Whether you can deduct lost earnest money depends on the purpose of the property you intended to buy.
If the Home Was for Personal Use
If you forfeited earnest money because a purchase contract for your personal residence fell through, the loss is not deductible on your federal income tax return. The IRS considers earnest money lost on the attempted purchase of a personal home to be a personal expense. Personal losses are generally not deductible.
If the Property Was Intended as a Rental or Business Investment
If you lost earnest money while attempting to purchase a property for rental or business use, you may be able to claim the loss as a capital loss. In this situation, the forfeited earnest money is generally treated as an investment-related loss and reported on Schedule D (Capital Gains and Losses).
How to Report a Lost Earnest Money Deposit for a Rental Property
To enter the loss in the program:
- Federal
- Income – Select My Forms
- Investments
- Stocks, Mutual Funds, Cryptocurrency, Collectibles, etc.
When entering the transaction:
- Date Acquired: Enter the date the earnest money was placed into escrow.
- Date Sold: Select the alternate date option and choose "Worthless."
- Choose "Worthless Short-Term" if the earnest money was held in escrow for less than one year.
- Choose "Worthless Long-Term" if the earnest money was held in escrow for one year or more.
- Cost Basis: Enter the amount of earnest money that was forfeited.
- Sales Proceeds: Enter $0.
- Cost Basis Type: Select "I did not receive a Form 1099-B."
The program will calculate the resulting capital loss and report it on Schedule D.
Short-Term vs. Long-Term Capital Loss
The length of time the earnest money was tied up in escrow determines whether the loss is short-term or long-term:
- Short-term loss: Escrow period was less than 1 year.
- Long-term loss: Escrow period was 1 year or more.
This distinction affects how the loss is reported and how it offsets gains on your tax return.