Rent Goes to Income, Deposits Go to Principal
Rental properties are one of the most common real estate assets held in trusts. Families often place rental homes, commercial properties, or vacation rentals into a living trust as part of their estate plan. When those properties generate revenue, the trustee needs to classify each receipt correctly.
To the extent that a trustee accounts for receipts from rental property pursuant to this section, the trustee shall allocate to income an amount received as rent of real or personal property, including an amount received for cancellation or renewal of a lease.
A.R.S. § 14-7414The rule for rent is simple. Monthly rent, lease payments, and amounts a tenant pays to cancel or renew a lease all count as income. That means these receipts flow to the current income beneficiary during the trust's operation. Property management costs are typically charged against rental income.
Security Deposits Require Careful Handling
Refundable deposits are treated differently. A security deposit or any deposit intended to be applied as rent for future periods goes to principal. The trustee holds it subject to the lease terms. It is not available for distribution to a beneficiary until the trustee has satisfied all contractual obligations related to that deposit.
This distinction matters for practical reasons. A security deposit is not the trustee's money to distribute. It belongs to the tenant until the lease ends and any claims for damages or unpaid rent are resolved. Distributing it early could leave the trust unable to return the deposit when required. That could create liability for the trustee personally.
For trusts with multiple rental properties, keeping income and deposits properly classified is an ongoing responsibility. The trustee should maintain clear records showing which amounts are distributable income and which are held deposits. Tax filing for rental income requires the trustee to report these amounts correctly on the trust's returns. Understanding how the state department of revenue and federal agencies view these classifications helps avoid errors.