Security Deposit. Apartment. Show as Income?

Hi, Tom.

Taxpayers and the IRS have debated this subject for years, with the IRS usually winning. At least, that was the situation when I retired in the early '90s and I don't think it has changed. Check with your CPA for the current status.

The taxpayer's argument is that, "I have to pay it back some day, so it's not really income." The IRS responds with, "In most cases, the deposit never gets refunded, but gets applied to the last month's rent, so it's really just income collected in advance." The courts have gone both ways, but the last I heard, they were agreeing with the IRS nearly every time. Even if you might eventually win in court, do you want to spend your time (and lawyer and accountant fees) fighting the issue?

The deposit IS cash flow, of course, so record it in your bank account. And you need to keep track of which tenant has a claim on it, so you probably do want to have a Security Deposits account to keep that straight. But, at tax time, include the not-yet-refunded deposits in your income. And do claim a deduction when you do return a deposit.

But be sure to ask your own CPA for the current rules.

RC

Tom -for only three tenants, a separate account probably wouldn't hurt, but you might wish to check out the 'CLASS' classifications and learn how to use them. (Note: NOT CATEGORIES! CLASSES! Different animal. The catagory in fact might well be the same for all three. Some thing "Income:Advance Rent/Jones" and ""Income:Advance Rent/Smith"" etc. In the example shown, JONES and SMITH are the classes.)

Hi RC, Actually, the security deposit is not money that I'm supposed to use for anything. It's supposed to sit in an account and not be touched.

In looking at Q's Business Center I came across a liability account. How about entering a security deposit in that? I thinking of considering it a liability because I probably will have to return it. Any damage to the apartment can lead to an assessment of security money however.

Does making it a liability account make any sense?

That is the correct accounting treatment and terminology. I'm sure that's what RC meant when he said to use a Security Deposits account - it would clearly be a liability until the time that it either gets returned to the tenant, or applied to damages when tenant vacates.

vcard

Hi, vcard - and Tom.

Yes, that's pretty much what I meant. As I said, I've been out of the arena for a while and haven't watched recent battles between taxpayers and the IRS. But clearly segregating the Security Deposits in a separate bank account is one of the factors that would weigh in the taxpayer's favor. This would be seen as quite different from a landlord who puts the Security Deposits into the same bank account from which he pays the mortgage or the utilities and other operating expenses of the rental. And simply using the term "liability" in the name of the Quicken account is an indication of the way the landlord thinks of that money. That won't win the case all by itself, but it will help.

This is certainly not a new topic and there are tons of discussion of it in the tax library. It comes up in many contexts, not just rentals. Some of the key cases that I recall involved dues collected in advance by the AAA (American Automobile Association), membership fees collected in advance by a dance studio (Schlude), security deposits collected by a utility company (Columbus Gas - or was it Columbia Gas? I haven't thought about this in several years.) - and many landlords, both commercial and residential. Only those taxpayers who could show that such deposits were often refunded to customers stood any chance of success.

Maybe someone here has recently argued with the government about this topic and can bring us all up to date on the current status. Or ask the question in misc.taxes.moderated. Those tax gurus stay up to date. ;^}

RC

This does not required a long winded, detailed analysis. The answer is quite simple, and is clearly and concisely stated above.

Hi vcard,

OK, I'll put the security deposits into a liability account. I started off making a new liability account for each tenant, but I think I'll change that to one liability account and a seperate Catagory for each tenant. A Catagory in Quicken seems to be what is usually called an Account in Accounting lingo.

I wasn't sure if I was supposed to enter the security deposit as an Increase or a Decrease. If I enter the Security as a Decrease, the balance becomes positive so that seems like the right way.

Would that be correct? I'm wondering what is it in accounting theory that I'm Decreasing?

Getting a little further with this, I have assigned a Catagory for each tenants security deposit and I must select Income or Expense for it. So I have it entered as Income in a Business Liability Account.

Getting a little further with this, I have assigned a Catagory for each tenants security deposit and I must select Income or Expense for it. So I have it entered as Income in a Business Liability Account.

Hi RC,

If your interested, (trivia, curiousity?), here's the fact sheet on Security Deposits for Rent Stabilized Apartments in NYC.

couple of the salient points are that security is not to be appliedto the last months rent and must be kept in a bank account. Theydon't specify a seperate account but I think that would be wise.4 family homes like mine are not Rent Stabilized anyway, (6 units andup are), but I'm kind of going by what they have there as a guideline. I also put it in my leases that Security is not to be used for thelast months rent.

Regards, Tom

The other quesiton would be: What do/did you do with the security deposit?

