How Property Managers Should Account for Security Deposits and Reserves

Tenant security deposits and owner reserves aren't your money, and they aren't income. A deposit is a liability you hold for the tenant until it's returned or applied to rent or damage, and a reserve is the owner's own cash you keep back for repairs. Both belong on the trust side, on each tenant's and owner's ledger, and neither should ever show up on your company P&L.

Two kinds of money you hold but don't own

Most of what runs through a property management trust account belongs to someone else. Two balances cause more confusion than the rest, because they sit there for months or years instead of passing straight through.

• Tenant security deposits. The tenant pays the deposit at move-in, and it stays owed to them until move-out. Then it's returned, applied to unpaid rent or damage under the lease, or some of each. Until that happens, it's a liability on the tenant's ledger.
• Owner reserves. Your management agreement usually sets a reserve, a balance you keep back from each owner's distributions so repairs and bills can be paid without waiting on the owner. It's still the owner's cash. It shows on their ledger and goes back to them when management ends.

Your property software, such as AppFolio, Buildium or Rent Manager, holds those tenant and owner ledgers. Your company books hold your own money: the fees and markups you've earned once they move from trust to operating, and the costs of running the company. If some owners hold their tenants' deposits themselves, your records should show which deposits you hold and which you don't.

Why it goes wrong

The bank doesn't know whose money is whose. A $2,000 deposit lands in the trust account looking exactly like $2,000 of rent. If it's coded as rent, the owner's statement shows income that isn't theirs yet, the money may go out in the next distribution, and when the tenant moves out the refund comes from money that's already gone.

On the company side, the usual problem is a trust bank account added to QuickBooks with no liability against it. Every deposit and reserve then looks like your company's cash. Your balance sheet overstates what the company has, and nobody can tell from that file what you actually own.

Reserves go wrong more quietly. A repair bigger than an owner's balance gets paid anyway, the owner's ledger goes negative, and another owner's money covers it. Nothing looks off in the bank until someone runs the owner ledgers.

A worked example: one move-out

Say a tenant paid a $2,000 security deposit at move-in. At move-out they owe $400 of unpaid rent, and the inspection finds damage beyond normal wear that a vendor repairs for $600. Under the lease, the deposit covers both, and the tenant gets the rest back.

Cash in trust drops by $1,600: the $1,000 refund and the $600 paid to the vendor. The other $400 doesn't leave yet. It moves from the tenant's deposit to the owner's balance as rent and goes out with the next owner distribution, less any fee your management agreement charges on rent. On the owner's statement, the $600 applied to damage and the $600 repair bill cancel out, so the owner ends up $400 better off before fees.

Whether the owner reports the $600 as income or nets it against the repair is a question for the owner's CPA. The bookkeeping job is to keep both lines visible so either answer is easy.

How to record a security deposit, step by step

1. At move-in, record the deposit to the tenant's deposit ledger, not to rent. Last month's rent collected up front is usually tracked on its own as prepaid rent and applied to the month it covers. Some states treat it like a deposit, so check your state's rules.
2. Hold the money where your state requires it. Some states and cities require deposits to sit in a separate account, and some require interest to be paid to the tenant. If the account earns interest, record it on its own line, because who it belongs to depends on your state's rules and the lease.
3. Leave it alone during the lease. The deposit isn't available for the owner's repairs or distributions while the tenant is in place.
4. At move-out, record the disposition from the itemized statement: each charge applied, by type, and the refund. Deadlines for returning deposits and itemizing deductions vary by state, so date every step.
5. Record applied amounts as owner income at that point, unpaid rent to rent income and damage to its own line, with the repair bill as a separate owner expense.
6. Pay the refund from trust and match it to the statement. The tenant's deposit ledger should end at zero.
7. Check the deposit total against the trust bank every month, as part of your three-way trust reconciliation.

How to handle owner reserves

A reserve works like a floor under the owner's balance. Rent comes in, fees and bills go out, and you distribute whatever is above the reserve.

Say your agreement sets a $500 reserve per property, and the reserve is full at the start of the month. Rent of $2,000 comes in, your 10% management fee is $200, and a $300 repair is paid. The owner's balance is $500 + $2,000 - $200 - $300 = $2,000. You distribute $1,500, and the reserve stays at $500. If the unit sits empty the next month and another $300 repair comes in, the balance drops to $200, nothing is distributed, and the next rent payment refills the reserve before anything goes to the owner.

