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Down Payment Contract in Spain

A down payment contract (Contrato de Arras) is a private contract that secures the intention to purchase and reserve a property. In this type of contract, "arras" (liability money) are often agreed upon. There are two types of "arras" payments:

"Arras penitenciales" are penalty payments that act as fines if one of the parties withdraws from the contract. If the buyer loses interest or fails to make the final payment, they forfeit their deposit. If the seller withdraws, they must refund the down payment in double the amount.

"Arras confirmatorias" are confirmatory payments that express a binding purchase contract without the possibility of undoing the commitment. If the buyer makes an initial payment, it confirms their seriousness and commitment to the purchase.

"Arras penales" are advance payments that function similarly to a contractual penalty.

Usually, the down payment contract is more advantageous for the seller. It's important to carefully review the terms of the contract and seek legal advice to ensure that you fully understand the implications of the arrangement.

When making a down payment for a property sale, different tax rates may apply depending on how the payment is transferred. For real estate sales, VAT is typically due when the deed of sale is signed, but for down payment contracts, VAT becomes due as soon as the seller receives the payment. If the buyer's payment is placed in an escrow account, no VAT is due until the seller actually receives the funds. The VAT rate for the down payment is the same as the rate applied to the eventual sale of the property, even if the property's condition changes between the down payment and final sale. If the property is exempt from VAT, then the down payment contract is also exempt.

When a down payment contract is made, the amount paid is considered an advance payment on the purchase price. If the sale includes VAT, VAT must be paid on this amount when it is received by the seller, at the rate applicable to the type of property being transferred: 10% for completed residential properties, 21% for others and any properties under construction.

However, if the down payment amount is paid into an account other than the seller's account, such as a trust account held by a notary public, lawyer or tax advisor, VAT is not due until the moment of the sale and effective transfer to the seller.

If the sale is subject to real estate transfer tax, a different legal regulation applies. In this case, the tax becomes due only at the moment of notarization of the sale, i.e. on the day of effective transfer of the real estate, regardless of whether the down payment is made to the seller or to an escrow account.

It is important to note that an option contract is only recommended for prospective buyers who want an enforceable right to purchase a specific property and are willing to accept the associated economic and tax disadvantages, such as the option premium as an additional cost and 21% sales tax. In contrast, a down payment contract does not guarantee an enforceable right to purchase, but the amount paid is directly part of the purchase price and is not subject to separate taxation.


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