Security deposits are liabilities on your books, not income. You’re holding money that belongs to the tenant until they move out. Recording it as revenue when you receive it creates tax problems and misrepresents your financial position.

When you collect a deposit, debit cash and credit a liability account called Security Deposits Held or Tenant Deposits. The money sits there until the tenant moves out. At that point you either return it or apply some portion to unpaid rent or damages, and only the applied amount becomes income or offsets an expense.

California requires the deposit back within 21 days of the tenant vacating. If you deduct anything, you must provide an itemized statement showing what you kept and why, along with receipts for repairs or cleaning over $125. Miss the deadline or fail to document properly and you can be liable for the full deposit back plus up to twice the deposit amount in statutory damages under Civil Code 1950.5.

Deposit limits changed in 2024. Under AB 12, most California landlords can only charge one month’s rent as a security deposit regardless of whether the unit is furnished. Small landlords, meaning natural persons or LLCs owning no more than two residential properties totaling no more than four units, can still collect up to two months’ rent. The older rule allowing 2x rent for unfurnished units and 3x for furnished no longer applies to the majority of property owners.

Hold deposits separately from operating funds. California doesn’t mandate a dedicated trust account the way some states do, but keeping deposit money in its own bank account prevents you from accidentally spending it and makes reconciliation straightforward. If you own multiple units, tag each deposit to the specific property and tenant in your accounting system so you know exactly whose money is whose.

Only recognize deposit money as income when you actually apply it. A tenant leaves owing $800 in rent and you keep $800 from their deposit, that $800 becomes rental income. A tenant damages a wall and you withhold $300 for repairs, that offsets the repair expense rather than creating standalone income. Any remaining balance either gets returned within the 21-day window or stays on your books as a liability if there’s a dispute.

Landlords with more than a couple of units benefit from having this tracked systematically so nothing slips through the cracks. Our property management accounting work covers deposit ledgers, tenant billing, and the operating expense tracking that keeps rental books clean. If you’re a landlord or small property owner in the area, the Pasadena bookkeepers at A Squared Bookkeepers can set up your deposit accounts properly and keep you compliant with California’s move-out rules.