The question I’ve been frequently asked by owners is whether a security deposit a taxable income. The security deposit or damage deposit you receive from a tenant should not be included in your rental income if you intend to return the funds to your tenant when they leave after the lease expires. However, if the tenant breaks the lease and you do not return a portion or all of the deposit, that amount is taxable income that year.
If you have your property managed professionally, the security deposit remains with the property manager in a trust account. It is not include as an income in your 1099 Misc reported to IRS.