Security Deposit Accounting: Journal Entries and a Worked Example

Security deposit accounting is the set of entries that keeps a tenant’s deposit on your books as money you owe, from the day it arrives until the day it is refunded or lawfully applied. Most mistakes come from one shortcut: booking the deposit as rent. This playbook shows the journal entries for each stage (receipt, holding, interest, move-out deductions, and refund), a worked example where every entry balances, and the monthly reconciliation that proves the deposits are all there.

Why a security deposit is a liability, not income

A refundable deposit belongs to the tenant until the lease ends and you either return it or keep part of it under the lease terms and your state’s rules. Until then, it is an obligation. In the general ledger that means a liability account, usually called Security Deposits Held or Tenant Deposits Payable, with a matching cash balance.

The tax side follows the same logic. IRS Publication 527 says not to include a security deposit in income when you receive it if you plan to return it at the end of the lease. If you keep part or all of it because the tenant does not live up to the lease, the amount you keep is included in income in the year you keep it. That is general guidance, not advice for your return, so confirm the treatment with your CPA.

Two consequences for your books:

• Rental income is never credited when a deposit arrives.
• The deposit liability (deposits held plus any interest owed to tenants) should equal the cash you hold for deposits at every month-end. If it does not, something is wrong.

Security deposits vs. prepaid and last month’s rent

Landlords often collect first month’s rent, last month’s rent, and a security deposit at move-in. Only one of those is a security deposit.

The tax treatment of prepaid rent is different from the deposit. Publication 527 says advance rent is included in rental income in the year you receive it, regardless of the period it covers or your accounting method. It also says that if an amount called a security deposit is to be used as a final payment of rent, it is advance rent. So a landlord who keeps accrual books will carry last month’s rent as a liability for bookkeeping, and the CPA will typically pick it up as income in the year received when preparing the return. Keep it in its own account so that adjustment is easy to see.

Some states also regulate last month’s rent (receipts, interest, or both), so check your state’s rules before deciding where it is held.

The security deposit journal entry at each stage

These are the standard entries for a landlord who holds deposits in a separate deposit account. Account names will vary with your chart of accounts.

1. Receipt. Debit Security Deposit Cash, credit Security Deposits Held. Deposit the check straight into the deposit account, not into operating.
2. Holding. No entry. The liability sits unchanged, and you reconcile it to the bank every month.
3. Interest, where required or where the account earns it. If the interest belongs to the tenant, debit Security Deposit Cash and credit Deposit Interest Payable when the bank credits it. When you pay it to the tenant, reverse those accounts. If your state sets a rate that differs from what the bank actually pays, ask your CPA how to record and report the difference.
4. Move-out deductions. Debit Security Deposits Held, credit Damage Recovery (an income account) for the amount kept. Record the repair bill as an expense when you pay it, and transfer the kept amount from the deposit account to operating.
5. Refund. Debit Security Deposits Held (and Deposit Interest Payable, if any), credit Security Deposit Cash.

Worked example: one deposit from move-in to refund

A tenant signs a 12-month lease starting June 1, 2025. At move-in she pays $2,000 for June, $2,000 for last month’s rent, and a $2,000 security deposit. The landlord keeps accrual books and holds the deposit in a separate account. The deposit account earns $20 of interest over the lease, which in this example belongs to the tenant. At move-out on May 31, 2026, the landlord keeps $350 for a damaged door and broken blinds (documented, beyond normal wear) and refunds the rest.

Each entry balances on its own, and the totals match. Now check the ending balances:

• Security Deposit Cash: $2,000 + $20 - $350 - $1,670 = $0
• Security Deposits Held: $2,000 - $350 - $1,650 = $0
• Deposit Interest Payable: $20 - $20 = $0
• Prepaid Rent: $2,000 - $2,000 = $0

The tenant gets a $1,670 refund ($2,000 deposit, plus $20 interest, minus $350 kept). The $350 kept and the $350 repair offset in the income statement, and the deposit account is empty once the tenant is paid. The deadline and paperwork for the refund are set by state law, so the timing in a real file depends on where the property is.

