Accounting for Security Deposits: The Escrow Guide

In property management, handling tenant security deposits is one of the most legally regulated accounting tasks. In many states, landlords are required to hold deposit funds in a separate bank account, interest-bearing escrow, or trust account, and are strictly prohibited from co-mingling deposits with operating funds.

A common landlord mistake is recording security deposits as income when received, and as an expense when returned. This is incorrect and violates double-entry principles.

In this article, we'll explain how to properly account for security deposits throughout a lease lifecycle.

The Core Concept: A Deposit is a Liability

When a tenant hands you a security deposit, it is not your money. It belongs to the tenant until they vacate the property and damages (if any) are assessed. Therefore, a security deposit must be booked as a Liability on your Balance Sheet.

You will typically use two accounts:

1. 1120 - Security Deposit Trust Cash (Asset): A dedicated bank account where the physical cash is held.

2. 2200 - Security Deposits Held (Liability): The liability account representing the obligation to pay this money back.

Step-by-Step Ledger Flow

Let's follow a deposit of $2,000 through a standard lease lifecycle.

1. Collecting the Deposit

When you receive the deposit at lease signing, you debit the trust bank account and credit the liability account.

Journal Entry:

• Dr 1120 - Security Deposit Trust Cash — $2,000.00
• Cr 2200 - Security Deposits Held — $2,000.00

Effect: Cash increases by $2,000, and liabilities increase by $2,000. Net income is unaffected.

2. Returning the Deposit in Full

When the lease ends and the tenant leaves the property in perfect condition, you return the money from your trust account.

Journal Entry:

• Dr 2200 - Security Deposits Held — $2,000.00
• Cr 1120 - Security Deposit Trust Cash — $2,000.00

Effect: Cash decreases by $2,000, and liabilities decrease by $2,000. Net income is unaffected.

3. Withholding for Damages

This is where accounting often gets messy. Suppose the tenant leaves a massive hole in the wall. You get a repair invoice from a handyman for $300 to fix it. Under the lease terms, you withhold $300 from the security deposit and refund the remaining $1,700.

To book this correctly, we must recognize the repair expense, recognize the reimbursement income, and clear the liability.

Step A: Record the repair expense (handyman paid from operating account)

• Dr 5010 - Repairs & Maintenance — $300.00
• Cr 1110 - Operating Cash — $300.00

Step B: Offset the expense by claiming $300 of the deposit as income

• Dr 2200 - Security Deposits Held — $300.00
• Cr 4090 - Other Income — $300.00

Step C: Transfer cash from Trust to Operating cash (to cover the expense)

• Dr 1110 - Operating Cash — $300.00
• Cr 1120 - Security Deposit Trust Cash — $300.00

Step D: Return the remaining deposit to the tenant

• Dr 2200 - Security Deposits Held — $1,700.00
• Cr 1120 - Security Deposit Trust Cash — $1,700.00

How Mogul Books Simplifies Deposits

In Mogul Books, you don't have to construct these complex multi-legged journal entries by hand.

When entering a transaction, you can pick the "Collected Deposit" or "Returned Deposit" intents. Mogul Books will automatically handle the mapping between your trust accounts and the liability ledger. If you deduct damages, Mogul Books' inline settlement form prompts you for the repair reference, automatically files the trust-to-operating cash transfers, and generates the balanced journal entries under the hood.

This keeps your escrow books perfectly aligned and ready for any regulatory audits.