage multiple properties, then the security deposits could all go into the same account. Separating the security deposits ensures that these funds are not comingled with your personal funds (remember, the money belongs to the tenant!), prevents accidental spending for other properties, and makes it easier to track and get back to the tenant once damages have been assessed.
Interest or Non-Interest Bearing Account?
In separating security deposits, you may have a choice of whether the funds earn interest. This is legislated on both the state and local levels. Some states require that security deposits are moved to an interest-bearing account and that the interest as well as the security deposit are returned to the tenant upon move-out. In Texas, no such law exists. In the Lone Star state, you may deposit the security deposit into an interest-bearing account without the obligation to return any interest generated from the funds to the tenants.
Tax it Correctly
One of the best reasons to keep on top of your accounting – besides being able to accurately predict future business directions – is that the IRS requires accurate income reporting. Although security deposits are funds that you receive from your tenants, again, this is not your money. Therefore, you would not count this as income upon receipt the same way you would account for rent. Security deposits do not become taxable as income until you have no legal obligation to return the amount to the tenant – and then, it would only be the portion of the deposit that was used and accounted as an expense to repair the property. You wouldn’t claim any funds that go back to the tenant as income.
Improper handling of security deposits can (and will) come back to bite you! A situation can get very litigious very quickly if a detail is overlooked or misunderstood. You need a property management company that understands the ins and outs of property law and state regulations. Frontline Property Management has a team of Accountants, Tenant Coordinators and Property Managers ready to take care of the details for you!
Find out how letting us manage your property will help you avoid costly mistakes!