How to Handle Security Deposits Properly
It’s not only wise to keep separate bank accounts for each property’s security deposits, but in most states, it’s required by law.
What’s a Deposit?
Since the dawn of time, landlords have been taking “security” or damage deposits from tenants to insure against potential property damages.
Centuries ago, a tenant could offer a promissory note against crops, livestock, or even children as a damage deposit. (Imagine that!)
Now, however, landlords require tenants to provide the money up front, usually one or two month’s worth of rent. This money is then held by the landlord until the end of the lease, and returned if there are no damages.
Problems with Commingling Funds
Technically, the security deposit money does not belong to the landlord. It’s on loan, while the tenant lives in the rental property.
The landlord must keep it safe until it is time to either to offset damages or return it to the tenant.
When a landlord keeps the deposit in the SAME account as his/her personal funds, or other deposits, three common issues arise:
Problem #1: Lack of Tracking
The deposit becomes almost impossible to track and validate in a court of law. In many states, commingling of funds can forfeit a landlord’s right to claim any of the deposit.
Problem #2: Accidental Spending
The deposit might accidentally get spent on a haircut for the landlord’s fluffy toy poodle, Louis Vuitton.
Problem #3: Interest Accrual
Since the security deposit does not belong to the landlord, many statesrequire that a landlord collect interest on behalf of the tenant. This becomes nearly impossible to calculate if the deposit is commingled with personal funds.
Some states, such as Pennsylvania, allow the landlord to keep part of the interest as an “administrative fee,” but other states require every penny that the deposit earns in interest be given back to the tenant.
The Solution: Separate Accounts
Most independent landlords don’t realize the importance of this basic accounting technique.
I have a bank account for each property. I ONLY use these accounts to hold money that does not belong to me, such as deposits.
Remember, when a tenant gives a deposit, the landlord has a responsibility to hold it for safe keeping, and sometimes even collect interest for the tenant.
Structuring the Bank Accounts
There are a dozen ways to organize your bank accounts. Because I manage my own properties (and only my own), the method that has worked best for me is to have one rental operating account for all my properties, and then a separate account for each property’s current security deposit.
With that said, I’m not an accountant or a lawyer, but this method satisfies most state laws that I’ve seen.
For example, if you own three rental properties, you might have the following bank accounts:
Personal Checking Date nights, personal mortgage, kids’ shoes, and haircuts for Louis.
Personal Savings Emergency fund for your family, vacation savings, orthodontia for the kids, etc.
Rental Operating Checking Repairs, maintenance, and mortgage expenses for ALL your rentals. You can track each property’s expenses in a separate ledger.
Rental Property #1 – Security Deposit Checking Account The only money in this account is the security deposit for property #1.
Rental Property #2 – Security Deposit Checking Account The only money in this account is the security deposit for property #2.
Rental Property #3 – Security Deposit Checking Account The only money in this account is the security deposit for property #3.
By keeping the security deposits in their own CHECKING accounts, you are able to issue deposit refunds directly from the appropriate account by writing a check – thereby keeping your books nice and clean.
I would not recommend keeping the deposits in savings accounts, because you would be forced to transfer money to and from a checking account in order to issue refunds via check. This defeats the purpose of keeping the money separate.
