Security deposits transfer with the building. They are not the seller's money to keep at close, and they are not the buyer's money to ignore. California Civil Code Section 1950.5 requires the security deposit to follow the tenancy — meaning the new owner inherits both the deposit and the corresponding liability to return it (less lawful deductions) when the tenant eventually moves out. The mechanics at close determine which party — seller or buyer — holds the actual cash.
For most LA multifamily sales, the structure is a credit on the closing statement: the buyer is credited the aggregate amount of all tenant security deposits, and the seller is debited that amount. The buyer takes the deposits onto their balance sheet as a liability and is responsible for their eventual return. The seller is released. Done correctly, the transition is invisible to the tenants — they never knew their deposit changed hands.
California law caps residential security deposits at one month's rent for most leases entered into on or after July 1, 2024 (Civil Code Section 1950.5(c), as amended by AB 12). Pre-existing leases with two- or three-month deposits remain in place until those tenancies end and new leases are signed; the cap applies prospectively to new tenancies.
For purposes of the sale, the seller's records should reconcile to the dollar what each tenant's deposit is. The lease should match the rent roll, the rent roll should match the trust accounting, and the trust accounting should match the deposit aggregate credited at close. Disputes after the sale almost always trace back to record-keeping gaps before the sale.
Components that should be tracked separately:
Non-refundable charges (cleaning fees designated as non-refundable in the lease, application fees) are not deposits and don't transfer.
The transfer of security deposits at close happens through one of two mechanical paths.
Credit on the closing statement. The most common structure. The escrow officer debits the seller for the aggregate deposit total and credits the buyer for the same amount. The net effect: the seller's cash proceeds at close are reduced by the deposit total, and the buyer assumes the deposit liability with the cash equivalent already in hand. No physical money transfers; the credit is an accounting entry on the closing statement.
Physical transfer of deposit funds. Less common but legally cleaner in some structures. The seller wires the deposit funds (held in the seller's trust or operating account) to the buyer's designated account at close. The buyer takes the cash directly and assumes the deposit liability. This structure makes the trust accounting cleaner because the deposit money physically moves with the liability, but most LA transactions use the closing-statement credit because it simplifies the closing wire mechanics.
Either structure satisfies California law. The cleaner the record-keeping on the seller's side, the smoother the close.
In practice, security deposits cause two recurring problems at LA multifamily sales.
Missing or inaccurate records. A seller who has owned the building for 25 years and has had multiple property managers across that time may not have clean records of every tenant's actual deposit. The lease says one number, the rent roll says another, the tenants remember a third. Resolving these discrepancies before close — by reconciling against the original lease and any documented deposit reductions or returns — is the seller's job. Buyers will not accept an aggregate deposit number that doesn't reconcile to the underlying tenancies; they will require resolution.
Pet deposits and "non-refundable" cleaning fees. Older leases sometimes characterized money as non-refundable that California law would treat as a refundable deposit. The seller's characterization in the lease doesn't bind the new owner's eventual liability. If the seller collected $500 as a "non-refundable cleaning fee" on a tenancy where state law would treat it as part of the refundable deposit, the buyer inherits the liability to return it (less lawful deductions) at the end of the tenancy. The closing statement should treat any genuinely refundable amount as part of the deposit transfer.
California Civil Code Section 1950.5(j) requires the transferor and transferee to handle the deposit through one of two prescribed paths at the time of sale.
Option one: the transferor transfers the deposits to the transferee, who provides written notice to each tenant of the transfer along with the transferee's name, address, and telephone number. This is the cleaner path. The tenants are notified that the building has changed hands and that their deposit is now held by the new owner.
Option two: the transferor returns the deposit (less any lawful deductions) to the tenants before the sale. This path is rarely used because returning deposits creates a refundable-deposit gap during the transition. Most sellers do not want their building's tenants to have no deposit at the moment of sale; new owners typically prefer not to start fresh either.
Most LA multifamily sales use Option One. The notice to tenants is typically prepared by the buyer's property manager shortly after close and delivered along with payment-direction instructions for the new ownership.
A seller who fails to transfer the deposits correctly retains personal exposure for the deposits even after the building has sold. California courts have held sellers liable for returning deposits when the seller failed to properly transfer them at sale and the buyer subsequently failed to return them at the end of tenancy. The exposure is not just the deposit amount — it includes statutory damages of up to twice the deposit amount under Civil Code Section 1950.5(l) for bad-faith retention.
The way to extinguish the seller's exposure is to (a) properly credit or transfer the deposits at close, (b) document the transfer in the closing statement and the post-close tenant notice, and (c) retain the documentation. Done correctly, the seller's liability ends at close. Done incorrectly, it can follow the seller for years.
The work happens in pre-close diligence, not at the closing table. Reconcile the rent roll to the leases. Reconcile the leases to the trust accounting. Identify any tenancies where the records disagree and resolve them before listing if possible, or at the very least flag them clearly in the disclosure package. Buyers are happy to inherit clean deposit obligations; they are unhappy to discover discrepancies at the closing table.
The other thing I tell sellers is that the deposit transfer is one of the items that most often gets handled correctly by escrow with no attention from the seller — when the seller's records are clean. When the records aren't clean, this becomes one of the more time-consuming items in the close. Cleaning the records before listing is meaningfully cheaper than trying to clean them in escrow.
Security deposits at sale are simple when the records are simple and complicated when the records aren't. The mechanics of the transfer are well-established California law that escrow handles routinely. The sellers who run into deposit issues at close are the ones who didn't reconcile their records before listing. The sellers who don't run into deposit issues are the ones who treated the rent roll as the legal document it actually is, kept it current, and produced clean documentation when the buyer asked for it.
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Michael Sterman is Senior Managing Director Investments at Marcus & Millichap, specializing in Los Angeles multifamily transactions.
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