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Refunded Security Deposit

Posted by taxguru on February 15, 2008

Q:

Subject: Question about security deposit and 1099

We (the tenant) just received a 1099 for a refund of our security deposit (office space that we rented) from a previous landlord. It is my understanding that security deposit is not income to the landlord when received nor to the tenant when returned to the tenant. It would only convert to income if it is forfeited and that would be income for the landlord not the tenant.  Can you point me to some printed verification of my thought or tell me I am incorrect?

Thanks for your time


A:

How landlords treat the handling of security deposits is optional.

One way (and the technically correct way) is to book it when received into a liability account and not as income.  If it is later forfeited by the tenant, it is transferred from the liability account into the Rent Income account.  If it is repaid to the tenant, the check is posted to the same liability account as the deposit was and would thus not be a deduction from current year income.

Since that is a little too complicated for many people to keep track of, what is more commonly done in real life is for the landlords to use a more pure cash basis of reporting rental income and expenses.  Under this method, all monies received, including potentially refundable security deposits, are reported as rent income in the year received. Any security deposits refunded to tenants are then deducted as expenses in the year paid out.

As long as the security deposits are handled consistently under whichever method the landlord chooses, things will be fine.

This only applies to money specifically designated as security deposit and does not apply to any money paid by the tenant which is specified as Last Month’s Rent.  That is taxable income to the landlord in the year it is received, even though the last month could be several years away.

Here is an excerpt from Page 7-5 of the latest edition of The TaxBook, a reference source any good tax pro should have:

“Security deposits. A security deposit is not included in rental income when received if the property owner plans to return it to the tenant at the end of the lease. If any amount is kept during the year because the tenant did not live up to the terms of the lease, include that amount as rental income. If an amount called a security deposit is to be used as a final payment of rent, it is advance rent and is included as income in the year received.”

It seems like your landlord is probably using the second method of accounting for security deposits on his tax returns and is planning to claim the refund as an expense on his current tax return.

As your own personal professional tax advisor will most likely confirm, your treatment of the refunded security deposit on your tax return will need to be consistent with how you accounted for the original payment of that deposit.  If you followed proper accounting methodology and booked it into an asset account on your books, the refund will be posted to that same asset account and will not be income to you.

If, on the other hand, you deducted that payment as a rent expense, you will need to pick up the refund as either income or a reduction of the current year’s rent expense.  The latter would be the proper way to handle a refund of a previously deducted expenditure.

I hope this helps.  Your own professional tax advisor can give you more specific advice on this matter.

Good luck.

Kerry Kerstetter

 

Business Plan Pro

 

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