Taxes From A To Z (2019): S Is For Security Deposit

It’s my annual Taxes from A to Z series! This time, it’s Tax Cuts and Jobs Act (TCJA) style. If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss under the new law, you won’t want to miss a single letter.

S is for Security Deposit.

If you’ve ever rented an apartment or a house, you’ve probably paid a security deposit. A security deposit is money that a tenant pays to a landlord at the start of the term of a lease. The rules vary for commercial versus residential properties, but in a typical residential lease, you’ll pay the equivalent of one or two months’ rent as a security deposit.

Here’s where things can get confusing. Because the amount of your security deposit is often keyed off of the amount of rent, we sometimes think of a security deposit as rent. But they are very different things. Rent is rent, and a security deposit is a security deposit. You can’t swap one out for the other unless the landlord and the tenant agree. So, you can’t skip a rent payment and assume that the landlord will apply the security deposit in its place and the landlord can’t just treat the security deposit as rent if you are late or don’t pay.

A security deposit is normally refundable when you move out, assuming that you didn’t cause damage to the property beyond the normal wear and tear, or break other conditions of the lease. That amount isn’t treated as income to the landlord when initially deposited (it’s considered a liability since it has to be returned). On the flip side, it’s also not treated as income to the tenant when the security deposit returned (it’s considered an asset since it’s owed to you). This is an important distinction because the term “refund” when the security deposit is returned may imply a taxable event when it is not. However, if the landlord keeps a portion of the security deposit, that amount is treated as income to the landlord (and the resulting expenses are deductible to the landlord in keeping with standard accounting practices).

In some states and localities, if the landlord holds a security deposit beyond a certain length of time, the security deposit must be kept in an interest-bearing account. If that happens, and the security deposit is returned to you at the end of the lease in addition to the interest, the interest is considered income to you. That’s the same result as if you had earned interest in your own bank account. Depending on the amount (and your landlord), the interest might be reported to you on a form 1099.

And there’s one more trick. Remember when I said that a landlord couldn’t just treat the security deposit as rent if you are late or don’t pay? However, if you both agree that the security deposit will be used as your final rent payment, that’s allowed. But the date on which the landlord makes the agreement is when the Internal Revenue Service (IRS) considers the rent paid – not in the month that the security deposit is applied towards the rent. So, for example, if you and your landlord decide in October 2018 that your security deposit will be used as your last month’s rent for January 2019, the rental payment is considered income to the landlord in 2018 – and not in 2019.

For more Taxes From A To Z^TM 2019, check out the rest of the series: