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Real property

earnest money

Earnest money is a deposit paid—often into an escrow account—to show a good-faith intention to complete a transaction—often a transaction for the purchase of real property (real estate).

If the prospective buyer defaults and fails to complete the transaction for the purchase of the real property (fails to close) the earnest money is usually forfeited and delivered to the would-be seller under the terms of the contract or agreement for the sale of the property.

Earnest money is generally not required for a valid contract for the purchase and sale of real property, but is often included to compensate the prospective seller for time and potential missed sales opportunities while the sale was “under contract” with the prospective buyer.

Earnest money may also be referred to as earnest; bargain money; caution money; hand money; or down payment.

In Texas, earnest money is a deposit made by a prospective buyer to demonstrate their serious intent to purchase real estate. This deposit is typically held in an escrow account during the period the property is under contract. While earnest money is not legally required to make a real estate contract valid in Texas, it is a common practice to provide assurance to the seller. If the buyer defaults on the agreement and fails to complete the purchase, the earnest money is usually forfeited to the seller, according to the terms outlined in the purchase agreement. The forfeiture of earnest money serves as compensation for the seller's time and the opportunity cost of having the property off the market. The terms and conditions regarding earnest money, including the amount, the conditions under which it may be forfeited or returned, and other details, are typically specified in the real estate purchase contract. It is important for both buyers and sellers to clearly understand these terms before entering into a contract. An attorney can provide guidance on the implications of earnest money in a real estate transaction and ensure that the contract terms are legally sound and protect the interests of the parties involved.

Texas Statutes & Rules

Federal Statutes & Rules

Internal Revenue Code, 26 U.S.C. § 1031
This statute is relevant because it addresses the tax implications of real property transactions, which can include the handling of earnest money in certain circumstances.

Section 1031 of the Internal Revenue Code allows for the deferral of capital gains taxes on the exchange of certain types of property, typically real estate. This is known as a like-kind exchange or a 1031 exchange. In the context of earnest money, if the deposit is held in an escrow account as part of a 1031 exchange, the treatment of the earnest money may be impacted by the rules governing these exchanges. The earnest money must be used in accordance with the 1031 exchange requirements to ensure the tax benefits are realized. If the transaction fails to close and the earnest money is forfeited, the tax implications for the buyer and seller may be affected.

Real Estate Settlement Procedures Act (RESPA), 12 U.S.C. § 2601 et seq.
RESPA is relevant because it includes provisions that affect the handling of earnest money deposits in the context of real estate transactions.

The Real Estate Settlement Procedures Act (RESPA) is a federal statute that governs certain aspects of the real estate settlement process. While RESPA primarily focuses on closing costs and settlement procedures, it also has implications for earnest money deposits as they are part of the settlement process. RESPA requires that all funds deposited in connection with a real estate purchase transaction be handled in a way that is transparent and compliant with federal regulations. This includes the handling of earnest money deposits, which must be disclosed to all parties and managed by a third party, such as an escrow agent. If a transaction fails to close, the disposition of the earnest money must be conducted in accordance with the terms of the agreement and RESPA regulations.

Uniform Commercial Code (UCC), Article 2
The UCC is relevant because it provides a framework for the sale of goods, which can include the contractual obligations surrounding earnest money deposits in transactions that may involve both real and personal property.

Article 2 of the Uniform Commercial Code (UCC) governs the sale of goods and, while it does not directly apply to real estate transactions, it can influence the contractual terms related to earnest money deposits when personal property is also involved in a real estate transaction. The UCC provides guidance on the formation of contracts and the rights and obligations of buyers and sellers, which can be analogous to the handling of earnest money in real property transactions. It is important to note that while the UCC has been adopted in some form by all 50 states, it is not a federal statute but a uniform state law. Therefore, its application to earnest money in real estate transactions may vary by state.