Security Deposits: How to Record Them Correctly in Your Books

Security deposits are one of the most commonly mishandled items in rental property bookkeeping. Most landlords either record them as income when received or ignore them entirely until a tenant moves out. Both approaches are wrong, and both create problems at tax time. Proper handling is a core part of property management accounting.

Here’s the correct way to handle them.

Why Security Deposits Aren’t Income

When a tenant pays you a security deposit, you don’t own that money. You’re holding it. If the tenant leaves the property in good shape, you return it. That makes it a liability, not income, the same way a loan you receive isn’t income.

Recording a deposit as rental income overstates your revenue and means you’ll owe taxes on money that isn’t yours. When you return the deposit, you then have an outflow with no matching expense, which makes your books look worse than they actually are.

The Correct Setup in QuickBooks

You need two accounts:

Security Deposits Held: a current liability on your balance sheet. This account increases when you receive a deposit and decreases when you return it.
Security Deposit Income: an income account used only when you keep all or part of a deposit because a tenant caused damage beyond normal wear and tear.

Here’s how each scenario plays out:

When you collect a deposit: Debit your bank account (money comes in), credit Security Deposits Held.

When you return a deposit in full: Debit Security Deposits Held, credit your bank account (money goes out). No income, no expense. It’s a wash.

When you keep part of the deposit for damages: The portion you return is handled as above. The portion you keep is moved from Security Deposits Held into Security Deposit Income, because at that point, it’s actually yours.

When you pay for repairs using withheld deposit funds: Record the repair as an expense under Repairs and Maintenance. The withheld amount becomes income, and the repair is a deductible expense that offsets it.

Keeping Deposits in a Separate Bank Account

Many states require landlords to hold security deposits in a separate account, not commingled with operating funds. Even where it’s not required, this is good practice. It makes reconciling easy, prevents you from accidentally spending money that belongs to a tenant, and keeps your books clean.

In QuickBooks, set up a separate bank account called something like “Security Deposits Trust” and make sure it connects to your Security Deposits Held liability account, not to your regular income.

What Happens If You’ve Been Doing It Wrong

If you’ve been recording deposits as income, you’ll need to reclassify them. This typically means:

Identifying which deposits are still outstanding (tenants who haven’t moved out)
Moving those amounts from an income account to the liability account
Making sure the bank balance in your deposit account matches the liability balance

This cleanup can be done at any point, though catching it early is much easier than untangling years of misclassified transactions.

Handling deposits correctly keeps your income statements accurate, your balance sheet meaningful, and your CPA’s job straightforward at year-end. It’s a small detail, but it’s one that shows up on every set of books we review. For more on keeping your rental records tight, see our guide on rent roll reconciliation.

If you’d like a second opinion on how your deposits are being handled, book a free consultation and we’ll take a look.