How security deposits are handled in a sale

Have had this question a few times in the past few weeks so I figured I’d answer it for everyone: How are security deposits handled in a sale?

First, owner typically do not maintain a separate account for security deposits. When a tenant moves into the building, he gives the landlord a check for the deposit and the landlord notes the amount on the lease and, often, a separate security deposit receipt. The landlord then deposits the check in his general operating account. The tenant’s assurance that he will receive his deposit back when he moves out is that, if the landlord unlawfully withholds the deposit, the tenant can sue and win triple damages.

But, if the money is simply deposited by the owner of the building, what happens when someone buys the building from the owner? Does the old owner have to write a check to the new one to transfer the deposits?

Fortunately, the answer is “no”. Escrow handles the transfer, in the form of a debit to the seller and credit to the buyer. During the escrow period, the escrow officer reviews the rent roll (and, if the buyer’s agent is smart, the estoppels) and calculates the total amount of security deposits. Then, the escrow officer simply reduces the price the buyer will pay for the property by the same amount. So the seller keeps the deposits, but the buyer gets an equivalent price reduction.

One wrinkle to keep in mind is that tenants in Los Angeles are notionally entitled to earn interest on their security deposits. Calculating the interest and paying it out is an unbelievable pain in the ass and, because interest rates have been so low for so long, the amounts of money involved are ridiculously small. So, most landlords and tenants ignore the law.

It’s worth mentioning here, though, because, in the event that there are long-term tenants in a building, the interest owed on their deposits can actually end up being a meaningful amount of money. Escrow is supposed to calculate the interest owed and add it to the deposit credit the buyer receives, but most escrow officers are too lazy to do this. This is another case of caveat buyer (or, if you’re properly represented, caveat agent).