How Is Security Deposit Recorded in Accounting?

Security deposit accounting is one of the more disputed aspects of property management. Landlords and tenants often get it wrong due to little or no understanding of the true concept of the security deposit. 

This is an in-depth look at what security deposit accounting is all about and essential tips that will guide landlords and tenants in this area.

What Is a Security Deposit?

A security deposit is money a tenant gives to the landlord of a rental property as proof of the intent to remain in the house, move in, and care for the unit. The security deposit is refundable. The purpose of the security deposit is to serve as a measure of security to the recipient and can be used to pay for property damage or loss.

How Does a Security Deposit Work?

A new tenant pays an amount of money before taking possession of the property. This amount is determined by the market, tenant credit, rental history, and the results of their background check and screening results. Typically, the security deposit amount starts at around one month's rent. The money serves as security and something to bank on if there are repairs and replacements needed when they are caused by the renter, as assessed after the tenant vacates.

For example, if a renter breaks a window or damages an infrastructure, the landlord will channel the money towards repairing the damaged infrastructure or property when the renter moves out. On the other hand, if the renter moves out without causing any damage to the property, the security deposit will be refunded.

Important things to note:

• A security deposit serves as money to fix and replace any damaged, lost, or stolen things in the rental unit.

• Upon the renter's departure, there is a need to refund the security deposit if the renter leaves the property in reasonably good condition (Like they received it minus normal wear and tear).

• Payment of the security deposits should be made before moving into the property and returned within 31 days after vacating with an account of any charges made against the security deposit.

What Is the Requirement for a Security Deposit?

The typical amount a renter pays for a security deposit is about a month's rent. Although we recommend not having it be the same exact amount as rent, there are times when the security deposit can be higher, such as the tenant has a low credit score or if the rental rate increases, the security deposit escrowed might not be sufficient.

Security deposits are not taxable income, and most local laws treat security deposits as trust funds.

Note: If there will be reasons to use the security deposit as final rent, it must be claimed as advance rent and are taxable when paid.

Security Deposit Special Considerations

Some states allow the landlord to apply the security deposit as rent from tenants who cannot pay or use the security deposit for the repair of the damage that the tenant has caused.

The state law of different states determines if the security deposit can be used for payment of monthly rent when the rent of the property comes to an end. Some states have laws because there might be a difference between the final month's rent and a security deposit (this means they need to be accounted for separately). The landlord might require written approval from the renter to use the security deposit for final rent.

Some cities and neighborhoods have a landlord that charges higher security deposits which can affect low-income earners to find houses in those areas. There might be the enactment of local legislation that will limit how large a security deposit may be about the amount charged for renting the property.

The landlord is obligated to account for any deposit made by the tenant within 31 days before the termination of tenancy.

Things to Note:

When the landlord regains possession of the property, they must complete a security deposit disposition statement covering security deposit accounting and refunds. The refund, total owed, and security deposit information should be placed in first-class mail and sent to the tenant within 31 days of transferring possession of the property. According to the law, documents must be mailed no more than 31 days after the tenant has moved out. The landlord can get proof of mailing.

Any deposit that is labeled security deposit can serve as a remediation fee for any payments, which can include: unpaid rent, noncompliance fees, utility bills, late fees, damage to the premises (damage does not include normal wear and tear), carpet cleaning, and cleaning fees.

Any deposit made that is labeled as last month's deposit, such as pet deposit, key deposit, carpet cleaning cost, last month's rent deposit, etc., must be used for that purpose. If there is an unused amount, the landlord must return the money to the tenant immediately, even if the tenant owes money for something else.

Damages, depreciation, and normal wear and tear tend to cause great conflict when the tenancy is coming to an end.

• Damages can be holes in the walls, gouges or scratches on counters or flooring, urine damage to the floor and subfloor, unauthorized painting, etc.

• Remember to keep depreciation in mind by thinking about the age and lifespan of the damaged item.

• The length of tenancy determines normal wear and tear. A tenancy of eight years is allowed more wear and tear than a tenancy of two years.

• Mold, filth, neglect, and waste are not normal wear and tear.

Charging for Time, Labor, and Unrepaired Damage

Any damage caused by the tenant is not the landlord's responsibility and can be charged against the security deposit. The labor cost assessed by the landlord under cleaning and repairs is generally at an hourly rate. Also, the law states that you do not have to repair an item to charge for it.

How Is the Charge for Carpet Cleaning Done?

Here are the reasons provided by statute for charging for carpet cleaning:

• Carpets were cleaned or replaced after the previous tenant vacated and before the new tenant took possession of the property.

• There is a written legal agreement that the landlord may deduct carpet cleaning costs regardless of whether the tenant cleans the carpet before delivering the possession.

• The carpet is cleaned by the landlord, who uses a machine specifically designed for carpet cleaning and shampooing.

Charging for Loss of Use:

The landlord can also charge daily rent for loss-of-use of the property during cleaning or repair performance, for which the tenant is responsible as long as the repairs and cleaning are done in a timely fashion.

How is daily rent calculated?

The standard calculation of the daily rent of a property is the monthly rent divided by thirty. You can calculate other monthly rent by dividing the monthly rent by the number of days in the specific month or the monthly rent multiplied by twelve divided by 365. Whatever method you choose - you must be consistent.

Whose name is on the refund check?

Everyone involved in the rental agreement at the time of termination or the "last man standing." If the landlord does not release the tenant or other parties involved and the tenant moves out on the lease, their names are entitled to be on any refund, but they remain liable for the damages.

In naming parties to a refund check, ensure each person is named. Make sure to use the word "and" to indicate the last-named party, which is to provide every party involved gets their refund. Any tenant could cash the check if the word "or" is used. However, if all the tenants cannot be together to cash out the check, the landlord may issue the check in the name of one or two tenants with the written permission of all others. If permission is denied even by one person, the landlord may not do this and can be liable to refund other tenants.

What can be done in cases of incomplete accounting?

It sometimes occurs that the landlord does not finish the work on the property before the deadline for mailing the accounting. There might be a need to send incomplete accounting to inform the tenant about the charges to that point and state clearly that there will be a finalized accounting in the future.

What happens if the tenant fails to provide a forwarding address?

Send the accounting copies to their property address or any other address on the file, such as the emergency contact address or work address. Best practice is just to mail it to their last known address, which is the residence they just vacated.