When advance / earnest money is received in respect of a proposed sale of a capital asset and the deal falls through, leading to forfeiture of the advance, the tax treatment depends on the date of forfeiture.
### Treatment Based on Date
Date of Forfeiture
Treatment
Before 1.4.2014
Deduct from Cost of Acquisition (when the asset is eventually sold) — reduces COA, increases future capital gain
On or after 1.4.2014
Taxable in the year of forfeiture as Income from Other Sources u/s 56(2)(ix)
### Forfeiture by Previous Owner
If the advance was forfeited by a previous owner of the asset (and not by the current assessee), it is completely ignored — no adjustment in COA and no IFOS taxability.
### Why the change in 2014?
Under the old regime, forfeiture only reduced COA, deferring tax until eventual sale (and giving an artificial reduction in capital gain). To prevent tax planning, Section 56(2)(ix) was introduced to tax forfeiture upfront as IFOS.
Worked example
### Example 1
Example 1 (Post-2014): Mr. F received ₹2 lakh as advance for sale of his house in FY 2024-25. Buyer backed out and ₹2 lakh was forfeited. Mr. F eventually sells the house in FY 2026-27 for ₹50 lakh (COA ₹20 lakh).
FY 2024-25: ₹2 lakh taxable as IFOS u/s 56(2)(ix)
FY 2026-27: Capital Gain = ₹50 lakh − ₹20 lakh = ₹30 lakh (COA not reduced)
### Example 2
Example 2 (Pre-2014): Mr. G received ₹1 lakh as advance in 2012, forfeited the same year. Sells the asset in FY 2024-25 for ₹40 lakh (original COA ₹15 lakh).
FY 2024-25: COA = ₹15 lakh − ₹1 lakh = ₹14 lakh; Capital Gain = ₹40 lakh − ₹14 lakh = ₹26 lakh
⚠️ Common exam mistakes
Reducing COA for forfeiture occurring after 1.4.2014 — that creates double taxation since it's already taxed as IFOS.
Adjusting COA for forfeiture done by the previous owner — such forfeiture is entirely ignored.
Forgetting to tax the forfeiture as IFOS in the year of forfeiture (post-2014).
Bare-Act text Section 51 read with Section 56(2)(ix) · Income-tax Act, 1961 · click to expand
Section 51: Where any capital asset was on any previous occasion the subject of negotiations for its transfer, any advance or other money received and retained by the assessee in respect of such negotiations shall be deducted from the cost for which the asset was acquired or the written down value or the fair market value, as the case may be, in computing the cost of acquisition: Provided that where any sum of money, received as an advance or otherwise in the course of negotiations for transfer of a capital asset, has been included in the total income of the assessee for any previous year in accordance with the provisions of clause (ix) of sub-section (2) of section 56, such sum shall not be deducted from the cost for the purposes of section 48.