Monday, December 28, 2015

Rent Deposits Confuse Most Small Ontario Landlords

Almost every time I am retained by a new small landlord, there is confusion about rent increases and last month rent deposits.  I will leave rent increases for another day, but let me describe how the deposit system is supposed to work, and then how it's being handled by many small landlords.


Rent deposits are permitted under the Residential Tenancies Act.  Damage deposits are not.  Last month's rent deposits (LMRD) can be equal to one month's rent, but not more.  They are negotiated prior to entering the tenancy, and paid prior to move-in.

Landlords are required to pay interest on the last month's rent deposit at the same percentage rate as the annual provincial guideline that's in effect at the time the interest is due.  So for instance, if a tenant moved in February 1st of last year, then January 31st of 2016 will be the end of the year, and interest is due immediately after.  If rent was $1,500, then the landlord owes 2% interest as that's the 2016 guideline.  So the landlord would owe $30 to the tenant.  The landlord can pay cash or write a cheque.

But there is another way of paying interest on the deposit rather than  actually paying by cheque.  In s.106(7) the Residential Tenancies Act allows a landlord to "top up" the LMRD with the interest owed.  So here's an example.

The monthly rent is $2,000.  The LMRD is also $2,000.  It's anniversary time (a year since move-in or a year since the last increase).  The landlord served an N1 notice of rent increase effective February 1st, 2016.  It should have been served in October 2015, since there is a 90 day notice requirement.  The rent will go up 2% as that's the 2016 provincial guideline.  So rent goes to $2,040.  Interest on the LMRD is owed on February 1st, also $40, as the percentage interest rate is the same.  But the Act permits the landlord to take the $40 and ADD IT to the LMRD, effectively making the deposit $2,040 instead of the rent.  No money changes hands.  It's a book entry only.  The rent and LMRD stay in sync.

Now remember you can ONLY do this top-up if you raise the rent by the guideline, since you are not permitted to have a LMRD equal to more than one month's rent.  This method of "topping up" the LMRD is the way almost all professional property managers handle rent deposits.  Sometimes a tenant thinks they were ripped off as they never saw a cheque.  I think it's important for good relations to let the tenant know that you've topped up the LMRD with the interest owed.  I have a nice letter in the forms package on my website that I suggest landlords give to tenants when raising the rent annually which explains how the deposit works.

So what happens with the LMRD you collected prior to move-in?  According to the Residential Tenancies Act, the rent deposit stays with the landlord forever until the tenant moves out.  When the tenant leaves with proper notice, the landlord APPLIES the last month's rent deposit to the last month of the tenancy.


Too often, landlords and Realtors who assisted them in getting into a tenancy don't understand rent, rent increases and rent deposits.  I teach Realtors at various real estate boards, and I'm shocked at the misconceptions about rent and rent deposits.  The confusion lies in the difference between lease TERM, and the tenancy.  Term is an artificial construct, usually one year, that may (but doesn't have to be) included in a residential tenancy lease.  Leases can be month-to-month.  Under Ontario law, after the initial lease term is over (if there was term), the tenancy becomes month to month automatically.  The written lease is still in force.  No renewal is necessary.  Nothing changes, except the term is over.

But what too many small landlords do is apply the LMRD to the last month of the TERM, the 12th month if it was a one year lease term.  At that point, they have lost their rent deposit.  They have given away their hedge against the time it takes for eviction if a tenant stops paying rent.  There is no way to force a tenant to give you another rent deposit.  What should have happened is that the tenant should have paid for the 12th month with a cheque just like every other month, post-dated or otherwise, and the LMRD stays with the landlord until some time in the future, perhaps years down the road, when the tenant give notice they are moving out, or the landlord evicts the tenant.  The LMRD is applied to the last month of the TENANCY, not the last month of the lease term.


This mistake happens because Realtors and most small landlords are generally confused about the distinction between term and tenancy, and don't understand what happens after term ends.  Usually in a rental where Realtors are involved, the tenant has given the landlord only 12 post-dated cheques.  Post-dated are not required under the Residential Tenancies Act (s.108), you can't force the tenant to give post-dated cheques, but most tenancies initiated by Realtors involve them.  The landlord pays the Realtor the equivalent of one month's rent as a commission.  The landlord deposits the LMRD in their bank and then deposits each cheque as it comes due each month.  On the 12th month, they have no cheques left.  They should have received 13 cheques, not 12, in order to have a year's worth PLUS the LMRD.  But they didn't.  And on that 12th month, they simply APPLY the LMRD in their mind, confused about term, confused about whether the tenant is staying etc.  Then when they finally get around to asking the tenant their intentions (no need for that, the tenancy continues month-to-month by default), they realize the tenant is staying, they ask for a replacement LMRD.  The tenant may agree, but sometimes says NO.  And truthfully, the tenant doesn't have to pay another LMRD.  It's something a landlord and tenant agree to prior to the start of the tenancy.


You fix it by not getting it wrong in the first place.  If you take post-dated cheques for a year, you need 13, one is the last month's rent deposit and the rest are for the first 12 months.

But to fix it, if the tenant fails to pay for the 12th month and you have no cheque, you just remind them that since they did not give 60 days notice (an N9 form), then the rent for the 12th month is due.  Assure them that their LMRD is still safe, has not been applied, although you will pay them the interest or top up the rent deposit.  If the tenant balks, it's an easy serve an N4 notice for the missing month's rent, and file an L1 application for rent and eviction at the LTB if they don't pay.

If the tenant says "haha, it's YOUR mistake landlord, you told me I didn't have to pay January's rent" (the 12th month), then apologize, tell them you made a mistake, and ask again for the missing rent.   Even if it was your mistake, it's fixable, since the Residential Tenancies Act clearly sets out in s.106(10) that you can ONLY use the LMRD as security for payment of the rent for the last month of the tenancy, and the Residential Tenancies Act also sets out in s.3(1) that even by agreement, you can't do otherwise.  In other words, it would be illegal for landlord or tenant to apply the LMRD to any month other than the last month of the tenancy.

So keep it simple.  You take the last month's rent deposit prior to entering the tenancy.  You put it in the bank.  You pay or apply interest on the LMRD annually using the current provincial guideline interest rate.  You apply the LMRD for the very last month they live there, never before.  Follow these rules and you won't get in trouble with rent deposits.


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