Is a refundable security deposit reported as rental income

[Howard1948]

From IRS Topic 414 re Rental Income:

Security deposits – Do not include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, do not include the amount in income if your practice is not to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant's final month's rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month's rent.

[Carl]

Basically, the rental deposit is NOT YOUR MONEY. It belongs to the renter until you make a written formal claim to it with a legal document you create referred to as a "Dissolution of Deposit".

[robertpilger]

Please furnish me a tax code reference # or other documentation that rental security(refundable) and a separate pet deposit (half of which is non-refundable)  is not to be included as income in the year received

[Carl]

Did you not see Howard's answer? Tax topic 414 on the irs.gov website. Just google it and read it yourself if desired.

[d609667]

Where on my tax form do I identify a $1,800 security deposit I fully intend on returning to my tennants? I assume if it's not entered somewhere in "expenses", I'll be taxed on the $1,800 as income. Tis confusion.

[Howard1948]

d609667 -- You do not include it anywhere.  As noted above, a security deposit that may be required to be returned at the end of the lease is not income.  Your comment about it being entered in "expenses" makes no sense.  It is either income or nothing and, based on your comments, in your case, for now, it is nothing.

[davesmilez]

Refundable security deposit is not rental income as all of the above comments have already noted, HOWEVER, it still MUST be included in GROSS INCOME.

Under the "claim-of-right" doctrine, payments must be included in gross income if the taxpayer receives them without restriction under a claim of right. The claim-of-right doctrine means you have unrestricted free and clear use of the funds. This is true even though you may have to repay all or a portion of the security deposit in the future.

If you have a property management company (which collects the payments from renters, deducts their ?10% fee and then forwards the remaining balance), it will send a 1099-Misc form at year end which would list that refundable security deposit as gross income for the aforementioned reasons.

[Carl]

You can actually do it either way, and it does depend on how the security deposit is handled. For me, security deposits I receive go into a non-interest bearing account, that for the life of me I can't recal what you call that type of account. There are only two ways to get that money out of the account.
 - When the renter moves out, I refund it to them out of my existing funds and provide proof I did so. The bank then releases the funds to me. Otherwise, the bank will cut the check payable to the tenant and mail that check to the last known address of the tenant, when either I or the vacating tenant provide the bank the "Termination of Lease" notice.
 - If I have a claim against the deposit, I must go through the process of notifying the tenant of my claim within 15 days after the end of the lease, or the tenant vacates the property - whichever is last. The tenant has 30 days to challenge my claim. If not challenged then the bank will cut me a check for the amount of my claim. If my claim is not for the entire deposit, the bank cuts a 2nd check for the difference and sends it to the vacated tenant at their last known address.
Now when I place claim on a deposit I do have to include it as rental income. But that's okay, since I will be offsetting the taxability of that income with the repairs/damages I am using that money to pay for. So in the end, it's a wash.

[dedwards]

A security deposit held during a rental would be "unearned revenue", a current liability (if a one year lease).  If you end up keeping the security deposit, reverse the "unearned revenue" (by debiting the the current liability) and offset with a credit to rental income.  If you return the security deposit, reverse the "unearned revenue" (by debiting the the current liability) and offset with a credit to cash.

[Carl]

Actually, a security deposit is not "your" money. It belongs to the tenant and the landlord holds it in escrow. It is not included as income for the landlord since legally speaking the landlord is just holding it "on behalf of the tenant" and a security deposit. While the landlord retains control of said deposit, the landlord has no legal claim to it until such circumstances arise that legally entitle the landlord to it.
For example, tenant's early termination of lease, or damages the tenant is responsible for, yet does not pay for.
Upon termination of the lease, if the landlord returns the security deposit to the tenant then nothing concerning said deposit is reported anywhere. However, if the landlord retains all or part of the deposit for any reason upon lease termination, then it's reported as rental income in the tax year the landlord lays claim to the deposit and if challenged on the legal front, retains what they claim.
Generally landlord claims to a security deposit (or portion of it) is for damages the tenant was responsible for, yet did not pay for. So the taxability of the amount of the deposit claimed and reported as rental income is offset by the cost of the damages it is used to pay for.

[PJTaxesU]

This is a part where the tax code differs from the law and in which neither of the aforementioned agree with GAAP.

I believe a best practice to apease all the government and professional association acronyms, is to treat the deposit as income in the year received and expense in the year returned. 

If you do intend to hold the deposit in unearned income per your landlording books and carry that treatment to the tax return, make sure the deposit is held in a separate interest bearing account that is set up with an escrow.  The interest earned should be credited to the tenants account ledger annually at a minimum.  When the tenancy terminates, send the reconciliation of their deposit, their refund check (or likely bill), and a timely form 1099INT for the amount of interest that their account accrued over their tenancy (if the tenant stays for multiple years, the 1099INT filing should align with entries to the tenants account ledger i.e. if crediting tenant account annually, send a timely form 1099INT for the interest earned each tax year.)

Additionally all of this should be double checked against some seriously stringent local statutes that vary widely at the city to city level, which landlords would be wise to head avoiding trouble with fair housing authorities and the like.

The above scenario has worked well in my experience in several California Counties, the state of Nevada, Texas, and various international outreaches.