Property Management Accounting: (More About) Security Deposits
In our last post, we discussed how to properly account for security deposits in your financial holdings. Which bank account to deposit the security deposit into, and how and when to tax it as income is important, but is just the tip of the iceberg. Issues arise with the heft of details that lay beneath the surface.
Security Deposit Laws Vary by State!
There is no guarantee that the property you own is in the same state as you. Don’t assume that the security deposit laws are the same! You don’t want to be caught withholding funds due to overlooking a state law! Know the state (and city!) laws and ordinances that cover your property.
What is the Maximum Amount That Can Be Charged?
This amount can vary from one state to another, and there may be considerations for people over a certain age, tenants who have pets, and how long of a lease is being signed. Deposits normally range between one and two month’s worth of rent as a base.
In many states (such as Texas) there is no legal limit to what can be charged for a security deposit. However, the standard is one month’s rent plus any pet deposits that are due. Keep in mind that city ordinances may also set local limits on security deposits.
How Much of the Security Deposit Can I Keep?
Property managers everywhere have, at some point, struggled with a tenant over charges upon move-out. It’s important to know that normal wear and tear on a property cannot be considered damage that is deductible from the security deposit. If a carpet is worn from years of tenants living in a property, that is to be expected. However, if a pet damages or stains the carpet, that is abnormal wear and tear and can be deducted.
All reasonable charges for abnormal damages must be itemized and documented in a letter, for both your records and for the tenant. Under Texas law, if there are any deductions from the security deposit, this accounting letter must be sent to the tenant’s forwarding address with the remainder of the security deposit (if any) – or the bill if charges were in excess of the security deposit.
The goal is not to keep as much of the security deposit as you can – the security deposit is entrusted to you in good faith that it will be used to cover damages to the property upon move-out. This is why the security deposit is not considered income until after the damages have been assessed and the remainder returned to the tenant. It should be equal to, not more, than the cost of repairs needed.
When Do I Return the Security Deposit?
In Texas, the security deposit must be sent to the tenant within 30 Days of receiving the tenant’s forwarding address. This is to allow time for a final walk-through and assessment of the property. An exception to this is if the tenant vacated the property while owing rent, you do not have to send an itemized list of deductions.
There are penalties for landlords who do not return the security deposit promptly when due – if a tenant becomes litigious, they can rightfully be awarded $100, three times the security deposit, court costs and attorney’s fees. A big price for what could be a simple mistake!
Can a Tenant Use their Security Deposit as Last Month’s Rent?
The short answer is no.
While it is legal in some states, it is inadvisable to your business as a landlord. Security deposits may not cover one month’s rent if rent increased over the tenancy. You would be cutting yourself short in that regard. Furthermore, if there are damages beyond normal wear and tear, then the tenant will still be responsible for those charges but you will not have easy access to funds and may be stuck out in the cold, or have to take your tenant to small claims court.
In Texas, it is outright illegal for a tenant to withhold payment on the presumption that their security deposit can cover last month’s rent. The penalty to the tenant for this is three times the monthly rent, and whatever court costs and attorney fees were incurred by the landlord’s suit to recover the rent.
Landlords will be faced with these questions lease after lease. It’s in your best interest to stay informed, maintain orderly accounts, clearly state your expectations in your lease, and to abide by the laws that govern your property!
If that’s a bit daunting, team up with Frontline Property Management! We have an on-point accounting department and a full staff of professionals and Property Managers who stay up-to-date on the latest regulations and will handle all of the details so that you don’t have to!
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!
Let us know if you need help with your rental!
Property Management Accounting Basics: Reconciliation and Redundancy
Humans are hard-wired to seek maximum reward with minimal effort. We are driven to find ways to get things better and faster while doing less work. We are also sometimes simply forgetful of details when we are focused on completing tasks.
In accounting, however, you cannot spare any details. Reconciliation is the process of making sure your bank account statements match the ledger for your business, dollar for dollar, penny for penny. If it’s off, then you’ve gone wrong somewhere.
First, you want to create the habit of reconciling weekly if not daily, and at the very least monthly (depending on the size of your business). It’s a lot easier to track down a discrepancy, transposed number in a transfer or a missing deposit someone forgot to enter – among a litany of other things that can go wrong – if it happened within the last thirty days and not sometime in the last half a year.
To combat the inherent nature of people to play fast and loose with the details, it’s also important to incorporate redundancy in your accounting. In the creation of your Chart of Accounts, you’ll need to properly set up accounts and sub-accounts that best reflect the nature of these transactions. You will also need to create Journal entries for any transfers made between accounts. Think of your Journal as a “dear diary: I moved this money from bank Account A to bank Account B because of reason X”. You can cross-reference the Journal entry as a memo line when you make the “real” transfer in your bank account.
Multiple layers of reporting will make your life easier and your accounts simpler to manage. Depending on your state, your property management business may also be subject to audit. While audits aren’t fun, they’re even less fun if your reports aren’t in order. The Trust reconciliation report is a collection of reports that are commonly required to pass audits conducted by state property management licensing boards.
The report combines Bank Reconciliation and Bank Account Balance Breakdown. Reconciling on a regular basis makes this monthly reporting a breeze! In property management, there are plenty of factors that are out of your control, but proper accounting isn’t one of them. Be diligent, detailed, and redundant, and you will be able to make the best financial decisions to further your business.
Are you too busy to reconcile appropriately?
Of course, if this is overwhelming (and it very well may be) – don’t worry! If you’re too busy making deals to handle details, let a property management company like Frontline Property Management handle them for you! Our accounting department is focused on keeping your reporting pristine and your monthly reports rolling!
Let us know if you need help with your rental!