Much like with residential leases, investors in commercial properties may require tenants to pay a security deposit before entering into the lease agreement. Security deposits, whether in commercial or residential settings, are used to protect the landlord from incurring a loss in the event the tenant does not pay the rent, breaches the lease agreement, or damages the property.
In short, the purpose of the security deposit is to secure the lease obligation. While security deposits can be requested in both the residential and commercial worlds, when it comes to commercial-lease landlords, there are no uniform provisions. State law does not place a restriction or cap on how much the landlord can charge for the security deposit.
In general, the law recognizes those who interact in the commercial real estate world to be sophisticated actors and, thereby, able to negotiate the terms of the security deposit, absent an existing statute. This gives the landlord free range when setting the security deposit.
Include a clause in the lease agreement
While there is no standing state law, landlords should include the negotiated terms of the security deposit in the lease agreement. The type of language included in a commercial lease agreement is important. When drafting the lease provision, the landlord should include language dictating when and how the security deposit will be used, refunded, and retained.
When drafting the lease, landlords may also want to consult an attorney to ensure it's airtight. The landlord may also want to consult with an attorney concerning how the funds should be handled. In some circumstances, the landlord is required to hold funds in interest-bearing accounts.
For this reason, the landlord should not only include within the lease the account in which the security deposit will be held but also consult with an attorney when drafting this provision.
How much to charge
Typically, state law should be consulted for guidance on how much the landlord should charge for the security deposit. The amount of the security deposit tends to fall between one and two months' rent.
Returning the security deposit
It is also advisable for the lease agreement to state how much of the security deposit will be retained by the landlord in the event that there is a breach, the property is damaged, or the tenant fails to pay the rent. The landlord should also include -- with specificity -- how much time it will take for the landlord to return the security deposit to the tenant. If you need assistance with this portion of the lease, consulting with a real estate attorney may be your best bet.
Including the security deposit in income
In addition to consulting with an attorney, the tax code should be reviewed to determine when the security deposit should be included in rental income.
If part or all of the security deposit is retained because the tenant leaves the property before the lease ends, the amount retained must be included as income in the year the tenant vacated. And if the security deposit is retained because the property has incurred damages, it must be included as rental income for the year the property damage occurred if the damage was deducted as an expense.
The Millionacres bottom line
In general, landlords in the commercial space have tons of flexibility when it comes to drafting their lease provisions. While this is so, consulting with a competent advisor is in your best interest. This should be the first step any landlord in a commercial space takes to limit their exposure to any future litigation.