Trust Accounting

One of the biggest red flags during a property management company audit involves improper handling of trust funds. To handle owner and tenant funds properly (and legally), a property manager must understand the basic principles of trust accounting.

Trust accounting regulations for property managers vary by state, so it is essential to consult your state and local requirements to ensure compliance.

What are Trust Accounts?

Specific rules govern how a property management company handles business funds and transactions. Property managers typically use trust accounts 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 brokerage's (property management company) funds.

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 this applies only 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.

Proper handling and accounting of these funds are essential to avoid commingling, 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 the state does not regulate it, the property manager decides whether to use a single or multiple accounts for accounting and tracking.

Some property management companies opt to establish two accounts: one as an operating trust account and the other as a tenant security deposit trust account. This is a 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 time to avoid future discrepancies.

Time Allowed to Deposit

One of the most problematic requirements of trust accounts is depositing funds promptly. Some states require funds to be deposited by the close of the next business day.

Consider using online payment processing (ACH) integrated with your property management software, which helps you avoid handling checks and meet 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 good practice to keep your Tenant Security Deposits in a separate account from your rent collections. Although this is not required in all states, it helps you track and report the security deposits you have deposited, ensuring you are not accidentally using these funds.

Learn more here: Security Deposit Management for Rental Properties

Commingling of Funds

One of the most serious misuses of a trust account is commingling 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 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 understand trust accounts and conduct internal audits.   It is important to stay in compliance and maintain accurate records so that, if you are audited, you are prepared. The right property management software can be an invaluable tool for staying 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.