Did you deposit it to your regular bank account with the first month's rent? (i.e., did you co-mingle it with your regular funds?)

OR, did you deposit it to a separate bank account, that contains ONLY security deposits, and that you don't touch until you refund it to the tenant or convert it to rent owed (and transfer it to your regular account)?

While these actions won't be "controlling", they will indicate how you considered the money at the time that you actually received it. And the second action presents a basis for the argument that you consider the monies to be a liability rather than income.

Hi, Tom.

Yes - and No. ;^}

The word "account" gets used in many different ways, both outside and inside the accounting world. When creating a set of books, we generally use 5 categories of accounts: Assets, Liabilities and Capital are "permanent accounts" that continue year after year. Income and Expense accounts are "nominal accounts" that get closed out at the end of each year. The difference between Income and Expense is Net Income (or Loss) and gets transferred into the owner's Capital account. Then we open new Income and Expense accounts to start the new year at zero again. But we don't zero out the permanent accounts, such as the bank balance, rental apartments, or debts, each December 31.

As it relates to this part of the discussion, accountants would choose between a liability account and an income account for your renters' deposits. But Quicken uses "account" to refer only to asset and liability accounts. Income and expense accounts are what Quicken calls "categories". So you must choose between a Liability Account and an Income Category, in Quicken-speak. If you put your deposit into a category, Quicken will treat it as income. If you put the deposit into a liability account, Quicken will recognize that you owe it to someone and will not count it as income.

Well, an accountant would tell you to "credit the deposits liability account" when you get a deposit. That would increase the amount that you owe to the tenant and that you must refund to him some day. But it also increases your bank balance. Maybe that's why accountants long ago began to use the terms "debit" and "credit" rather than "increase" and "decrease". ("Debit" and "credit" are from ancient words meaning "he owes" and "he trusts", respectively, and they still have those meanings in some parts of accounting; in other parts, they are just "terms of art".)

Asset accounts should normally show a debit balance; liability accounts normally have credit balances. A debit increases an asset account and decreases a liability account. But both assets and liabilities can go down as well as up, of course, and can even go below zero, in which case the asset may become a liability - and vice versa. When you receive a deposit, it increases your bank account (debit) and also increases your liability (credit) to the tenant. You also debit (increase) your bank account when you receive a rent payment, but the credit side in that case increases your Rental Income Category, rather than a liability account.

(That's probably enough accounting-speak for today. You don't want to read all that I learned in college and decades of practice!)

I'm not familiar with the Rent Control rules you mentioned in your other message, but they generally affirm what we've been saying: Make it clear that you regard the deposits as debt and not as advance rental income.

RC

RC, I certainly hope you are enjoying your retirement. Those of us not so fortunate wouldn't have time to write such a long post even during the two and one half months in between tax seasons .

Tom - Again, I'd use a CLASS, not a CATEGORY, for the individual tenants. Read the help file on the difference. Not sure if you saw my earlier post where I suggested this. Of course, how you do it is up to you, but CLASSES are what I believe you should be using for the same type of income but fordifferent 'people'.

================ Hi Andrew,

I saw your earlier post suggesting the use of Classes and actually I did go to the Quicken help files to read up about them; but I was a little disappointed to find there was very little explanation there, although there was some.

At the time, I thought classes might be better reserved for designating different properties rather than individual tenants. Quicken uses applying a seperate Class to different properties as an example of how to use Classes.

However, I don't have any other real property and don't forsee getting any in the near future. And after getting into it a little and actually making some entries, I think I see where using classes would probably be better. I will have to either increase my number of catagories or increase my number of classes, and since a Security Deposit account will have very little activity, why make more than one of them? I'll reenter it to one Catagory and several Classes.

Maybe if I have some expense exclusive to one tenant that class might be useful to segregate that too. I suppose I could also asign each tenants rent to their own class if I wanted to, but that is probably not important to track. Cheers, TomBk

I just thought of another question regarding security deposits.

Would it be appropriate to make an invoice for it?

I have a feeling that might throw it into an income account, whereas I want to put it into a liability account.

I just thought of another question regarding security deposits.

Would it be appropriate to make an invoice for it?

I have a feeling that might throw it into an income account, whereas I want to put it into a liability account.

I just thought of another question regarding security deposits.

Would it be appropriate to make an invoice for it?

I have a feeling that might throw it into an income account, whereas I want to put it into a liability account.

When you set up the invoice, set up an item that will feed to your selected liability account instead. Then, when tenant leaves, you would enter a negative quantity for your item to Refund, and then either (a) pay it out to tenant, or (b) receive it as income (another invoice would be required) as appropriate.

vcard