Avoid Five Common Security Deposit Mistakes

All too often, tax credit owners lose money because they make mistakes in withholding residents’ security deposits. It’s easy to overlook basic rules when you’re mired in the details of complying with security deposit laws. To help you avoid these mistakes at your tax credit site, we’ve compiled the five most common ones and given you cases to illustrate them.

Mistake #1: Avoiding Ex-Resident’s Attempts to Provide Forwarding Address

Many states’ security deposit laws say that you don’t have to return an ex-resident’s security deposit if she doesn’t give you her forwarding address. But you can’t avoid the ex-resident’s attempts to give you her address. Courts penalize owners for withholding security deposits in situations where the owners knew or easily could have found out an ex-resident’s new address, even if she didn’t formally notify the owner. Here’s what happened to one Vermont owner who tried to ignore the forwarding address provided by the resident.

Following the expiration of the lease and after the resident had moved out, the owner sent a statement to the former resident indicating that he was holding a portion of the security deposit for damages. The owner sent the statements regarding the remaining security deposit to the addresses of the emergency contacts listed on the resident’s rental application.

The court decided that the owner had forfeited his right to retain the security deposit by failing to send the deposit statements by certified mail to the resident’s last known address as required by state law. Although the owner contested the claim, the resident testified and the court found that resident had provided the owner with his forwarding address in writing.

The court concluded that the owner’s failure to use this address, rather than the emergency contact addresses provided by the resident in his rental application two years earlier, constituted a violation of state law [In Re Kwon, February 2011].

Mistake #2: Lumping Deductions under ‘Other Damages’ or ‘Miscellaneous’

Most states’ security deposit laws require owners to list each repair or replacement and its cost separately. It’s not enough to state that the money was for “other damages” or “miscellaneous” repairs. One Indiana owner made this mistake on part of an otherwise well-itemized list and, as a result, lost the entire security deposit.

The owner withheld two residents’ entire $2,500 security deposit to pay for substantial damage that the residents had caused. The owner itemized most of the deductions, but labeled one deduction “Other Damages $670.” The residents sued the owner for their deposit, claiming that by not itemizing the $670 charge, the owner had violated the security deposit law. The owner claimed that the itemization was specific enough.

The court agreed with the residents and ordered the owner to return the entire security deposit. The owner had properly itemized such items as carpet replacement and trash removal, but had lumped a number of smaller items into other damages. Since the Indiana security deposit law doesn’t provide for partial compliance, the minor violation voided the entire notice. So the entire security deposit was wrongfully withheld, the court said [Pinnacle Properties v. Saulka, March 1998].

In some areas, you must also state the cost of each item of damage and deduct that exact amount. In other areas, you may estimate the cost if you can’t get an exact number before the deadline. Check with your attorney to see what the rule is in your area.

Mistake #3: Commingling Deposits or Deposit Increases

Many states’ security deposit laws also say that owners must keep deposits separate from other funds, such as rent and other payments. If you commingle security deposits with other funds, you could lose the right to keep any security deposit money. You could also end up paying penalties of two or three times the deposit, plus attorney’s fees. Most states and local governments strictly enforce these laws. Here’s how one New York owner’s simple error cost him dearly.

After residents discovered toxic mold on the ceiling of the bedroom, they vacated the premises and sought the return of their security deposit. The appeals court found that the trial court should have awarded the residents their security deposit since the owner violated state law by commingling the security deposit with his own personal funds. As a result of such commingling, the owner forfeited his right to avail himself of the deposit for any purpose, and the tenants had an immediate right to the return of the funds notwithstanding that they might have breached the lease [Paterno v. Carroll, July 2010].

Mistake #4: Not Providing Full Notice Before Deadline

You must send the resident an itemized list of damages and deductions within the time period stated in your area’s law—usually 30 to 45 days after the resident moves out, but shorter in some areas. Sending a notice that doesn’t comply with the law is the same as not sending a notice at all.

One owner learned this lesson when he failed to comply with the state’s notice of damages requirement. When the resident vacated the unit, there was wear and tear to the premises. Under state law, the owner was required to provide a resident with written notice of the damages within 45 days of the termination of the rental agreement or delivery of possession. If the owner, despite having the resident’s address, failed to comply, the resident was entitled to return of the entire security deposit plus attorney’s fees.

According to the court, the failure to comply with the notice of damages requirement constituted an agreement by the owner that no damages were due. The resident provided the owner with her future address upon vacating the premises. The owner admitted that an itemized list of damages wasn’t tendered to the resident within 45 days of the termination of the resident’s occupancy. Thus, the trial court properly determined that the tenant was entitled to a return of the security deposit [Durf v. Molter, December 2005].

Mistake #5: Starting a Lawsuit Instead of Sending Security Deposit Withholding Notice

If a resident moves out and leaves behind damage beyond ordinary wear and tear, or owes you rent, you can deduct the damage amount or unpaid rent. Then, if the security deposit isn’t enough to cover the damage or unpaid rent, you can sue the resident for the balance. But starting a lawsuit doesn’t fulfill your legal obligation to notify the resident that you’re withholding all or part of the security deposit. Most states require owners to give residents notice that they’re withholding all or part of a security deposit. If your state does and you sue the resident without sending a security deposit withholding notice, you could face steep penalties.

An Arizona owner deducted unpaid rent from an ex-resident’s security deposit and then sued the ex-resident for the balance owed. But Arizona law requires owners to deliver a written notice itemizing security deposit deductions to the resident no later than 14 days after the end of the residency. The owner sued within the 14-day period, but never sent the written notice. He argued that filing the lawsuit satisfied the requirement to send the former resident an itemization of deductions.

The court ruled that filing the lawsuit didn’t satisfy the state notice requirement. The court said that the resident was entitled to get the security deposit back plus damages equal to twice the amount of the deposit, as permitted by Arizona law [Shaefer v. Murphey, January 1982].

The notice, which is required by law in most states, should explain how the deposit was applied, and should describe the damages and the cost of repairing them if you’re withholding money to cover damage to the unit. Keep a copy of the notice and proof of the date it was mailed or delivered in the resident’s file. Send these notices by certified mail, return receipt requested, to help document delivery.

If, after sending the notice, the ex-resident still owes you money above and beyond the security deposit, have your attorney or someone knowledgeable in collections review the file to determine whether you should sue the resident for the balance. Generally, if you didn’t properly send the security deposit notice, you shouldn’t file a lawsuit. The ex-resident could countersue you, claiming that you failed to comply with your state’s notice requirements. This can subject you to penalties of up to two or three times the amount of the security deposit.