A few rules keep reserves clean:

• The reserve is owner money, always. It sits on the owner's ledger in your property software. It never moves to your operating account, and it never pays your company's bills.
• An owner's first reserve is a contribution, not income. When a new owner funds the reserve, record it on their ledger as an owner contribution.
• Don't pay past the balance. If a bill is bigger than what the owner has, ask the owner to fund it first, as your agreement allows. Paying it anyway uses other owners' money.
• Return it when management ends, after final bills are paid, and record it as a payment from that owner's ledger.

Common mistakes to avoid

• Coding deposits as rent. The owner's income is overstated, and money owed to the tenant can go out in a distribution.
• Mixing deposits with prepaid rent. A deposit is held until move-out. Prepaid rent is applied to a specific month. Lumped together, neither balance is right.
• Treating pet fees and pet deposits the same. A refundable pet deposit is a deposit. A nonrefundable pet fee, where your state allows one, is income, to the owner or to you depending on your management agreement.
• A trust account in QuickBooks with no liability against it. Owner and tenant money shows up as your company's equity.
• Letting uncashed refunds disappear. A refund check the tenant never cashes is still owed. It stays a liability until it clears or is handled under your state's unclaimed property rules.
• Losing track of deposits when an owner leaves. When an owner sells or moves to another manager, their tenants' deposits usually go with the property, to the owner, the buyer or the new manager, depending on your state's rules and your agreement. Record each transfer tenant by tenant, so every deposit ledger ends at zero with a record of where the money went.

The monthly routine, and what to hand your CPA

1. Run the tenant deposit report from your property software and total it.
2. Run the owner balance report, reserves included, and check that no owner is negative.
3. Reconcile the trust bank to the software, with deposits and reserves inside the ledger total. If deposits sit in their own account, reconcile that account to the deposit report.
4. Review the month's move-outs: every disposition recorded, every refund paid or listed as outstanding.
5. Move earned fees to operating and record them in your company books by type.

At year end, your CPA gets company books with fee income by type and no trust money mixed in, the monthly trust reconciliations, and the deposit and owner balance reports as of December 31. Your owners get statements their CPAs can use, with rent, applied deposits and expenses on separate lines. How an owner reports a kept deposit or prepaid rent is that CPA's call. IRS Publication 527 covers residential rental property, including security deposits.

How we handle it

Our bookkeeping for property managers keeps your company books in QuickBooks Online and works from your property software's deposit, owner balance and trust reports. Every month we check the tenant deposit total and owner reserves against the trust bank, flag negative owner balances and stale refund checks, and keep deposits and reserves off your company P&L. Where and how deposits must be held is set by your state, so you and your broker of record stay responsible for compliance. We keep the numbers clean and documented.

It sits under our wider real estate bookkeeping for agents, brokerages, investors and property managers. Plans start at $299 a month; any setup or catch-up fee is quoted up front. If your deposit and reserve balances haven't tied out in a while, we rebuild them month by month from your bank statements and software reports first. See our property management bookkeeping page for the full scope.

Common questions

Is a tenant security deposit income?

Not while you're holding it. A deposit is a liability, money owed to the tenant, until it's returned or applied under the lease. The part applied to unpaid rent or damage becomes the owner's income at that point. How the owner reports it is a question for the owner's CPA.

How do I record a security deposit refund with deductions?

Start from the itemized move-out statement. Apply each charge from the tenant's deposit to the owner as income, by type, record the repair bills as separate owner expenses, and pay the rest to the tenant from trust. The tenant's deposit ledger should end at zero.

What is an owner reserve in property management?

It's a balance you keep back from an owner's distributions, usually set by your management agreement, so repairs and bills can be paid without waiting on the owner. It's still the owner's money. It stays on their ledger, never moves to your operating account, and goes back to them when management ends.

Do security deposits belong in a property manager's QuickBooks?

Not as income. Deposits live on tenant ledgers in your property software, on the trust side. If your trust bank account is in QuickBooks at all, it needs an equal liability against it, so the money never shows up as your equity or income. See our bookkeeping for property managers page for how we keep the two sides apart.