Correct treatment of tenants’ security deposits and holding deposits

The way deposits are treated for tax purposes depends on the type of deposit and the basis on which a landlord’s accounts are prepared. First, let’s explore the two different types of deposit.

Types of tenant deposit

All landlords require a security deposit from a tenant to safeguard against damage to the property. At the time of writing, this must be:

Less than 5 weeks’ rent if the annual rent is less than £50,000, or
Less than 6 weeks’ rent is the annual rent is more than £50,000.

A landlord can also ask for a holding deposit to reserve a property. This must be less than the equivalent of 1 weeks’ rent.

Best practice for security deposits

Security deposits taken by a landlord should be held in a custodial scheme such as one offered by a tenancy protection scheme.

During the term of the tenancy, the deposit continues to belong to the tenant. If there is no damage to the property at the end of the tenancy, the security deposit is returned to the tenant. If there are some damages to the property, the landlord may be entitled to all or part of the security deposit – with the tenant’s agreement.

When is a security deposit considered as income?

As the landlord is not entitled to the security deposit when it’s paid by the tenant, it’s not considered as income at the start of the tenancy. However, if all or part of the deposit is retained by the landlord at the end of tenancy due to damages, the full or partial retained security deposit is considered income.

👉If the landlord’s accounts are prepared under the cash basis, the amount retained is considered income in the tax year the landlord received the security deposit.

👉If the accruals basis is used to prepare the landlord’s accounts, the retained amount is considered income in the tax year the landlord became entitled to it.

The landlord may be able to offset repair costs for the damage incurred against the retained security deposit.

📢❕Allowable costs differ between residential lets and holidays lets, and according to the legal status of the landlord (i.e. incorporated or not): check the relevant tax rules or these blog posts for details:

Best practice for holding deposits

As the name suggests, a holding deposit is paid by the tenant to secure the property while the tenancy agreement is signed. In return, the landlord will take the property off the market. This is common when demand for property is high.

A holding deposit must be less than one week’s rent and the terms and conditions (T&Cs) of the use of such a deposit should be clear to all parties.

When is a holding deposit considered as income?

If a prospective tenant changes their mind for whatever reason, under the terms of the agreement, the landlord may retain all (or some) of the deposit as compensation for the inconvenience and costs incurred in relation to the prospective let.

👉Under the cash basis system of accounting, the retained holding deposit amount is considered as income in the tax year it’s paid.

👉If the accruals basis is being used, the retained amount of the holding deposit is considered as income in the tax year in which the aborted lease occurs.

The landlord would be entitled to claim any costs actually incurred in relation to the aborted let, such as advertising or legal fees.

If the let goes ahead, the holding deposit would either be returned to the tenant or used to form part of the security deposit (see above).

If the holding deposit is returned, there is no need to declare the income as there isn’t any – it was returned.

If the holding deposit is used as part of the security deposit, the rules set out above on the treatment of security deposits should be followed.

📢❕The information in this blog post was correct at the time of writing. Please check with your accountant for the latest information or, if you don’t have an accountant, join the Financial Resilience Hub to get access to one of ours! Alternatively, keep an eye on HMRC’s website for updates.