We’re pleased to republish this article from Mark McLaughlin: experienced tax author, editor and consultant. The article looks at the tax treatment of forfeited deposits to purchase property.
In property transactions, the payment of a deposit by the buyer to the seller is not uncommon. Sometimes, the buyer will lose the deposit without owning the property; effectively ‘money for nothing’.
What is the tax treatment of lost deposits received and paid by individuals for properties?
Taxable receipt?
On the receipts side, the first issue is whether the receipt is taxable income, as this would take precedence over capital treatment. If the recipient is a property trader, HMRC could regard the forfeited deposit as a trading receipt, as having been received as part of the individual’s trade (Elson v Prices Tailors Ltd [1963] 1 WLR 287).
If the recipient individual is not a property trader (e.g., a landlord), the forfeited deposit might be treated as a capital receipt instead.
For capital gains tax (CGT) purposes, a forfeited deposit on an abandoned property sale falls to be treated in the same way as the consideration for an option binding the vendor to sell the property where the option is not exercised (TCGA 1992, s 144(7)). Broadly, if the option is not exercised, there has been a deemed disposal of the option, and the property seller is liable to CGT on the proceeds from granting the option. The gain is chargeable when the contract is rescinded and the forfeited deposit received.
Deductible payment?
What about the individual who pays a forfeited deposit? If that payer is a property trader, the expenditure might be an allowable deduction from taxable profits as being ‘wholly and exclusively’ incurred for trade purposes if the property would have been a trading asset if acquired.
Otherwise, a forfeited deposit generally falls to be treated as an option binding the grantor to sell that is not exercised. The abandonment of an option does not (subject to certain exceptions, which are not relevant here) constitute an asset disposal by the individual paying the deposit (TCGA 1992, s 144(4)). The individual paying the forfeited deposit will therefore potentially incur a non-allowable capital loss.
Adding insult to injury
In Hardy v HMRC [2016] UKUT 0332 (TCC), the taxpayer entered into an agreement for the purchase of a property. A deposit of 10% of the purchase price was payable on entering into the contract. However, funds were not subsequently available to complete the purchase. The vendor rescinded the contract and kept the deposit. HMRC subsequently disallowed the taxpayer’s claim for the resulting capital loss. The taxpayer was found not to have acquired an asset for CGT purposes when entering the contract, so had no asset to dispose of when the contract was rescinded.
Subsequently, in Drake v Revenue and Customs [2022] UKFTT 25 (TC), the taxpayer entered into a contract with the seller relating to a property, which provided for a deposit to be paid on the date of contract, and a stage payment 12 months later. The taxpayer paid the deposit but not the stage payment because of financing difficulties. Consequently, the seller treated the contract as repudiated and kept the deposit. The taxpayer claimed an allowable capital loss for the deposit paid, but HMRC disallowed it. The First-tier Tribunal dismissed the taxpayer’s appeal, concluding that Hardy (see above) was binding authority. The rescission of the contract due to the taxpayer’s breach did not constitute an asset disposal for CGT purposes.
Practical tip
Even if tax relief for the forfeited deposit can be claimed successfully, from a financial standpoint the loss of deposits should obviously be avoided where possible.
The above article was first published by Property Tax Insider and is available here on the Tax Insider website.