Security deposit deductions at move-out: how each one is booked, and when it becomes income
When you keep part of a security deposit, sort every deduction into one of three buckets: unpaid rent you already recorded, unpaid charges that were never booked, and damage costs. Rent already on the books is just cleared, while the other two become income in the year you keep the money under the IRS rule. The repair you then pay for is a separate expense, and it can fall in a different year.
The rule in one paragraph
Publication 527 says not to include a security deposit in income when you receive it if you plan to return it. If you keep part or all of it during a year because the tenant does not live up to the lease, include the amount you keep in your income in that year. The general entries for receiving and returning a deposit are in security deposit accounting. This post is about the day you decide what to keep.
State law decides what you may keep, how you must itemize it, and how many days you have to send the statement and any refund. Rules differ, and missing a deadline can cost you the right to deduct. Read your state's landlord-tenant statute and your lease before you finalize a statement.
Sort each deduction before you post it
| Deduction | What it is in the books | Income? |
|---|---|---|
| Rent already charged and recorded | Clears Rent receivable | No new income on accrual books; on cash books it becomes rent income when applied |
| Cleaning, a lock change or another charge never booked | New income, Deposits kept | Yes, in the year you keep it |
| Damage beyond normal wear | New income, Deposits kept | Yes, in the year you keep it |
| Normal wear and tear | Not chargeable in most states | No: it is your cost |
Ordinary wear (faded paint, light carpet wear) is usually the owner's cost of running a rental, not something the deposit covers, but the line between wear and damage is set by state law and the facts. Photos from move-in and move-out are what settle it.
One move-out, entry by entry
Example a made-up tenant in unit 2A leaves on November 30 with an $1,800 deposit. The owner finds $600 of December rent unpaid (already recorded as a receivable), $150 of professional cleaning, and $480 of carpet damage beyond normal wear. Deductions total $600 + $150 + $480 = $1,230, so the refund is $1,800 - $1,230 = $570.
Example the entry on the day the statement is sent: debit Security deposits held $1,800. Credit Rent receivable $600. Credit Deposits kept (income) $630, which is $150 + $480. Credit Operating bank $570 for the refund. Debits $1,800 equal credits $600 + $630 + $570 = $1,800. The rent was already income when charged, so only $630 is new income.
On cash books the $600 is also income at this point, because it was never received before. The tax result is the same $1,230 of income from the deposit in the year you keep it. Your preparer decides how it appears on the return.
The repair bill is a different entry, and maybe a different year
Keeping the deposit and paying for the repair are two events. The first creates income. The second is an expense, booked when you pay or owe the contractor, usually in repairs or cleaning.
Example the same made-up owner pays the cleaner $150 in December and the carpet contractor $520 in January. December: debit Cleaning and maintenance $150, credit Operating bank $150. January: debit Repairs $520, credit Operating bank $520. The $630 of deposit income is in the first year, the $150 expense is too, and the $520 expense lands in the next year. Keep the invoices with the move-out file.
Notice the $520 bill is higher than the $480 charged. You can only keep what your itemized statement supports; the extra $40 is your cost. Whether new carpet is a repair or an improvement that must be depreciated is a question for your tax preparer.
What the move-out statement should show
The statement is both a legal document and your support for the income you book. List each deduction on its own line with the date, the reason, the amount and the invoice or photo behind it. Show the deposit you held, the total deducted and the refund, so the three numbers add up on the page the way they do in your books. Keep a copy with the lease, the move-in and move-out photos and the vendor invoices. For the wear versus damage question, see our guide to normal wear and tear vs damage.
Send the statement and any refund within the time your state allows, and keep proof of when and how you sent it. Late or missing statements are where owners lose deductions they were otherwise entitled to.
When the damage is more than the deposit
If the costs exceed the deposit, the tenant may owe the balance. Record only what you actually hold and keep a note of the amount claimed. On accrual books the balance can sit as a receivable. On cash books nothing is income until it is collected. The IRS says a cash-basis owner does not deduct uncollected rent because it was never included in income; an accrual owner may be able to treat unpaid amounts as a bad debt. Our post on deducting unpaid rent covers this.
How DoorKeeping handles it
DoorKeeping keeps deposits held in the property's own books, apart from rent. At move-out you can see the deposit, unpaid charges and the work orders and bills tied to the unit in one place, and any money step, such as the refund, waits for your one-tap approval. DoorKeeping never holds the deposit; it stays in your bank. DoorKeeping gives no legal or tax advice, so check your state's deposit statute and your tax preparer.
Sources
Questions
- Is the part of a deposit I keep taxable?
- Under IRS Publication 527, if you keep part or all of a security deposit in a year because the tenant breaks the lease, you include the amount you keep in your income that year. Ask your tax preparer about your return.
- Can I deduct the repair if I already kept the deposit?
- The deposit you keep is income, and the repair you pay for is a separate expense. A repair is generally deductible when paid, though a big replacement may have to be depreciated. Your tax preparer decides.
- Can I keep money for normal wear and tear?
- In most states no, but the exact rule and your deadlines come from your state's statute. Read it before you itemize.