Trust account, security deposit, licensing, and audit requirements for property managers are set by each state and sometimes by local rules. The framework below is common, but your state's real estate commission or licensing agency sets the actual rules. Confirm with it or a qualified attorney.
A property management company's books look like those of a regular business on top of a second set of books for other people's money. Mixing the two is the single most dangerous mistake in the industry, because it can threaten your license, not just your tax return.
Two sets of money
- Operating funds: your management fees, leasing fees, and other income, which belong to the company and run through its operating account.
- Client funds: rents collected for owners, owner reserves, and tenant security deposits, which belong to others and are held in trust.
- Client money should never be used for company expenses, and company money should not be commingled in trust accounts beyond what state rules allow.
Trust accounts
Most states require licensed property managers to hold client funds in designated trust or escrow accounts separate from the company's operating account. Some require a separate account for security deposits, and some require interest-bearing accounts or specify what happens to the interest. Banks may require special account titling. Setting these up correctly at the start is far easier than fixing them after a state audit.
Three-way reconciliation
The standard control is a monthly three-way reconciliation of: the bank statement for the trust account, the trust account balance in the general ledger, and the sum of all owner and tenant ledger balances in the property management system. All three should agree. If they do not, the difference needs to be identified and resolved immediately. Many state regulators ask to see these reconciliations in an audit.
Owner statements
- 1Opening balance and reserve held for the owner.
- 2Rents received and other income for the period.
- 3Expenses paid on the owner's behalf, with invoices attached or available.
- 4Management fees and leasing fees deducted.
- 5Owner disbursements and the ending balance.
- 6A year-end summary the owner can give to their own tax preparer.
Security deposits
Deposits are liabilities, not income. They must be tracked by tenant and lease, held according to state rules, and returned or applied to damages within the required timeframe. Many states have strict deadlines and itemization rules, and penalties for improper handling. The books should show deposits held by tenant and reconcile to the bank.
Your own income
- Management fees, typically a percentage of collected rent.
- Leasing, renewal, and placement fees.
- Maintenance coordination fees or markups, where permitted.
- Late fees and other income, where the management agreement says the manager keeps them.
- Record each as company revenue only when earned and transferred properly from trust to operating.
1099 and tax reporting
Property managers commonly report rents paid to owners and payments to vendors on information returns, and must collect W-9s from owners and vendors. Reporting thresholds have changed in recent legislation, so confirm the current rule. Your own company files its income tax return based on the operating books only. Client funds are not your revenue. See Schedule C tax preparation or S-corp tax return filing, depending on your entity.
Software and controls
- Use a property management system that tracks owner and tenant ledgers, and reconcile it to your accounting records.
- Limit who can disburse from trust accounts, and require two-person approval for large disbursements.
- Review owner and tenant ledgers for negative balances. A negative owner balance means you paid out more than you held.
- Keep records for the period your state requires.
Common mistakes
- Paying owner expenses before rents clear, creating negative owner balances.
- Using security deposits to cover operating shortfalls.
- Skipping the monthly three-way reconciliation.
- Recording trust receipts as revenue.
- Poor records of who approved owner disbursements.
For general reconciliation help, see bank reconciliation problems and monthly bookkeeping checklist. Our bookkeeping service supports property managers with trust reconciliations and owner statements. To discuss your bookkeeping needs, tell us your state, number of doors, and which software you use. We do not provide legal advice on trust account compliance.
