At first glance a rental security deposit might seem straightforward, but security deposits can be surprisingly complex. States and many municipalities have laws that regulate security deposits, such as the maximum security deposit amount that can be collected or whether a landlord can use a tenant’s rental security deposit to pay for excess property damage caused by a tenant.
Key takeaways
A landlord may collect a rental security deposit from a tenant to help ensure that the tenant abides by the terms and conditions of the lease, such as paying the rent on time and taking care of the property.
Although a landlord isn’t legally required to collect a security deposit, most choose to do so as a general business practice. That’s because a refundable security deposit serves as a financial incentive for a tenant. If a tenant knows their deposit will be returned at the end of the lease, they may be more likely to pay the rent by the due date and follow the rules outlined in a lease.
State landlord-tenant laws limit how much of a rental security deposit a landlord can collect from a tenant. As a rule of thumb, a security deposit is equal to 1 month or more of rent, depending on the state.
The legal resource website Nolo.com publishes a chart of state security deposit limits that a landlord can charge, depending on the state that a rental property is located in.
For example, states like Alabama and Nebraska limit a security deposit to 1 month of rent, while other states such as California and Nevada allow a security deposit of between 2 and 3 months’ of rent.
There are also 20 states that have no statutory limit to a security deposit, including Colorado and Florida. The phrase “no statutory limit” means that the state does not have a law that specifies how much of a security deposit a landlord can charge.
In addition to state landlord-tenant laws, a landlord may also wish to consider factors such as the monthly rent price, features and amenities of the property, competition, and customs in the local real estate market.
Asking for a rental security deposit that is too high may result in an extended period of vacancy if prospective tenants choose to rent a similar property with a lower security deposit amount. On the other hand, setting too low of a security deposit could end up attracting a tenant who consistently pays late and doesn’t take care of the property .
Effective ways to decide what a security deposit should be include speaking with a local investor-friendly real estate agent, talking to a property management company, or even making phone calls to people advertising places to rent to ask about a security deposit amount.
However, a landlord should take care to compare the security deposits of similar properties in the same area. For example, the security deposit required to rent a single family home may be different than an apartment building with 100 or more rental units.
When setting a security deposit, it’s important to not accidentally violate the Fair Housing Act by discriminating among applicants. While a landlord may be able to charge a different security deposit amount based on an applicant’s credit report, charging people with children or a tenant with a service animal a bigger deposit is a discriminatory practice.
A security deposit amount is commonly based on the monthly rent price.
To illustrate, assume a landlord has a single family rental home in Phoenix and the rent is $1,800 per month. In Arizona, the security deposit is limited to 1 ½ months’ rent. If a landlord collects the maximum deposit allowed, the security deposit would be $2,700 in addition to other up-front money collected when a tenant moves in.
A landlord will generally collect a security deposit on or before the move-in day, in addition to other up-front money. If a tenant promises to pay the security deposit after moving in and then refuses to do so, a landlord may end up having to negotiate with the tenant or filing for an eviction to remove the tenant for non-payment.
For example, assume that the landlord with the Phoenix rental property in the section above has a tenant moving in on the 1 st of July. The amount of up-front money collected would be:
If the state the property is located in has a rental tax, a tax would also be charged on the first month’s rent and collected when a tenant moves in.
Is a rental security deposit pro rated?
As a rule of thumb, a landlord may wish to collect the full security deposit due, even if a tenant moves in the middle of the month. While the monthly rent may be pro rated, a security deposit generally is not.
For example, if a tenant moves in the middle of the month a landlord may pro rate the rent and calculate the total amount of money due when a tenant moves in like this:
Rental security deposit vs first and last month of rent
There’s a difference between collecting the first and last month of rent and a security deposit. A security deposit is collected by a landlord and meant to be refunded when a tenant moves out, provided that the terms and conditions of the rental agreement have been met.
By comparison, collecting the first and last month’s rent is a type of advance rent because the tenant pays the last month of rent in advance. Assume a tenant moves out and there is property damage beyond normal wear and tear. A landlord who collected the first and last month of rent instead of a security deposit will have no remaining funds available from a tenant to pay for excess damage.
A security deposit is not rental income if the deposit is meant to be returned to a tenant at the end of the lease agreement. However, as IRS Publication 527, Residential Rental Property explains, any part of a security deposit withheld by a landlord – such as to pay for damage caused by a tenant – is treated as rental income in that year.
On the other hand, if a security deposit is intended to be used as a final rent payment, the amount of the deposit is included as rental income by a landlord when it is received, even if a lease does not end until the following year.
A refundable rental security deposit must be returned to a tenant within the timeline required by the landlord-tenant laws where the rental property is located. In general, a landlord must refund a deposit to a tenant between 2 weeks to 1 month after a tenant moves out.
Nolo.com publishes a chart of the deadline for returning security deposits by state, along with links to state security deposit statutes . Depending on state law, a landlord may be able to use part or all of a tenant’s refundable security deposit to pay for unpaid rent or property damage caused by the tenant, other than normal wear and tear.
Some states require a landlord to hold a security deposit in a separate trust account, and in some cases pay interest that accrues on the security deposit to a tenant. As a general business practice, a landlord may wish to open a savings account to hold a security deposit, in addition to a checking account used to pay for rental property operating expenses. When a landlord receives a security deposit, the amount is recorded as a liability on the real estate balance sheet, because the deposit is money a landlord owes a tenant.
Free rental property software from Stessa automatically records money received from a tenant to the correct line item on a chart of accounts.
For example, assume a tenant pays the 1 st month rent of $1,800 plus a security deposit of $2,700 when moving in. Stessa will automatically record $1,800 as rental income and $2,700 as a liability on the balance sheet, and also record the monies received as a deposit to a landlord’s checking and security deposit trust accounts.
Thanks to Stessa, a landlord doesn’t have to spend time learning double entry accounting and can focus on the big picture of maximizing potential profits.
