The most important thing to understand is that security deposits are not your money. They belong to the tenant until the lease ends and you determine whether any deductions apply. This means they’re recorded as a liability on your books, not as income.

When you receive a security deposit, record it as a credit to a liability account called Security Deposits Held or something similar. The debit goes to your bank account. Your profit and loss statement shouldn’t be affected at all because this isn’t revenue. It’s money you’re holding temporarily for someone else.

Michigan law requires landlords to keep security deposits in a regulated financial institution. Many property managers use a separate bank account just for security deposits to keep them from mixing with operating funds. This makes reconciliation cleaner and helps you stay compliant. Your accounting software should have a dedicated bank account for these funds that ties to your Security Deposits Held liability account.

When a tenant moves out and you return the full deposit, you reverse the entry. Debit the liability account to reduce what you owe and credit your bank account to show the cash leaving. Again, no impact on income or expenses.

The accounting gets slightly more involved when you retain part of the deposit. If you keep $300 for cleaning and damages from a $1,500 deposit, you need to split the transaction. The $1,200 returned follows the normal process. The $300 you keep becomes income and should be credited to a revenue account like Damage Recovery or Forfeited Deposits. Some property managers categorize it differently based on what the deduction was for. Cleaning fees might go to a different account than repair reimbursements.

Track each deposit by tenant and unit so you know exactly what you’re holding for whom. A simple spreadsheet works for a few properties, but once you’re managing multiple units, your accounting software should handle this tracking. QuickBooks and similar programs let you create sub-accounts or use customer tracking to keep deposits organized by property and tenant.

One common mistake is recording security deposits as income when received and then recording the return as an expense. This inflates both your revenue and expenses, makes your profit look wrong throughout the year, and creates confusion at tax time. Your accountant will have to fix it, and that costs you time and money.

Another mistake is forgetting to record interest on security deposit accounts. In Michigan, you may owe tenants interest on their deposits depending on the situation. Any interest earned in the security deposit bank account needs proper tracking as well.

If you manage properties for other owners, the accounting adds another layer. You’re holding deposits on behalf of the owner, which means your liability is really a pass-through. Work with a Metro Detroit bookkeeping service familiar with real estate accounting to set up the right account structure from the start.

Getting security deposit accounting right protects you legally and gives you accurate financials. Set up the liability account, use a separate bank account, and record transactions correctly from day one. Fixing years of incorrectly recorded deposits is tedious work that’s completely avoidable with the right setup.