Taxes and books

How to track an earnest money deposit for taxes

Tracking an earnest money deposit for tax purposes involves recording it as a liability until the deal closes or falls through. You need to differentiate between earnest money paid out and earnest money received, as their accounting treatment differs.

October 13, 2026 · 3 min read

What is an earnest money deposit in bookkeeping?

An earnest money deposit (EMD) is a good faith payment made by a buyer to show commitment to a purchase. From a bookkeeping perspective, it is not immediately an expense or income.

Instead, it typically begins as a liability for the party holding it, or a current asset for the party paying it, until the transaction's outcome is decided. This treatment ensures your books accurately reflect its temporary nature.

Recording earnest money paid out

When you, as the investor, pay an earnest money deposit, you record it as an asset on your balance sheet. This might be under an account like 'Earnest Money Deposits - Receivable' or 'Deposits Held by Third Parties'.

This shows that you have funds committed to a deal that will either convert to part of the purchase price or be returned to you. The cash account you paid from decreases, and the EMD asset account increases.

Recording earnest money received

If you are the party receiving and holding an EMD, perhaps through your own brokerage or title company for a transactional funding scenario, you record it as a liability. This is because you owe that money to someone else until the deal closes or terminates.

A common account for this is 'Earnest Money Deposits - Payable' or 'Client Trust Funds'. The cash account you received the money into increases, and the EMD liability account increases.

What happens to EMD at closing?

At closing, the earnest money deposit typically applies toward the purchase price. For the buyer, the EMD asset account decreases, and the property asset account increases by the full purchase price.

For the seller, the EMD liability account decreases as it's applied, reducing the final cash needed from the buyer. This is when the EMD is truly recognized as part of the transaction's consideration.

How to adjust EMD for terminated deals

If a deal falls through and the EMD is returned to the buyer, you simply reverse the original entry. The EMD asset account decreases, and your cash account increases.

If the EMD is forfeited to the seller, the buyer would record it as an expense, and the seller would recognize it as income. This is where the temporary liability or asset becomes a permanent financial event. For more on tracking all your deal costs, see our guide on /bookkeeping-best-practices-for-real-estate-investors.

Important note on tax advice

This information is for general bookkeeping principles only and is not tax advice. Real estate transactions have complex tax implications that can vary based on your entity structure and jurisdiction.

Always consult with a qualified tax professional to understand how EMD and other real estate activities affect your specific tax situation. They can provide guidance tailored to your business. For an overview of investor types, check out /for/new-investors.

Questions people ask

Is earnest money considered income?

Earnest money is generally not considered income until it is forfeited by the buyer in a terminated deal. If the deal closes, it becomes part of the purchase price, not separate income.

How do I record an EMD that gets returned?

When an EMD is returned to you, you reverse the original entry. You would debit your cash account and credit the earnest money deposit asset account. It essentially cancels out the initial transaction.

Do I need a separate account for earnest money?

While not always legally required for your own EMD (check your state laws), it's good practice to track earnest money distinctly in your bookkeeping. If you hold EMD for others, a separate trust account is often legally mandated.