One of the biggest red flags during a property management company audit involves improper handling of trust funds. In order to properly (and legally) handle owner and tenant funds, a property manager must understand the basic principles of trust accounting.
Trust accounting regulations for property managers are state-specific, so it is very important you consult your state and local requirements in order to be compliant.
What are Trust Accounts?
There are specific rules about how business funds and transactions are handled by a property management company. Trust accounts for property managers are typically used to keep tenant deposits and rent payments separate from operating capital.
Some states require that all owner funds be maintained in a separate federally insured checking account. This account and the funds within, also known as a trust account, must be separate from your business and personal bank account(s).
These funds are considered to be client funds (or rental property owner funds) and not funds of the brokerage(property management company).
Both rents collected on an owner’s rental property and security deposits collected from tenants are considered trust funds and must be placed into a trust account. Please keep in mind that rent collected on behalf of another person must be deposited into a trust account. Some believe that this only applies to security deposits/tenant deposits but that is not true, trust accounts are for all funds received on behalf of another for a real estate transaction.
The proper handling of these funds and accounting is important to avoid the commingling of funds, which is illegal.
Some states require property managers and owners to specify in the management contract exactly how trust accounts will be used. Even if your state has specific regulations for trust account use, it is always good practice to identify specifics in your management agreement.
One or Multiple Accounts?
Depending on your state guidelines, a property manager can set up one aggregate trust account of separate accounts for each owner. If not regulated by the state, it is up to the property manager to decide between one or multiple accounts for accounting and tracking purposes.
Some property management companies choose to set up two accounts- one account established as an operating trust account and one serves as a tenant security deposit trust account. This is good practice so you don’t accidentally spend the security deposit funds.
Check with your state guidelines to determine if you are able to hold trust funds in an interest-bearing trust account.
Remember to reconcile all your accounts on a timely basis to avoid any future discrepancies.
Time Allowed to Deposit
One of the most problematic requirements of trust accounts on how quickly the funds must be deposited. Some states require funds be deposited by the close of the next business day.
Consider using online payment processing (ACH) that is integrated with your property management software to avoid handling checks and making those deposit date deadlines.
Security deposits are considered tenant funds until the landlord becomes entitled to receive all or part of the security deposit under the terms of the lease. When a property manager collects security deposit funds from a tenant, the money must be held in a trust account.
It is a good standard practice to have your Tenant Security Deposits in a separate account from your rents collected. Even though this is not a requirement in all states, it will help in tracking/reporting the amount of security deposits you should have deposited and that you are not accidentally using these funds.
Commingling of Funds
One of the most serious misuses of a trust account involves the commingling of owner and manager funds. Depending on your state laws, different acts can be considered commingling:
- Personal or company funds are deposited in the trust account
- Trust account funds are deposited in a business or personal account
- Commission fees/ management fees are left in the account for a longer period of time than what is legally allowed
- Rent or security deposits on the broker-owned property are placed in a trust account
- The property manager conducts personal business from the trust account
- One client’s funds are used for another client’s property
- Tenant security deposits are used to cover operating expenses
The rules, regulations, and customary practices vary wildly across the country and between states, so make sure you are familiar with your state’s specific laws.
Trust account regulations also specify how long records of trust account transactions must be kept.
To protect yourself and your business, it is important to keep any paperwork that might be necessary to defend yourself in the future should you face an audit or a legal battle.
Important records include (but are not limited to):
- Past and present management agreements
- Past and present lease agreements
- Checkbooks and checkbook registers for all accounts
- Record of all checks issued, including voided checks
- All bank statements
- All deposits
- Access to your bookkeeping system, such as your property management software
- Copies of all financial reports that have been provided for your owners
- Invoices paid to vendors
- Records of all security deposit refunds
It is critical for property managers to be aware of trust accounts and do their own internal audits. It is very important to make sure to stay in compliance, have your records in good order so if you happen to be audited you will be ready. The right property management software can be an extremely helpful tool to help you stay organized and compliant.
Important Note: This article is intended to provide an overview of general practices for managing trust accounts and should not be taken as legal advice.