What are best practices for Rental Security Deposits?

Question

All,

In talking with various investors, I understand that in certain states security deposits must be maintained in cash, cannot be invested, and accounted for in a separate account.  Thus this would tie up tens of thousands of dollars in a non-interest bearing account.  Additionally, with a portfolio of properties, tying up this cash with a very low risk of payout while a new deposit is coming in would seem ineffective.

Is this accurate and does this apply to Colorado?

What are best practices for maintaining security deposits?  Any advice greatly appreciated.

Thank you.

Kevin

Gita Faust · Answer

So there is the state law, accounting, bookkeeping and bank accounts. And not to forget the tenants.

State law: nothing we can do about it but just follow it. Few states will either ask to distribute the interest and other would let you earn the interest.

In the Bank: Open a main security deposit bank account (mostly savings) and subaccounts for each tenant's deposit specially if they have to be an interest bearing account.

In a software: You can track all the money in one Bank Account as long as you enter the money received with each tenants name. (not sub accounts as you refer to the statements any time)

Reconcile: All you have to do is reconcile the main account and not the subs.

Bill Gulley · Answer

Security deposits do not belong to you, they are funds in trust. Don't assume you'll be entitled to them. Look to state law, security deposits are usually for damages beyond normal wear and tear, not for rents, not to clean, not to market a unit, but for damages.

Best practice, give a receipt for the deposit with a disclosure of state law defined as to what is covered then deposit those funds in an Escrow Account and then follow escrow accounting guidelines and state law as to management of the account. Often, you can agree to an interest bearing account with interest retained by the holder for maintenance of the account and bookkeeping expenses, the account may not be required to be an escrow account by the depository but will be on your books. Deposits are a liability on your balance sheet to offset cash accounts, you owe it.

State law and local custom dictate collection, holding disbursements and charges allowed to security deposits, a conversation with a RE attorney is best practice.

You may want to consider a rent deposit if allowed and agree that rents or other losses may be covered by that deposit, what you call things in RE is important, but again, ask your attorney. :)

Kevin Greer · Answer

Thanks everyone for the excellent advice on Security Deposits.  This was very helpful advice will research Colorado law and apply these practices!

Kathleen Leary · Answer

This state does not require that any earned interest be passed onto the tenant, although it can be. In my mind, it's like an escrow account: it sits there for one specific purpose, & only when called for. It's not my money until move-out (if the situation warrants).

I would advise that deposits be increased as rents go up (as allowed by law; every state is different); otherwise, you may be stuck with a big deficit at the end of a tenancy. When the rent increases, you might spread the increase to the deposit over 3-4 months for a good tenant.

Michele Fischer · Answer

In Washington state, it has to be in a separate account, it can be interest bearing, and we are not required to pass the interest to the tenant.  We have our deposits all together in one isolated savings account with a clear accounting of ins, outs, and what deposits make up the current balance.  Regardless of how large, security deposits are not the funds of the landlord, and need to be treated as such.  They need to be readily available in case of sale of property or move outs.  It doesn't bother me that the money is just sitting there idle, because it's not my money to invest with.

Thomas Weir · Answer

@Kevin Greer

You may want to consult with an RE attorney to verify what Colorado requires. Here in FL the deposit would have to be in a non interest bearing account. Most  have a different account for each property.

What are best practices for Rental Security Deposits?

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