A security deposit on the balance sheet is an asset for the party who paid it and a liability for the party who received it. It never hits the income statement at the moment of the transaction, because no revenue has been earned and no expense incurred. The deposit stays at face value on the balance sheet until it is returned, forfeited, or applied against damages. Getting the placement wrong distorts working-capital ratios and misleads anyone reading the statements about actual financial position.
If You Paid the Deposit
Record it as an asset. You handed over cash, but you still hold a contractual right to get it back, and that right belongs on the asset side until the deposit is actually returned or lost.
The journal entry is a debit to an asset account (typically “Security Deposits” or “Other Assets”) and a credit to Cash for the same amount. Pay a $10,000 deposit on a new office lease and your cash drops by $10,000 while your deposit asset increases by $10,000. Total assets don’t change. The form of the asset does.
Don’t confuse a security deposit with prepaid rent. Prepaid rent is payment for a future service you’ll consume over time, and you expense it gradually across the months it covers. A deposit is not payment for services at all. It sits untouched on the balance sheet, never amortizing, until the lease ends. Expense a refundable deposit like prepaid rent and you’ll understate assets and overstate expenses for the period.
Under current lease accounting rules, refundable security deposits are excluded from the calculation of lease payments. A refundable deposit is not folded into your right-of-use asset or lease liability, because you expect the money back and it creates no long-term obligation or benefit tied to using the property. A nonrefundable deposit functions like any other fixed lease payment and is included in the lease liability calculation.
If You Received the Deposit
The accounting is a mirror image. Cash comes in, but you owe it back. That obligation is a liability, not revenue. Booking a received deposit as income is one of the more common small-landlord mistakes, and it creates problems at tax time and on the balance sheet at the same time.
Debit Cash and credit a liability account, often called “Security Deposits Held” or “Tenant Deposits Payable.” The liability stays on your books for the entire duration of the lease. You cannot move it into operating revenue until you have a legal basis to keep the funds, such as unpaid rent or property damage after the tenant leaves.
Many states require landlords to hold deposits in a segregated trust account, separate from operating funds. 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 both a legal risk and an accounting problem, because your cash balance then overstates what you can actually spend.
Current or Non-Current?
Where the deposit sits on the balance sheet depends on when you expect it to settle. Under GAAP, an asset or liability is current if it will be settled 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 twelve-month mark is what controls in practice. Certain construction and manufacturing companies have longer cycles, and in those cases the longer cycle governs.
A deposit tied to a five-year commercial lease belongs in non-current assets for the payer and non-current liabilities for the recipient. The cash isn’t expected to change hands for years, and putting it in the current section would overstate short-term liquidity or obligations. A deposit on a six-month equipment rental is clearly current.
The classification isn’t permanent. Once a long-term lease enters its final twelve months, you reclassify. The payer moves the balance from non-current assets to current assets. The recipient moves the matching liability from long-term to current. Skip this step and your current ratio will be off in the final year of the lease: understated for the payer, and understated on the liability side for the recipient.
When the Deposit Comes Back, or Doesn’t
Full Return
If the full deposit is returned at the end of the lease, both sides reverse their original entries. The landlord debits the Security Deposits Payable liability 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. No income, no expense.
Partial or Full Forfeiture
When the landlord retains some or all of the deposit, the retained amount shifts from a liability to income on the landlord’s books. Debit Security Deposits Payable to remove the obligation and credit a revenue account. The money is no longer owed back, so it’s earned income.
On the tenant’s side, 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, the loss is typically deductible in the year the forfeiture occurs.
Keep the supporting invoices and documentation tied to any deduction entries. Auditors and tax preparers will want to see that the amount recognized as income matches damages you can substantiate. Most states also require landlords to provide an itemized statement of deductions within a statutory window after move-out, often 14 to 30 days, and lump-sum deductions without itemization can forfeit the right to retain any of the deposit.
Writing Down a Deposit You May Not Get Back
A deposit sitting on your books as an asset assumes the counterparty will actually return it. That assumption needs periodic testing. If a landlord files for bankruptcy, stops responding, or shows other signs of financial distress, the deposit 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 landlord a few days late on a maintenance request doesn’t warrant impairment. A landlord entering 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.
Tax Timing Doesn’t Match Book Timing
Book treatment and tax treatment of a security deposit are not the same, and the distinction trips people up. For tax purposes, the IRS treats a refundable security deposit as not income when received, because the landlord may have to give it back.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses It becomes income only in the year the landlord gains the right to keep it.3Internal Revenue Service. Publication 527 (2025), Residential Rental Property But if a lease says the deposit will be applied to the final month’s rent, the IRS treats it as advance rent, taxable in the year received regardless of what the lease calls it. For the tenant, a refundable deposit is not deductible when paid, because nothing has been consumed. If the landlord later retains part of the deposit for legitimate damages, the forfeited amount may be deductible as a business expense in that later year.
Mistakes That Distort the Balance Sheet
- Expensing a refundable deposit at payment. It isn’t an expense. Recording it as one understates assets and overstates costs for the period.
- Recognizing a received deposit as revenue. The landlord overstates revenue and understates liabilities, and the tax treatment won’t match either.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses
- Forgetting to reclassify in the final year. A deposit that sat in non-current for four years has to move to current once the lease has twelve months or less remaining.
- Treating a “last month’s rent” deposit as refundable. If the lease says the deposit covers the final month, the IRS considers it advance rent, taxable in the year received.2Internal Revenue Service. Topic No. 414, Rental Income and Expenses
- Commingling deposit funds. Even where state law doesn’t require a separate account, segregating deposits keeps the accounting clean and prevents accidentally spending money you still owe back.