Follow Eight Rules for Proper Handling of Security Deposits

As an assisted site owner or manager, you must collect security deposits from all households when they move in. These security deposits protect you from losing money when residents damage your units or fail to pay rent. However, handling security deposits incorrectly can cost you.

HUD imposes strict requirements on how you collect and maintain security deposits. When HUD auditors visit your site, they will check that you have followed various rules. According to the multifamily housing chapter of the HUD Consolidated Audit Guide, auditors will check that a site’s security deposits are kept in appropriate accounts and that disbursements from the security deposit account is only for refunds to tenants and for payment of expenses incurred by or on behalf of the tenant, not to exceed the amount to which the tenant is entitled. Auditors will check that all disbursements have supporting documentation and whether state and local government specific regulations governing the handling of tenant security deposits are followed [HUD Handbook 2000.04, par. 3-25 (L)]. If auditors find that you have not followed the rules, you could be charged with serious offenses, such as “equity skimming” and “misappropriation of funds.”

We’ll cover the basic rules for collecting and maintaining security deposits, to help you avoid making common mistakes and to remain in compliance with HUD requirements for handling security deposits. These tips can help you avoid legal trouble with HUD and the courts.

Rule 1: Determine Correct Amount of Security Deposit

Owners can reject applicants who are unable to pay the security deposit at move-in [HUD Handbook 4350.3, par. 6-15(J)]. Alternatively, owners can allow residents to pay the security deposit in installments [HUD Handbook 4350.3, par. 6-15(A)]. Regardless of whether you allow installment payments of security deposits, you need to know the correct amount to collect.

The deposit you can charge to your residents depends on several factors, including the type of assisted site involved, the date the housing assistance payment (AHAP or HAP) contract was signed, and the amount of the residents’ total tenant payment [HUD Handbook 4350.3, par. 6-15(E)]. A chart indicating the security deposit you should charge for the different types of assisted sites can be found in HUD Handbook 4350.3, Figure 6-7.

Rule 2: Keep Separate Bank Accounts for Each Site

If you own or manage more than one site, be sure you open a separate bank account for each site’s security deposits. The account must be opened in the site’s name—for instance, “ABC Apartments Security Deposit Account.”

The account can hold only security deposit funds; you can’t mix the security deposit funds with funds from any other source. For example, you must not put deposit funds that belong in the site’s reserve for replacements account into the security deposit account [Handbook 4370.2, par. 2-9 (A)].

Rule 3: Keep Bank Account Balance Below FDIC Limits

The balance in the security deposit account may not exceed the FDIC insurance limit. Therefore, if you collect more than the FDIC limit in security deposit funds at a particular site, you’ll have to open security deposit accounts at more than one bank to ensure that the account balances remain below the FDIC limits.

Also, because the security deposit account balance is constantly changing as residents move in and out throughout the year, you must remain watchful and make sure that the balance doesn’t go over the FDIC limit at any time [Handbook 4381.5, par. 6.47(b); Handbook 4370.2, par. 2-9(A)].

Rule 4: Follow Applicable Interest Payment Rules

Owners must comply with state and local law as well as HUD rules regarding interest on security deposit accounts. This can be tricky because the rules differ for the various types of assisted sites. Each state and many municipalities have their own rules regarding security deposits and whether they go into interest-bearing accounts. According to legal precedent, whichever rule is most beneficial to the resident is the one that prevails.

Unless state or local law requires an earlier distribution, you must invest security deposits in an interest-bearing account and pay accrued interest to households at move-out for the following Section 8 sites [Handbook 4350.3, par. 6-17(B)]:

• Section 8 New Construction sites with HAP contracts signed on or after Nov. 5, 1979;
• Section 8 Substantial Rehabilitation sites with HAP contracts signed on or after Feb. 20, 1980;
• Section 202/8 sites;
• Section 202 PRAC sites; and
• Section 811 PRAC sites.

In addition, for Section 202 properties with Section 8 or PAC have additional requirements for allocating interest and maintaining records. For these sites, the owner must maintain a record of the amount in the segregated interest-bearing account that is attributable to each tenant. The owner must also allocate interest accrued on the tenant’s security deposit on an annual basis and when a tenant vacates the unit. And, finally, unless prohibited by state or local law, the owner may deduct, from the accrued interest attributable to the tenant for the year, the administrative cost of computing the allocation of interest to the tenant’s security deposit balance. The amount of the administrative cost must not exceed the accrued interest allocated to the tenant’s balance for the year [HUD Handbook 4350.3, par. 6-17(C)].

Rule 5: Keep Account ‘Adequately Funded’

Collecting security deposits ensures that you won’t get stuck paying for unit damage or unpaid rent when a resident moves out. However, if residents don’t owe you any money for damage or rent when they move out, you must refund their security deposits.

Auditors who visit your site check whether your security deposit accounts are “adequately funded” to provide required refunds. Your security deposit account balance should at all times equal the total amount you collect from all of the residents currently in occupancy, and any accrued interest (if required).

Thus, the security deposit funds you collect should be deposited in the security deposit account and not used for other purposes. This ensures that you’ll always have the funds to cover refunds at resident move-outs.

Rule 6: Keep Proper Books, Records for Your Accounts

You must record security deposits in your site’s books to show the amount you’ll have to refund to residents as a liability. Two ledger entries are required:

1. Enter the amount of the security deposit you receive as a site asset in account 1191 on HUD’s Chart of Accounts. Remember that you hold this asset “in trust” for the resident and will refund it to the resident at move-out if she doesn’t owe you money.
2. Enter the amount of the security deposit as a corresponding liability in account 2191 [Financial Assessment Subsystem – Multifamily Housing Programs, Appendix A].

When you refund security deposits to residents, deduct the amount of the refund from both accounts above.

Rule 7: Track Monthly Account Activity

Although it’s not a requirement for every type of site, the handbook suggests that you keep a record of the amount in the security deposit account attributable to each resident [Handbook, par. 6-17(D)].

It’s also a good idea to keep a detailed monthly activity record to follow the deposits and withdrawals made in your security deposit account. Regularly keeping track of the activity in the security deposit account will help you make sure that your account is properly funded and allow you to catch mistakes before the auditors do.

You can keep a monthly activity record similar to a personal checking account record. Each month, record the deposit of any security deposit funds, specifying the name of the resident and the amount of the deposit—for example, “Jane Smith, $150 security deposit paid at move-in.” Record on a separate sheet all the withdrawals from the account, specifying the name of the resident, the reason for the withdrawal (for example, “Refund of John Doe’s security deposit at move-out”), and the amount of the withdrawal.

In addition, record the interest earned on security deposits that month on the monthly activity record.

Rule 8: Reconcile Bank Balance with Ledger Entries

When auditors visit your site, HUD requires them to check the current balance in your security deposit bank account. They’ll perform a “reconciliation”—that is, they’ll compare the bank account balance with your ledger entries. If the bank balance doesn’t at least equal the liability listed on your ledger, the bank account is underfunded.

To ensure proper funding, compare your bank balance and ledger entries each month when you get your monthly bank statement. This way, you can find any errors immediately and correct them before they cause problems.