What does a down payment contract consist of?

Have you ever heard of a down payment contract in the purchase process? VIVA Sotheby’s International Realty explains to you everything about this process, find out more here!

Sometimes, prior to sale, a down payment contract is signed between the parties. Thus, with the down payment, both parties agree to carry out the transaction, as one party undertakes to sell and the other to acquire the property. For this purpose, the buyer pays a deposit called ‘a down payment’.

This document is private and is usually understood as a contract that – in some way – prepares the ground for the subsequent sale and purchase. However, the down payment contract allows either party to withdraw from their intention (either the buyer or the seller), although this action is usually associated with a pentalty that both parties would have previously agreed on.

Thus, in the case of the buyer, we are talking about the loss of the amount paid in advance. But if it is the seller who withdraws, they must return double the amount.

How are down payments taxed?

This is a complex question with many nuances. We will try to answer it clearly and succinctly.

Specifically, we will see what would happen in the delivery of the down payment:

  •  If we are dealing with a second-hand property, the Property Transfer Tax (PTT) must be paid, but the delivery of the down payment does not imply the accural of the tax.
  • On the other hand, if it is subject to VAT, as would be the case with newly built homes, the seller must charge VAT on the aforementioned amount.

However, if at the end there is a withdrawl, we will be faced with the following scenario:

  • In the case of the individual, the compensation will be a capital gain in the personal income tax of the recipient and a capital loss in the personal income tax of the other party who has breached the contract.

How are down payments made?

In general, it is agreed to do so at two points in time:

  • The buyer pays the agreed amount at the time of signing the contract which will subsequently be deducted from the purchase price of the property.
  • The second part is handed to the seller in the presence of a notary with the signing of the purchase contract.

Contents of a down payment contract

In such a contract, the following information is usually recorded:

  • Identification of both the selling party and the buying party.
  • Identification and description of the property.
  • The final price of the property, plus details of the payment method to be used.
  • The amount of money that is advanced on the property.
  • The period of time given to formalise the contract.
  • Commitment of both parties to carry out the transaction by means of a public deed.
  • Distribution of the expenses incurred by the sale.
  • Signature of both parties.

Who signs the down payment contract?

The buyer and seller must be properly identified with their ID card, name, surname and place of residence. Of course, it is up for them to provide their signature for the earnest money contract to be considered duly formalised.

Types of down payment contract

In our legal system there are three types of deposit. We deal with:

1- Confirmatory down payments

From the moment the contract is signed and the amount is paid, both parties can demand that the contract is fulfilled, even if the other party renounces.

2-Penitential down payments

Both, the buyer and the seller, may withdraw from the contract. Although it will not be a free gesture, since the former will lose the amount delivered and the seller will have to pay double the amount received if they are the one who has refused to continue with the process.

3- Penalty down payments

They are considered a hybrid between the confirmatory and the penitential ones, since the defaulting party must assume the payment of the fixed penalty, but the other party may demand the fulfillment or the termination of the contract. 

Having said all this, it should be made clear that the law does not oblige the signing of a deposit. It is up to the parties involved to decide freely to agree. However, this is a less and less frequent option.

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