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Mortgages

What is an arras contract and what is it for?

The contrato de arras (earnest money contract) is a document whereby the buyer of a property delivers a certain amount of money to the seller to guarantee that it will honour its side of the contract, meaning the eventual purchase and sale. In other words, it is a form of reservation of ownership, or pre-agreement that prevents either party from backing out before the public deed is signed.

Although it counts towards the final price of the house, it is not just an advance payment, as it could be forfeited if the contract does not ultimately go through.

While not a strict requirement, it is a recommended mortgage document because it provides a certain assurance of compliance. However, there are other commitment options aside from deposit agreements, such as purchase and sale commitments, purchase and sale with deferred payment and purchase options.

What information does a contrato de arras (earnest money contract) contain?

This document must include:

  • The personal details of the buyer and seller.
  • The details of the property: characteristics, address, cadastral reference number, etc.
  • The reservation cost for the property.
  • The price of the property.
  • The purchase and sale costs and the party responsible for each: notary fees, property registry fees, TIP, VAT, etc.
  • Any liens and encumbrances on the property.
  • The deadline for completion.
  • The penalties for both parties if they back out of the contract.

How many types of earnest money agreement are there?

There are three types of earnest money contract.

First, we have what are known as arras penitenciales, which are governed by Article 1,454 of the Civil Code. This is the most common and gives the parties an option to back out of the purchase and sale. If the seller backs out, they have to return two times the amount of earnest money furnished by the buyer. If the buyer backs out, they forfeit their earnest money. The parties may back out until signature of the deed of purchase and sale is signed (this can take some time, as the buyer may take while arranging things with the notary, securing a mortgage, etc.), even if the buyer has made some further payment after the earnest money.

Secondly, we have arras penales, as provided for in Articles 1,152 and 1,152 of the Civil Code. This type of contract requires the party who walks away to pay compensation. If it is the buyer, they will forfeit their deposit while the seller must return twice the amount given if they back out. The affected party may also insist that the contract be honoured and compensation paid. In other words, breach of the purchase and sale does not mean that the sale will not go through.

Lastly, we have what are known as arras confirmatorias, as provided for in Article 1,124 of the Civil Code. This contract guarantees the purchase and sale agreement and the money delivered is an advance on the total price of the property. Breach means that the matter will go to court.

Earnest money contracts should be drawn up carefully, because if they fail to explicitly state the right to withdraw, it will be assumed that the contract qualifies as arras confirmatorias (simply a down payment on the final purchase price).

How to draw up an earnest money agreement

First of all, we need to decide on the type of arras we want to rely on. We must think this through carefully, because each type has different implications. Once drawn up, each page must be signed and any annexes added: non-certified copies of deeds, plans, etc. Each party will retain a copy. Reliable templates and forms are available, such as the one provided by the OCU (Spanish Organisation of Consumers and Users).

What tax is paid on an earnest money contract?

Is earnest money taxed? Yes, but in various ways.

For new homes, the buyer will be required to VAT to their earnest money. For existing properties, the buyer pays Impuesto de Transmisiones Patrimoniales (Property Transfer Tax) on the sale price, including the deposit, when the deed is signed.

If the purchase goes through, the seller must pay plusvalía municipal (municipal capital gains tax) and declare any gain they may have made in their personal income tax return. If the sale does not go through and the earnest money is forfeited or paid back twice over, what generally happens is that the party who retains the deposit will declare it in their personal income tax return, while the party that forfeits it declares the loss in their personal income tax return.