If you are a landlord, you are certainly taking a renter’s security deposit at some point. You may call it a damage deposit, security deposit, or just plain extra rent. In most cases, you will have to return all or some of it back to the renter at some point. And you have to return it correctly.
If you are going to be sued as a landlord, this is the number one reason why you will be sued, and you will likely lose.
States have various laws on how the deposit is supposed to be kept and how it must be returned. Here is how I do it in Minnesota.
Separate Rental Security Deposit Accounts
Some states mandate that you must keep the security deposit in a separate account for the tenant. In Minnesota, I do not have to do that. I can co-mingle the funds for any purpose I need to. Having said that, if you are minimally capitalized, you better not spend this money. It will be needed to give back to the tenant, or repair your unit after the tenant leaves.
If you have a 6+ figure, after-tax investment account, I am sure you can figure out a way to come up with a thousand dollars or two to return the security deposit to your tenant or repair your rental.
Using the Security Deposit for The Last Month’s Rent
A landlord can deduct from a security deposit any rent that has not been paid. Anytime. That is true whether it is the first month’s rent, or the last month’s rent, or anywhere in-between. They do not need the tenant’s approval to do so. A tenant in Minnesota is prohibited by law from doing so, unless both the tenant and landlord agree.
Once a tenant moves out, unpaid rent is damages and you take the unpaid rent (and damages) from the tenant’s damage deposit. Never let a tenant, or anyone else tell you that you cannot deduct unpaid rent from the security deposit. You can do it no matter what state you are renting in. It is a myth that is often spread by poor quality tenants to get out of paying the past month’s rent.
I have on occasion for a higher risk tenant, collected the last month’s rent upon move in. This works great until the tenant decides to move out. You use the last month’s rent you already collected for their last month in your rental. Then, the tenant may change their mind about moving out, and you need to collect the monthly rent. Guess what, a marginal tenant will not have the rent to replenish the security deposit.
You cannot evict, as they have paid rent from your deposit, and you are now in a risky position. You have a marginal tenant and a smaller deposit.
Do Not Get Fooled
I have (once) let the tenant use the security deposit for their next place’s deposit, when they moved out (to a different place that I did not own). It did not work out. There was no incentive to clean and remove all the tenant’s belongings. Do not do it.
Get a larger deposit rather than the last month’s rent. Do not call it any sort of rent. Keep the money until the unit is vacated. Never let a tenant move out without a security deposit they think will be returned. If you cannot get a larger deposit due to state law, you may then call it last month’s rent. But better yet, get a better tenant.
Wear and Tear vs Damages
You can certainly deduct for damages when a tenant leaves your rental. I always assume a judge is looking over my shoulder when I make deductions. If I cannot justify a deduction, I do not make it. I give each tenant a move out list, and I expect the unit to be 100% clean. If it is not, I deduct for cleaning.
If a tenant has lived in a place for over five years, and they ruin a carpet, it may not be damages. I use a 10-year wear warranty, and only put carpet in the bedrooms, so I expect my carpet to last a minimum of five years. Tenants are harder on the carpet than a home owner, and you can always benefit for new carpet in terms of renter quality, so do not wait until it is completely worn out to replace it.
If they have lived in the place for ten years, and the carpet is 100% worn out, even if it has stains and tears, it is considered wear and tear.
The number one thing I see in regards to broken appliances is broken refrigerator door shelves, handles, and butter doors. If a tenant has younger children, especially boys, this will likely happen if the parents do not watch their children close enough. It is surprising how much a refrigerator door shelf can cost.
No worries, just deduct the broken part from the damage deposit.
Charging for Your Own Labor
Some states prevent a landlord from charging the tenant for the landlord’s own labor. I suspect that it is because a landlord would technically earn the income and not claim the income on their tax return. I charge for my labor as part of my S-Corporation. It is a very small amount in the scheme of things. I deduct from the damage deposit for my time spent cleaning and repairing.
If you have a state that prevents you from charging for your labor, create a company and hire your own company to do the work. Set it up so it has minimal net profit, and it will not affect your taxes too much.
Adding Interest for the Tenant
In Minnesota, and many other states, I need to give the tenants a 1% return on their money. Take a deposit of $1,000, I need to send the tenants back $1,010 after one year, and $1,020 after two years.
Add the interest amount to the deposit, and then take any deduction.
Return the Renter’s Security Deposit on Time!
In Minnesota, I have 21 days to return the security deposit. The clock starts ticking when I get the keys, utilities have been transferred, or the end of the lease happens. No one will ever complain about getting their deposit back too early, and there is no benefit to waiting until the last minute. The cleaner a place is, the faster I give the deposit back.
Generally, returning the deposit is not a problem, but there are a few tricky situations.
A tenant pays rent for the entire month, and moves out on the 15th. The utilities are still in the tenant’s name. The tenant has relinquished keys on the 15th. I start the clock on the 15th.
A tenant moves out, and still has the keys and some belongings in the apartment. It is still their apartment, and you and they have to wait to return the deposit. The clock has not started.
Itemize All Deductions in Detail
If you are going to get sued as a landlord, the most likely cause will be for keeping too much of the security deposit, or not returning it fast enough. Use a form like this, and document all deductions. Make the charges reasonable, so a tenant will not want to sue you, and a Judge will not look at you with a “you are screwing the tenant” look.
You can email the form to the tenant, and send the money via PayPal, bill-pay, or other electronic means. Or you can snail mail it.
Have you ever kept some of a tenant’s security deposit, or have had a landlord deduct from your own deposit? What has your experiences been?