Trust Accounting
One of the biggest red flags during a property management company audit involves improper handling of trust funds. 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 essential to consult your state's and local requirements to ensure compliance.
What are Trust Accounts?
There are specific rules about how a property management company handles business funds and transactions. 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 client funds (or rental property owner funds) and not the 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 note 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 essential 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 governing trust account use, it is always good practice to specify these details in your management agreement.
One or Multiple Accounts?
Depending on your state guidelines, a property manager can set up either an aggregate trust account or separate accounts for each owner. If not regulated by the state, it is up to the property manager to decide whether to use one or multiple accounts for accounting and tracking purposes.
Some property management companies choose to set up two accounts: one established as an operating trust account and one serving as a tenant security deposit trust account. This is good practice to prevent accidentally spending the security deposit funds.
Check with your state guidelines to determine if you can 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 is how quickly the funds must be deposited. Some states require funds to be deposited by the close of the next business day.
Consider using online payment processing (ACH) that is integrated with your property management software, allowing you to avoid handling checks and meet those deposit date deadlines.
Security Deposits
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 track and report the amount of security deposits you have deposited and ensure 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 more extended 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.
Record Retention
Trust account regulations also specify the minimum retention period for records of trust account transactions.
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.
Essential 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
Final Notes
Property managers must be aware of trust accounts and do their internal audits. It is very important to ensure that you stay in compliance and have your records in good order, so that if you happen to be audited, you will be ready. The right property management software can be an invaluable tool to help you stay organized and compliant.
Important Note: This article provides an overview of general practices for managing trust accounts and should not be considered legal or financial advice.