Security Deposit during sale of property

Ryan SpathBusiness Member

Real Estate Agent · Boise, ID · Member since 2017 · 557 posts · 374 votes

1y

You’re right—this is a fairly common issue when selling rental properties, especially with the security deposits already in play. It sounds like you're in a tricky position, balancing the fairness to the tenants, your past expenses, and the new owner’s interests. Here’s how you can approach it:

Security Deposit Allocation: The primary purpose of the security deposit is to cover any damages, unpaid rent, or costs related to tenant turnover, so you’ve already accounted for the expenses where the deposit would have been applied. If the deposit has already been used (for repairs or unpaid rent), then you're right to feel that you're not obligated to hand over the full amount to the new owner. Essentially, the deposit has already been "spent" in your case, even if the tenant hasn't been officially informed about the exact balance used.
Documenting and Adjusting the Deposit: What you could do is adjust the deposit amount to reflect the remaining balance owed to the tenant, after accounting for any damages or missed rent. This would be a fair way to pass on the deposit to the new owner without either you or the tenant feeling unfairly treated. You can present the new owner with an updated ledger showing the tenant’s current deposit balance, which should include any deductions for damages or rent arrears.
Liability Agreement: A liability clause, like the one you suggested, is a solid idea. You could draft an agreement that the new owner assumes the deposit but you remain liable for any disputes that arise related to the deposit, especially if the tenant claims they should have received more. This way, you're protected in case the tenant challenges the amount or you’re asked to cover the full deposit in the future. The agreement should also clarify that you're not transferring the liability for pre-existing issues, only the remaining balance of the security deposit.
Communicating with Tenants: It's always a good idea to be transparent with tenants. If you're planning to reduce the deposit based on repairs or unpaid rent, they should know. In some cases, tenants may be willing to negotiate or pay outstanding amounts, which could resolve the issue before the transfer to the new owner.
Legal Considerations: Double-check the state or local laws around the transfer of security deposits during a property sale. In many places, sellers are legally required to provide an accounting of the security deposit to both the new owner and the tenant. You might also want to ensure that the tenant is properly notified about the transfer of their deposit to the new owner, which is typically required by law in many jurisdictions.

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William WhitleyBusiness Member

Accountant · TN · Member since 2025 · 144 posts · 91 votes

1y

Hello, Alex,

First of all the sales contract should specify how to handle the security deposits.

That being stated, I am taking a different viewpoint than you on this. Yes, the security deposits in part are for covering damage done to the unit beyond normal wear and tear. However, in theory you are being compensated by the purchaser in selling the property, because presumably it is being purchased based on the condition of the property which, if those expenses have been incurred would mean you improved the condition via those repairs.

Typically, security deposits pass to the purchaser as part of the sale. As long as the deposits are still security deposits, the money doesn’t technically belong to you; the money belongs to the tenants. When you transfer those deposits to the purchaser, the money doesn’t belong to them either. It still belongs to the tenants. It is a liability on the balance sheet to the property owner. Only when the tenants are charged for the repairs and the charge is paid from the security deposit does it transfer from a liability to an asset at the time it is transferred from the company escrow account to the company general bank account

As such, I recommend you first look at the purchase agreement to see what it says about the handling of security deposits. Second, I recommend you get a legal opinion from your attorney, because as previously stated, security deposits while typically held by a property owner, are considered liabilities (other people’s money, i.e. tenants’ money in this case) until such time as they become assets due to a transfer to cover repairs and/or unpaid rent.

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Chris SeveneyBusiness Member

Moderator

Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes

1y

Quote from @Alex Martin:

I'm selling a chunk of my portfolio and in the process of handing over the security deposits to the new owner. There are several tenants that if they moved out tomorrow would not be getting a portion or any of their deposits back due to damages, they caused, which I've already repaired or from being short on rent some months.

In my mind, I've already incurred the expenses that are exactly what a security deposit is there for. So why would I give it to the next owner if it's already been allocated towards something and the tenant potentially get back something they otherwise would not have been entitled to simply because there was a sale of the property?

I'm sure this is not an uncommon issue, but I just was not sure how to best handle it. Across the entire portfolio it's not an insignificant amount of money, in the 10's of thousands. I wasn't sure if I should just update the deposit to what is still owed to the tenant and that's what I give the new owner and possibly sign something saying that if the tenant disagrees with that portion of it, I will still assume all liability for that?

Congrats on selling a portion of your portfolio. In regards to the deposits I look at it another way - you are selling the properties as-is based on current conditions and the contract states what happens to the security deposits.

As an owner I would not think i would be entitled to any of the deposits even if there was damage - this is one piece of the deal and how the deal was structured. f you felt you were due a part of it I would have included it in the asking price BUT would not reduce the tenants deposit as I am guessing by law you cannot do that without doing the physical repairs.

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Gregory SchwartzBusiness Member

Rental Property Investor · College Station, TX · Member since 2016 · 1k+ posts · 1k+ votes

1y

In our area, the standard practice is that the deposit amount specified in the lease should be transferred because that is technically the tenant's money and as long as they occupy the unit, the funds should stay with that unit. Additionally, we're required to provide documentation whenever a tenant’s deposit is used. For example, if I charge a tenant for damages incurred during their tenancy and use $200 of their $1,000 deposit, I ensure there is clear documentation and communication with the tenant. This documentation, when provided to a buyer, helps justify any discrepancies in the deposit amount.

**As a general rule, we don’t use security deposits for repairs while the tenant is still occupying the property. The deposit is intended to cover damages at move-out. If I allow tenants to use the deposit for damages during their tenancy, I won't have enough left to cover potential damages during the turnover.

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Security Deposit during sale of property

Security Deposit during sale of property

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