What is a rent deposit?

To provide security for the payment of rent or the performance of a tenant's covenants in a commercial lease, a landlord will typically require a deposit of money to be paid by the tenant.

Rent deposits are attractive to landlords as they provide an immediate source of money in the event of non-payment of rent or the financial consequences of a breach of the lease. Having an accessible pot of money prevents the landlord from having to take legal proceedings to recover any debt.

Rent deposits are also advantageous to tenants as they prevent having to use alternative forms of security such as bank guarantees, which involve the tenant having to make additional payments to the bank to secure a payment or personal guarantees from directors, which means that their personal interests are protected.

A rent deposit is usually required by a landlord on the grant of a lease or before a landlord gives their consent to the assignment of a lease if:

  • The tenant is a company located overseas, with few UK assets;
  • The tenant shows signs of weak financial status;
  • A tenant's covenants are weak and insufficient to the landlord.

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Issues to consider with rent deposits

  • There is no prescribed amount required for a rent deposit; however, they are usually between six to twelve months' rent. The value of the rent deposit will be determined by the value of the rent under the lease, the period taken to re-let the property and the risk of the tenant defaulting on their rent.

  • Landlords may be authorised to deduct from rent deposits if there is: unpaid rent, insurance rent and service charges, if a landlord suffers a loss due to a breach of any covenants in the lease or if the lease is terminated earlier than the term. It is deemed reasonable for a landlord to give notice to the tenant before making any deductions so that they can rectify any action(s) that have triggered a deduction.

  • Repayment of a rent deposit may be negotiated between a landlord and a tenant. A lawful assignment, an expiry of the term, a surrender or an option to break in a lease may trigger the repayment of a rent deposit to a tenant. A tenant may also prove that they can meet their financial obligations under the lease to receive their rent deposit back.

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How rent deposits are held

Rent deposits can be structured in several ways. The most common structures are as follows:

  • The money is held by the landlord on behalf of the tenant in a separate account. The tenant will have ownership of the money but will grant an equitable charge over it for the landlord, or
  • The funds will be held on express trust for the tenant.

The most appropriate structure to hold rent deposits may depend on the individual circumstances of the landlord and tenant.

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Rent deposit deed

The terms on which a landlord can draw from a rent deposit, how it is to be held, and the conditions that must be satisfied for the monies to be repaid to the tenant must be set out in a rent deposit deed.

The assistance of a solicitor can be obtained to draft this document to ensure that it is a valid document tailored to the circumstances of the individuals.

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Tax on rent deposits

Stamp duty land tax may be payable if rent deposits are disguised as premiums.

Rent deposits are generally excluded as income of a landlord, however, if a landlord makes a withdrawal from a rent deposit, this may be deemed as income, and tax may be payable.

Where a landlord has opted to tax, it is common for them to request that the money deposited incorporates a figure equivalent to the VAT on the rent deposit to ensure that the landlord can claim the full amount due if the tenant fails to pay rent. 

VAT is not payable when the money is put on deposit since the landlord is making no supply at that date.

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If you are a landlord or a tenant and require any advice on rent deposits or assistance drafting a rent deposit deed, please call our commercial property lawyers:

0161 941 400