Capital gains for forfeited security deposit
I listed a home for sale in California where I lived for the last 3 years. First buyer paid earnest deposit of 3% and decided to back out from the contract by forfeiting the security deposit. I received 100% of the deposit. Within a week, i got another offer and ended up selling the home. My total gain (home sale gain+ forfeited deposit) is less than $500k from this transaction. Can the forfeited deposit be considered as capital gain or should it be considered as an ordinary income?
Quick Answer:
The forfeited earnest money deposit, in this scenario, is considered additional proceeds from the sale of your home. Since the property was ultimately sold, the deposit is not treated as ordinary income. Instead, it increases the "amount realized" from the sale of the property.
Therefore, its character follows that of the gain from the sale of your primary residence. This means the forfeited deposit would be considered a capital gain. Given that your total gain (including this deposit) is less than $500,000, it would generally be excludable from income under the primary residence gain exclusion rules, assuming you meet all other requirements for the exclusion.
Note: This answer is provided for convenience only. It is important that you speak to a CPA about your individual tax situation.
