if you break a real estate contract, you'll incur a penalty, which is classified as income and taxable. If you break the contract, you'll have to withhold 22%, including local income tax, and if you break the contract, you'll report it as other income on your comprehensive income tax return. If you miss a withholding, you'll be subject to a surcharge of up to 10%.
table of contents
- what is the real estate penalty?
- real estate penalty tax obligations
- tax treatment when the seller cancels
- tax treatment when a buyer cancels
- penalty tax caveats
- frequently asked questions
what are real estate penalties?
when you're in the process of buying or selling real estate, unforeseen circumstances can make it necessary to terminate the contract, such as sudden financial difficulties, a better property coming along, or a change in personal circumstances.
article 41 of the Implementing Decree of the Income Tax Act clearly defines penalty and compensation: "Compensation for damages received as a penalty or termination of a contract relating to property rights, regardless of its name, is the value of money or goods that compensates for damages beyond the damage to the original contractual content of the payment itself.
in other words, it is the compensation paid to the other party for breaking the contract. However, it is also income for the recipient, so it is obligated to pay real estate penalty tax.
real estate penalty tax liability
many people think of penalties as just damages, but according to the Income Tax Act, penalties are also a type of income, so you need to pay income tax as a real estate contract termination tax.
however, the method of payment and the tax rate are completely different depending on who is terminating the contract. Let's take a look at the case of the seller terminating the contract and the case of the buyer terminating the contract.
tax treatment when the seller terminates the contract
triggering withholding obligations
when a seller terminates a contract, the seller has a tax withholding obligation. What this means is that the seller has to withhold taxes before paying the penalty and then pay the rest to the buyer.
penalty tax rate of 22% applies
the tax rate is 22%, which includes 20% income tax and 2% local income tax. For example, if the penalty is 10 million won, the seller has to withhold 2.2 million won in taxes and pay 7.8 million won to the buyer.
the seller must report and pay the withheld taxes to the tax office within a certain time frame. This process is called penalty withholding.
issue a withholding receipt to the buyer
as a buyer, you can deduct the amount of tax that's already been withheld when you file your comprehensive income tax return, so it's a good idea to give the seller a withholding receipt.
tax treatment when the buyer terminates the contract
no withholding obligation
the situation is different if the buyer cancels the contract. In this case, you're not required to withhold taxes, and you can simply pay the seller the full amount of the penalty.
seller's combined income tax return
instead, the seller who receives the penalty must report it as penalty miscellaneous income on their comprehensive income tax return in May of the following year. Comprehensive income tax is a tax on all income earned during the year.
in this case, the tax rate varies depending on the total amount of income. Other income, excluding necessary expenses, is subject to comprehensive taxation if it exceeds KRW 3 million, and you can choose separate taxation if it is less than KRW 3 million.
penalty surcharge tax
the most important part of the real estate penalty tax is the surcharge tax. What happens if the seller terminates the contract and fails to fulfill the withholding obligation?
failure to withhold or failure to report and pay can result in a penalty surcharge of up to 10%, which means you'll owe more tax than you should.
so it's important to make sure you're on top of your taxes and complete your filings and payments on time when you close on a property.
frequently asked questions
Q1. Do I really have to pay taxes on penalties?
A1. Yes, under the Income Tax Act, penalties are classified as other income, so the recipient of the penalty is liable to pay income tax. However, the method of payment is either through withholding or a comprehensive income tax return, depending on who terminated the contract.
Q2. Why is the penalty tax rate 22%?
A2. The withholding tax rate for other income is 20% income tax, and 2% local income tax is added to it, totaling 22%. Remember that the penalty tax rate including local income tax is 22%.
Q3. What are the penalties for not withholding tax?
A3. Failure to fulfill the withholding obligation can result in a surcharge of up to 10%, and the buyer may not receive a withholding receipt and may not be able to claim the tax credit.
Q4. If the buyer cancels the contract, does the buyer not have to pay tax?
A4. If the buyer terminates the contract, the buyer is in the position of paying a penalty. The person who pays the penalty does not owe taxes. The seller who receives the penalty pays the taxes on his or her comprehensive income tax return.
Q5. When do I file a comprehensive income tax return for the penalty?
A5. The tax filing period is May 1 to May 31 each year. You can report all income, including penalty payments received in the previous year, during this period.
conclusion
real estate penalty taxes are paid differently depending on the party that terminates the contract: 22% withholding for seller termination, and seller's comprehensive income tax for buyer termination. It's important to file and pay on time to avoid additional taxes.
if you have more questions about organizing your real estate taxes, ask them in the comments. and don't forget to subscribe and set up alerts to stay informed.