How to Set Up an Escrow Account for a Security Deposit

If you own a rental property, you'll need to follow state laws regarding security deposits.
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When you own a rental property, there are a number of legal requirements by which you must abide. Depending on your state, you will need to comply with laws and guidelines concerning tenant privacy, rent collection and eviction processes. One thing you’ll definitely want to do to make sure you comply by your state law is open a separate account to hold your tenants’ security deposits.

Opening an Escrow Account

An escrow account is essentially a bank account wherein a neutral third party holds funds for safekeeping. During the home-buying process, an escrow account is used to hold closing funds until all the requirements of the transaction are met. Likewise, if you’re a landlord, the escrow account will hold the security deposit money until the appropriate time for disbursement -- when your tenant has moved out. Your bank or credit union can help you set up an escrow account. You’ll need a copy of the lease agreement for each tenant that details the security deposit collected. Depending on your financial institution, you may need to bring other paperwork or identification forms with you.

Holding Funds

Because security deposits do not belong to you as the landlord, in many states you are required to keep them in a separate account. Some states require these separate accounts to be escrow accounts while others simply mandate that the funds are held in an account that does not co-mingle with your personal money or corporate accounts if the property is owned by a corporation. Regardless of your state laws, you’ll be required to account for the security deposit at the end of your tenant’s lease, so it’s a good idea to keep these funds in a secure and separate account.

Returning the Deposit

When the terms of the lease are up or your tenant moves out, you’re required to return their security deposit, less any valid claims on the money. Depending on your state, you may be required to conduct a formal walkthrough of the property with your tenant to ascertain deductions from the security deposit. Some of the most common security deposit deductions are owed rent, charges agreed upon in the lease and significant damage above normal wear and tear. Your state will stipulate how long you have to return your tenant's deposit, but it’s usually somewhere between 10 and 60 days.

Explaining Deductions

In most states, if you deduct funds from a security deposit to cover back rent, cleaning, damages or other charges, you’re required to give your tenant a written explanation of these charges. Your explanation should list specific charges and include receipts if applicable. In the event that your deductions exceed the deposit funds, you’re still required to send your tenant the written accounting explanation within your state’s time frame, even if you will not be returning any money.

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