Yes, you must pay them the interest. It is not your income if you are giving it back.

Sorry, this didn't answer my question. If I am planning on giving the money back, and it is not my income, then I should NOT report it as my taxable income. Is that correct?

Correct.

So I have the same exact question. Only I have over $70,000 in security deposits gaining interest. State requires this to be returned with interest if Tenant occupies the property for a year or longer only. So I don't always have to return it with interest. So the bank has sent me a 1099- INT showing over a $1000 interest payment for 2019. I assume I need to report all this as income. So my question is how do I record the portion of this that I had to pay back to Tenants? For the purpose of this question let's just say I had to pay back $500 of that thousand to Tenants this year. 

Landlords with over a certain number of rental units are obligated in most locales to pay interest on the deposits to tenants each year. 

 

Since the interest earned is claimed as income by the landlord, such paid interest is usually tax deductible as an expense.

 

When all or part of the security deposit is taken for rent or repairs, it becomes income to the landlord. 

Thanks for the info. I should have clarified further. I know the expense is deductible, but what would the title for this expense be? Is this something I just have to enter as a "other business expense" and provide a description for? Far as I can tell none of the default expense options in turbo tax cover this type of expense. 

You can put it under Miscellaneous or you can use Other Business Expenses.

Someone needs to pay the tax on the interest earned.

 

Since the landlord is holding the security deposit account in their custody, they will very likely be the one to pay the tax on that interest reported on a 1099-INT.

 

With that said:

 

1. Is it reasonable for the landlord to deduct the cost of taxes from the balance in the security deposit account? (e.g. $1,000 security deposit, earns $10 in Interest = account balance of $1,010. $4 in taxes due, seems reasonable the landlord pays these taxes out of the $1,010 due to the tenant? The interest is due to the tenant ultimately but so should the tax on that interest?)

 

2. How does one actually calculate how much tax was paid on the interest? It will be subject to the landlord, not the tenant's marginal tax rates and the impact of that 1099-INT gets mixes in with everything else the landlord is paying tax on and thus it's not very intuitive to know how much tax the landlord paid against that 1099-INT specifically. The only way I can think of doing is for the landlord to finalize their entire federal and state tax returns and run the SW both with and without this interest to see what the difference is in tax liability. Any other thoughts?