Tax treatment of forfeited deposits

It is possible, albeit unfortunate, to lose a deposit and never own the asset to which it relates. This most commonly occurs when a potential buyer enters into an agreement to purchase a property and pays a deposit to the vendor but is unable to secure the funds to complete the purchase. This article considers the tax consequences for the parties involved.

Receipt- income or capital gain?

For the person who receives a forfeited deposit, there are two possible ways in which the sum might be taxed, depending on the circumstances of the recipient.

If the recipient is a property trader, such as a housebuilder or property developer, it is likely that the forfeited deposit will form part of their taxable trading income.

However, in circumstances where the recipient is not a property trader and is, for example, a landlord or owner-occupier then the forfeited deposit may be treated as a capital gain with no deducible base cost, so the entire deposit would be taxable to the extent that it exceeds the recipient’s annual CGT allowance.

If the forfeited deposit relates to the seller’s only or main residence, the gain will not be eligible for main residence (PPR) relief. This is because, although the receipt has some connection to the residence, it is not in relation to the disposal of an interest in the residence.

Is there any tax relief for the individual who loses their deposit?

If the individual who pays and subsequently loses the deposit is a property trader, the expenditure might be an allowable deduction from their taxable trading profits on the basis that it was incurred “wholly and exclusively” for trade purposes where the property, had it been acquired, would have been trading asset.

Author Claire Charlton

Following the logic of the treatment of the receipt as described above, it would be tempting to think that a non-trader who suffers the loss of a deposit would incur a capital loss which could be offset against capital gains made on other assets. Unfortunately, recent tribunal cases show that HMRC think otherwise. They have stated that forfeited deposits do not constitute the disposal of a capital asset, therefore the loss cannot be deductible for CGT purposes.

The difference in treatment between recipient and payer arises because the recipient is treated as having disposed of an option to acquire property which is treated as an asset, whereas the abandonment of an option does not constitute an asset disposal by the individual paying the deposit. Unfortunately, this means that a non-property trader who loses their deposit faces a double blow as they receive no tax relief for their loss.

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