How to handle Security Deposits

Question

I have a question about the best place to hold a tenant’s security deposit. Should I keep it in savings? Could I earn interest on it in the short term? Are there any other options I should consider? Tax implications?

Abby Howe · Answer

@Lauren Robins Thanks, I'll look and see what my state requires regarding security deposits.   I appreciate your help!

Lauren Robins · Answer

Hi Abby!

You're asking a smart and important question—where and how to hold a tenant’s security deposit isn’t just a matter of convenience, but of legal compliance and financial protection. The first thing to understand is that many states and local municipalities have specific laws about how landlords must handle security deposits. In some places, like Massachusetts, New York, or Illinois, you’re required to keep the deposit in a separate, interest-bearing account. In others, you may not be required to earn interest, but you still have to keep the funds separate from your personal or business operating accounts. Some jurisdictions also require that you disclose the bank name and account number to the tenant and provide annual statements reflecting any interest earned. Because of this, it’s essential to check your local landlord-tenant laws before deciding where to hold the deposit—penalties for noncompliance can be severe, including being forced to pay the tenant three times the amount of the deposit.Even if you're not legally required to hold the funds in a separate account, it’s still considered best practice. Keeping security deposits in a dedicated business checking or savings account—ideally one under your LLC if you use one for your rental business—protects you from accidentally spending the money and helps demonstrate proper accounting if there’s ever a dispute, audit, or court proceeding. It also makes your bookkeeping cleaner and avoids co-mingling funds, which can quickly lead to legal trouble in tenant-landlord relationships.You can absolutely earn interest on the deposit, and in fact, some states may require it. However, keep in mind that in many places, the interest belongs to the tenant—not you. Some states allow landlords to keep a small portion of the interest earned as an administrative fee (e.g., 1%), while others require the full amount to be returned to the tenant at the end of the lease. The best way to safely earn interest while keeping the funds liquid is to place the deposit in an FDIC-insured high-yield savings account or a money market account. What you should not do is invest the deposit in anything with market risk—like stocks, crypto, or mutual funds—because you must have the full deposit available for refund when the lease ends.

Note: This information is for educational and informational purposes only and does not constitute legal, tax, financial, or investment advice. No attorney-client, fiduciary, or professional relationship is established through this communication.

Greg Scott · Answer

I would recommend any FDIC insured account.  I heard about a small management company that invested funds in Bitcoin. When Bitcoin hit a dip, they didn't have enough cash and it took down the business.

In a dispute, a judge may want to see you have properly managed the security deposit.  Some people like to have a separate bank account for holding security deposits.  If you have several properties, it becomes a lot of work if you one bank account for each tenant, so most people just switch to tracking the amounts through an accounting package but still holding all the security deposits in one separate account.

On our apartments, we have all those funds in the operating accounts and keep careful track of each resident's deposit in our accounting package.

Abby Howe · Answer

@Greg Scott Thanks Greg!   I appreciate your help.