Understanding the Tax Rules for Rental Deposits

When renting out a property, most landlords ask tenants to pay a deposit. This deposit acts as financial protection against possible damage, unpaid rent, or other costs during the tenancy. It can be called a security deposit, damage deposit, or rental deposit.

Some landlords may also request a holding deposit — a smaller amount paid to reserve the property while the paperwork and referencing process are completed.

It’s important for landlords to understand how these deposits are treated for tax purposes and what rules they must follow to stay compliant.

Tenancy Deposit Schemes (TDS)

If you collect a security deposit, the law requires you to protect it in a government-approved tenancy deposit scheme (TDS).
In England and Wales, you can choose from:

• Deposit Protection Service (DPS)

• MyDeposits

• Tenancy Deposit Scheme (TDS)

Separate approved schemes apply in Scotland and Northern Ireland.

There are also limits on how much deposit you can ask for:

• Up to five weeks’ rent if the annual rent is below £50,000

• Up to six weeks’ rent if the annual rent is £50,000 or more

At the end of the tenancy, landlords must return the deposit within 10 days of agreeing on any deductions.
If there’s a dispute, it can be resolved through the same TDS service — as long as both parties agree to use it.

How Security Deposits Are Taxed

If you retain some or all of the security deposit, that amount becomes taxable income for your rental business.

However, you can also deduct any related expenses — for example, repair or maintenance costs caused by tenant damage.
If your expenses exceed the amount you’ve kept from the deposit, you can still claim the full cost as a business expense when calculating your taxable profit.

Holding Deposits: What Landlords Should Know

A holding deposit is different from a security deposit. It’s taken to reserve the property while checks or agreements are processed, and it doesn’t need to be protected in a TDS.

Key points to remember:

• The maximum holding deposit is one week’s rent.

• If the rental agreement falls through, you may retain part or all of the holding deposit to cover costs such as advertising, referencing, or preparing the tenancy agreement.

  • The amount you keep counts as rental income for tax purposes.

  • You can deduct any related expenses.

If you refund the deposit to the tenant, it’s not counted as taxable income.
However, if the holding deposit is later used as rent or added to the security deposit, it must be taxed accordingly — following the same rules as those deposits.

Key Takeaways

• Always protect tenant deposits using an approved TDS (if required).

• Only the portion of a deposit you keep counts as taxable income.

• You can deduct reasonable expenses connected to that income.

• Keep clear records of all deposit transactions and related costs.

Understanding the tax treatment of rental deposits helps landlords stay compliant, avoid penalties, and manage their rental business efficiently.

                                                   For more information, Book a Free Consultation