Land Sale Ernest Money

[user17630568333]

We have sold some land (we have owned for longer than a year) that will close in 2026. We accepted and gained control of $50,000 Ernest Money in 2025. My question is if this Ernest Money needs to be claimed as "additional income" or can it fall under "Capital Gains" and that particular amount only, be taxed at the appropriate Capital Gains Rate of 15% for our income tier. Thank you.

[Bsch4477]

The earnest money is part of the sale to occur in 2026 and as part of that transaction will be treated as part of your capital gains for 2026. 

[user17630568333]

And to clarify , if needed, I am in Washington State. Thank you

[user17630568333]

I saw someone comment on a somewhat similar question that the Ernest Money needs to be claimed in the year we gained control of the money. We deposited the $50k in 2025 and will be reported to the IRS as a deposit into our personal account in 2025. 

[user17630568333]

From what I have read, we pay taxes in the year we gained control of the money and we received $50k of the Earnest Money in 2025 so would pay taxes on that portion in 2025 even though we will receive more and close in 2026.

[Opus 17]

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@user17630568333 wrote:

From what I have read, we pay taxes in the year we gained control of the money and we received $50k of the Earnest Money in 2025 so would pay taxes on that portion in 2025 even though we will receive more and close in 2026.

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I agree with @Bsch4477 , this should be treated as part of the sale in 2026.

While the rule of "constructive receipt" does exist, applying it to this situation can be complicated.  Under your sales contract, do you keep the money even if the buyer defaults?  Then it might be your income now.  But if you would be required to return a portion or all of the money if the sale falls through, then it is not your money yet.  And if the sale is contingent, it can be even more complicated.  (For example, you keep the money if the buyer backs out for no reason, but you return the money if the sale fails to close because of a failure to pass some required inspection or other unforeseen problem--in that case, is it really your money now?  Probably not.)

If you really do want to report this as income in 2025, then you should see a good tax accountant.  There could be some issues with splitting the transaction.  

[Bsch4477]

IRS Pub 544 states that a capital gain or loss occurs when the transaction is completed. Since your transaction will not be completed until 2026 the earnest money which is part of that transaction should be part of the capital gain calculation. 

[AmeliesUncle]

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@Opus 17 wrote:Under your sales contract, do you keep the money even if the buyer defaults?  Then it might be your income now.  But if you would be required to return a portion or all of the money if the sale falls through, then it is not your money yet.  

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This is the key.  If it is non-refundable to the payer, it is income in 2025.  If it is refundable until 2026, it would not be income until 2026.

[user17630568333]

We do keep the money no matter if the buyer defaults. My question is, does the $50k get calculated as Capital Gains for 2025, so a separate percentage than our income. Thx

[Bsch4477]

If you keep the money anyway you report it as other income and it is taxed at your marginal tax rate not as capital gains.