Mark McLaughlin looks at the tax position of forfeited deposits when property deals fall through.
Property transactions do not always go according to plan. For example, suppose a potential buyer pays the seller a deposit for a property. The purchaser has sufficient cash to pay the deposit but is subsequently forced to pull out of the deal as they were unable to obtain the necessary borrowings to meet the full purchase price.
Lost property … and cash!
Furthermore, suppose the purchase agreement provided that the deposit was non-refundable if the property deal fell through. Is the forfeited deposit a taxable receipt for the property owner? Is it an allowable deduction for the payer?
In the above example, the prospective property buyer and seller are both individuals; the position for companies is subject to different considerations not addressed here.
Taxable receipt?
If the recipient is a property trader, HM Revenue and Customs (HMRC) is likely to regard the forfeited deposit as a trading receipt on the basis that it is 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 or owner-occupier), the forfeited deposit may be a capital receipt instead (but first, it should be considered whether the receipt is taxable income, as income treatment generally takes precedence over capital treatment).
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)). It is therefore necessary to consider how an option to acquire the property would be treated.
The grant of an option to acquire a property is generally treated as the disposal of a separate asset (i.e. the option) by the individual selling the property (TCGA 1992, s 144(1)). This treatment as a separate asset broadly applies unless the option is exercised, and the whole proceeds are chargeable as a gain (Strange v Openshaw [1983] STC 416).
However, 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 The gain is chargeable when the contract is rescinded and the property seller receives the forfeited deposit (subject to any allowable expenditure).
Allowable payment?
If the individual paying the forfeited deposit is a property trader, the expenditure might be an allowable deduction from profits on the basis it was ‘wholly and exclusively’ incurred for trade purposes, if the property would have been a trading asset had it been 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 the property acquisition does not generally constitute an asset disposal by the individual paying the deposit (TCGA 1992, s 144(4)). The individual who paid the forfeited deposit will therefore potentially incur a non-allowable capital loss (e.g., see Hardy v Revenue and Customs [2016] UKUT 332 (TCC)).
Practical tip
For a forfeited deposit to purchase an individual’s dwelling, HMRC will not allow private residence relief for CGT purposes on the receipt, on the grounds there has been no disposal of the property itself (see HMRC’s Capital Gains manual at CG64609).
