Depending on your local regulations, security deposits may need to be kept in an interest- bearing account. Rules vary from state to state. If you're not sure, your best bet is to check with your local real estate commission or licensing entity to see what you need to do to stay in compliance.
There are two common scenarios for handling security deposit interest:
Adding interest on a security deposit to a lease ledgerShowHide
In this scenario, security deposit interest needs to be paid to tenants and the cash is kept in an interest bearing bank account. The total liability grows over time as interest is added.
To record this interest:
- Create an equity account called security deposit interest equity.
- Use your monthly bank statement to determine how much interest was earned during the month. For example, a total of $10.00 was earned in July.
Of that total amount, calculate how much interest should be applied to each lease. For example, $1 of interest per each of ten properties.
Not sure how to allocate the interest? Try the Rent Roll report for a lease-by-lease breakdown of deposits held.
- Enter the interest as an Other Deposit Item in a bank deposit. Add one line item per lease. (If it's easier, you can add one line item per property instead.)
- On each lease, add a charge for security deposit liability. This charge should total the amount of interest that was earned. For example, the lease on 100 Main Street earned $1 in security deposit interest this month.
- On each lease, issue a credit to offset the new charge.
- Choose the third credit option - for money previously deposited in the bank. Choose the security deposit interest equity as the offsetting account.
- Apply the credit to security deposit liability
- The amount of the credit should equal your total from step 5.
When you're done, double check to make sure that everything has been entered correctly:
- The total outstanding balance on the lease ledger should be unchanged to what it was before. For example, the tenant was caught up and owed nothing, then that should still be the case.
- The total security deposit liability should have increased by the interest amount. For example, if you held $1000 in security deposit before the interest and you added $1 in interest, the total security deposit should now be $1001.
Security deposit interest as a property expenseShowHide
In this scenario, security deposit interest needs to be paid to tenants, even though the cash is kept in a non-interest bearing bank account. Thus, only an expense needs to be applied to the books of the property. This scenario is especially common in areas where the security deposit is considered to be owned by the state and simply stewarded by the landlord or property manager.
To record the expense and update the lease ledgers:
- Create an expense account called security deposit interest expense.
- Calculate the amount of interest that needs to be paid to the tenant.
- Issue a credit on the lease ledger.
- Choose the second credit option - in exchange for goods or services. Choose the security deposit interest expense as the offsetting account.
- Apply the credit to Interest income.
- The amount of the credit should equal your total from step 2.
- Once the credit has been added to the lease ledger, issue a refund for that same amount. Use Interest income as the offsetting account.
When you're done, the total amount of security deposit should remain the same.