Earnest money received is taxed as a price advance rather than a capital gain

The tax treatment of earnest money (arras) in real estate purchase and sale contracts has raised doubts regarding its correct reporting in Personal Income Tax (IRPF). The Dirección General de Tributos (DGT) has clarified the nature of these amounts and the moment when the loss derived from their return due to a breach of contract must be taxed.

What the DGT has ruled

The administration establishes that the receipt of earnest money should not be considered a capital gain. Instead, these amounts constitute an advance on the price, which will only affect the transfer value if the sale is ultimately completed.

In the event that the contract is not carried out and a breach occurs, the amount exceeding the initially received earnest money generates a capital loss. According to the DGT's criteria, this loss must be included in the general taxable base, and its temporal reporting must take place in the tax year in which the ownership of the money is lost, not at the moment the earnest money contract was signed.

What this means for you

If you are an individual who has received earnest money and subsequently had to return it due to a breach of contract, the tax treatment is as follows:

• Nature of the income: The money received is not an immediate capital gain, but part of the price of the future sale.
• Timing of the loss: The capital loss derived from the return of the earnest money is reported in the tax year in which the loss of ownership of the money occurs.
• Rectification of tax returns: If you erroneously taxed the amount as a capital gain in a previous tax year, it is possible to request a rectification of the tax return to correct the error.

What you should do

In a situation of breach of contract that requires the return of amounts received as earnest money, it is necessary to determine exactly the tax year in which the loss of ownership of the money occurs. Since the treatment of these amounts depends on whether the sale is completed or not, each situation requires a technical analysis to ensure that the inclusion in the general taxable base is carried out in the correct tax year and to avoid errors in the income tax return.