The Difference Between Last Month's Rent and a Security Deposit
Anyone who has rented an apartment knows that the landlord collects a deposit at the beginning of the rental term in addition to the first month's rent. The deposit may be exactly that--a deposit made by the tenant as a security against damage that the tenant might cause while renting the premises. However, if the landlord takes that deposit with the understanding that it will be considered "last month's rent," then the deposit, and what the landlord can do with it, takes on a different meaning.
Security Deposit or Last Month's Rent?
If the deposit is considered last month's rent, then that's all it can be used for by the landlord. That money cannot be used to pay for damages caused by the tenant or to clean the apartment after the tenant moves out. If the landlord only requires a deposit of "last month's rent", then that landlord has taken away from himself financial flexibility to pay for repairs and services typically required by normal wear and tear. Any such action will now have to be paid for out of the landlord's pocket.
Let's illustrate this with an example:
You're a landlord who is about to take your first tenant. You want the tenant to pay first month's rent and a deposit to cover damage and any unpaid rent should the tenant abruptly leave before the lease expires. Instead of calling that deposit "last month's rent", which would force you to pay for any cleaning or repairs at the end of the lease, you should simply call it a security deposit. By doing so, you give yourself flexibility on how to spend the money should the need arise.
Differences in State Laws
States have different rules on how security deposits are handled. Some require landlords to place security deposits in escrow accounts and have specific rules on who gets the interest on these accounts. Be sure to check the laws of your state and municipality with regards to the handling of deposits.
Last Month's Rent and Increased Rent Amounts
A related issue with "last month rent" deposits is the issue of increasing the amount of rent due. In most states, if you increase the rent but fail to require the tenant to increase the amount of their pre-paid last month's rent, you can't collect the extra amount when the tenant moves out.
In the example above, let's say that you decide to increase the rent by $100. When you increase the rent, you can require the tenant to pay an extra $100 to cover their pre-paid last month's rent as well (so an extra $200 total for the first month of the increase--$100 for the deposit and $100 for the current month). However, if you fail to increase the initial deposit of last month's rent soon after increasing the rent and just continue collecting the extra $100 for each month, you cannot make the tenant pay that extra $100 during the last month of the tenancy.
As a landlord, you're safest and give yourself the most flexibility by calling a deposit a security deposit, and by following the laws of your locality in handling that money. Make the deposit as high as you think necessary (within the limit of the law) to cover any potential losses, and don't bother with the label of "last month's rent."