New Jersey Security Deposit

[Andy R.]

I have a rental propert located in Nj. and I am in the eviction process with a tenant. I do not have their security deposit in a separate account and they just sent me a letter a few days before the court hearing telling me to use the security deposit funds towards back rent / lawyer fees. I have a couple of questions  -

1. Its a 3 unit property and its owner - occupied which I thought by state law I did not have to separate the security deposit from my savings account? I read that the tenant can send me a 30 day notice asking me to receive the Act's protection. I am understanding that wrong? 

2. If they send me that letter dont I have 30 days to correct that situation before they can use their security deposit funds towards rent / lawyer fees? 

3. Am I out of options?