Security deposits in trust accounts (property managers)

When a property manager holds the deposit, the entries are the same idea with one more layer: the money belongs to the tenant, the property belongs to the owner, and the manager owns neither. In a property management system:

• The deposit is posted to the tenant’s ledger inside the trust account, and the trust account’s liability to tenants goes up by the same amount.
• A deduction at move-out moves money from the tenant’s deposit to the owner’s ledger, where it offsets the repair bill the owner pays. It is not the manager’s income.
• The refund comes out of the trust account, and the tenant’s deposit ledger goes to zero.

Run the worked example below through a trust account and it looks like this: the $2,000 deposit sits on the tenant’s ledger in trust. At move-out, $350 moves from the tenant’s deposit ledger to the owner’s ledger and pays the $350 repair invoice from the owner’s funds, and the remaining $1,650 plus the $20 interest ($1,670) is refunded to the tenant from trust. The owner statement shows $350 of damage recovery and $350 of repairs. The manager’s own operating books show neither.

Some owners hold their own deposits instead of leaving them with the manager. Whichever it is, write it down in the management agreement and make sure the books show who holds what. If you want the bigger picture of how trust money is tracked, our guide to real estate trust accounting covers commingling, owner and tenant ledgers, and the monthly checklist, and the property management accounting guide shows how deposits fit into the monthly close.

State rules vary: where deposits are held and what interest is owed

Security deposit law is state law, and the rules differ on how much you can collect, where the deposit must be held, whether it earns interest for the tenant, what receipts you owe, and how fast it must be returned. Massachusetts is a strict example. Under M.G.L. c. 186, § 15B, a deposit must be held in a separate, interest-bearing account in a Massachusetts bank, beyond the reach of the landlord’s creditors. The landlord owes the tenant interest at 5% per year or the lower rate the bank actually paid. The deposit must be returned within 30 days after the tenancy ends, and any deduction for damage needs an itemized list sworn under the pains and penalties of perjury. Our Massachusetts security deposit law checklist walks through it.

Other states are looser, and some are stricter in different ways. Before you set up your accounts, check your state’s statute or ask a local attorney, then build the chart of accounts around what the law requires.

Monthly security deposit reconciliation to the bank

Deposits are easy to lose track of because nothing happens to them for months. A monthly reconciliation catches problems while they are still small. At each month-end, these three numbers should agree:

1. The bank: the deposit account’s statement balance, adjusted for deposits in transit and outstanding refund checks.
2. The general ledger: Security Deposits Held plus Deposit Interest Payable.
3. The tenant list: the total of every current tenant’s deposit (and interest owed), one line per tenant.

If they do not agree, look first for a deposit booked to rental income, a deposit put into the operating account, a refund recorded in the ledger but not cleared at the bank, a move-out deduction never moved to operating, or a former tenant still on the list. A short account is a serious problem, especially in a trust account. Find the cause, restore the funds, and document it.

For property managers, this deposit check is part of the monthly three-way reconciliation of the whole trust account. Our property management trust accounting services include security deposit tracking and three-way reconciliations, documented and ready for review. For tax preparation and planning, we work with trusted CPA partners, or with your own CPA.

Security deposit liability checklist

• A separate liability account for deposits, and a separate one for prepaid rent
• Deposits received straight into the deposit or trust account, never into operating
• A deposit list by tenant with move-in date, amount, account, and interest terms
• Interest recorded and paid on the schedule your state requires, if it requires one
• Move-out deductions documented with photos, invoices, and the itemized statement your state requires
• Refunds issued from the deposit account within the state deadline
• Bank, ledger, and tenant list reconciled every month, with the report saved

This article is general information, not tax or legal advice. Talk with your CPA or attorney about your situation.