A security deposit is an asset for the party who paid it and a liability for the party who received it. It sits on the balance sheet at face value and stays off the income statement until the deposit is returned, forfeited, or applied against damages. Getting the classification wrong distorts working capital and misleads anyone reading the statements about your real position.
Recording a Deposit You Paid
When your business hands over a security deposit, you’ve swapped one asset for another. Cash left the account, but you hold a contractual right to get it back, and that right belongs on the asset side of the balance sheet.
The journal entry is a debit to an asset account (usually “Security Deposits” or “Other Assets”) and a credit to Cash. Pay a $10,000 deposit on a new office lease, and cash drops by $10,000 while the deposit asset rises by $10,000. Total assets don’t move. Only the form changed.
This is where a security deposit gets confused with prepaid rent, and the difference matters. Prepaid rent is payment for a future service, and you expense it as the months it covers go by. A refundable security deposit is not payment for services at all. It sits untouched on the balance sheet, never amortizing, until the lease ends. Expense a deposit the way you’d expense prepaid rent and you understate assets and overstate costs for the period.
Under current lease accounting rules, refundable security deposits are excluded from the calculation of lease payments. A refundable deposit is not factored into the right-of-use asset or lease liability because you expect the money back, so it creates no long-term benefit or obligation tied to using the property. A nonrefundable deposit behaves like any other fixed lease payment and gets folded into the lease liability.
Recording a Deposit You Received
If you’re the landlord or vendor collecting the deposit, the entries mirror the payer’s. Cash comes in, but you owe it back, and that obligation makes it a liability, not revenue. Booking a received deposit as income is one of the more common small-landlord mistakes, and it causes problems on the balance sheet and at tax time at once.
The entry is a debit to Cash and a credit to a liability account, often “Security Deposits Held” or “Tenant Deposits Payable.” That liability stays on your books for the entire lease. You can’t recognize it as operating revenue until you have a legal basis to keep the funds, such as unpaid rent or property damage after the tenant moves out.
Many states require landlords to hold these deposits in a segregated trust account, separate from operating funds. The rules vary by jurisdiction, but the accounting consequence is the same everywhere: restricted cash needs to be disclosed. Commingling deposit funds with your operating account creates a legal risk and an accounting problem at once, because your cash balance overstates what you can actually spend. States that mandate segregation often impose penalties for violations, sometimes double damages or statutory fines.
Current or Non-Current?
Where the deposit sits within the asset or liability section depends on when it will settle. Under GAAP, an item is current if it will settle within one year or one operating cycle, whichever is longer.1FASB. Summary of Statement No. 78 For most businesses the operating cycle is well under a year, so the one-year mark controls. Certain construction or manufacturing businesses have longer cycles, and in those cases the longer cycle governs.
A deposit tied to a five-year commercial lease is a non-current asset for the payer and a non-current liability for the recipient. Parking it in the current section would overstate short-term liquidity or obligations. A deposit on a six-month equipment rental is clearly current.
Classification isn’t permanent. Once a long-term lease enters its final twelve months, the deposit gets reclassified: the payer moves it from non-current to current assets, and the recipient moves the matching liability from long-term to current. Skip the reclassification and your current ratio is wrong in the final year of the lease.
Returns, Forfeitures, and Partial Deductions
Full Return
When the tenant leaves and the deposit comes back in full, both sides reverse the original entries. The landlord debits Security Deposits Payable and credits Cash. The tenant debits Cash and credits the Security Deposits asset. The balance sheet returns to where it was before the deposit existed, with no income, expense, gain, or loss recognized.
Partial or Full Forfeiture
Things change when the landlord keeps some or all of it. On the landlord’s books, the retained amount shifts from a liability to income: debit Security Deposits Payable to remove the obligation, credit a revenue account. The money is no longer owed back, so it’s earned now.
On the tenant’s books, the forfeited amount becomes a loss. Debit an expense account (something like “Loss on Deposit Forfeiture” or a general expense category) and credit the Security Deposits asset to reduce or zero out the balance. If the property was used for business, that loss is typically deductible in the year of the forfeiture.
Keep the supporting invoices tied to any deduction. Auditors and tax preparers will want to see that the amount recognized as income matches damages you can substantiate.
When a Deposit Becomes Taxable Income
The IRS draws a hard line between a refundable security deposit and advance rent. A refundable security deposit is not income when you receive it, because you may have to give it back.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses It becomes income only in the specific year you gain the right to keep it, whether that’s because the tenant broke the lease, damaged the property, or failed to pay rent.3Internal Revenue Service. Publication 527 (2025), Residential Rental Property
Advance rent is different. If a tenant pays what the lease calls a “security deposit” but the same lease says it will be applied to the final month’s rent, the IRS treats it as advance rent. You include it in income the year you receive it, not the year it covers.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses The substance of the arrangement controls, not the label.
For the tenant, a refundable deposit is not deductible in the year paid. Nothing was consumed. If the landlord later retains part or all of it for legitimate damages, the forfeited amount may be deductible as a business expense in that later year, assuming business use of the property.
From the landlord’s side, any portion kept for repairs is rental income in the year retained. If you deduct the repair costs on your return, you include the retained deposit in income for the same year. If you don’t deduct the repair costs, you don’t include the reimbursement in income either.4Internal Revenue Service. Rental Income and Expenses – Real Estate Tax Tips
When the Deposit Receivable Should Be Written Down
A security deposit sitting as an asset assumes the counterparty will actually return the money. That assumption needs periodic testing. If your landlord files for bankruptcy, stops responding, or shows other signs of financial distress, the receivable may be worth less than face value.
When recovery becomes doubtful, record an impairment loss: debit a loss account (such as “Loss on Impairment”) and credit the Security Deposits asset to write down the carrying value. If you later recover some of the funds, reverse the impairment to the extent of the recovery.
The judgment call is when to pull the trigger. A late maintenance response doesn’t warrant impairment. A landlord in receivership does. The standard is whether you have reasonable grounds to believe the full amount won’t come back. An overstated asset is worse than a conservative write-down you might reverse later.
Common Mistakes
- Expensing a refundable deposit at payment. It’s an asset, not a cost of the period.
- Booking a received deposit as revenue. It’s a liability until you have a legal basis to keep it, and the IRS agrees.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses
- Failing to reclassify from non-current to current when the lease enters its final twelve months.
- Treating a “last month’s rent” deposit as refundable. The IRS calls it advance rent and taxes it the year received.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses
- Commingling deposit funds with operating cash. Even where state law permits it, a separate account keeps the books cleaner and prevents spending money you owe back.