Indiana earnest money laws are set mainly in the state’s real estate licensing statutes and administrative rules, and they govern every step a broker takes with a buyer’s deposit. The core rule: once a purchase agreement is signed, the listing broker has two banking days to move the funds into a trust account, cannot mix them with any other money, and cannot release them to either side except as the contract or a court directs. Brokers who break these rules face fines up to $1,000 per violation, license suspension or revocation, and in cases of intentional misuse, criminal theft charges.
The Written Purchase Agreement Controls Everything
Indiana’s statute of frauds requires real estate purchase contracts to be in writing to be enforceable. An oral promise to buy a house, even one backed by a check, does not give either party reliable footing. The written agreement is what decides how much is deposited, who holds it, which contingencies allow a refund, and what happens if the deal collapses.
A well-drafted agreement names the escrow holder (usually the listing broker or a title company), states the earnest money amount, and lists every contingency that can trigger a refund. The common ones are financing approval, a satisfactory home inspection, and the property appraising at or above the purchase price. If a scenario is not addressed in writing, resolving it later becomes slower and more expensive.
Typical residential deposits run about 1% to 3% of the purchase price, though the parties can agree on any figure. Competitive markets push deposits higher as a signal of commitment; slower markets accept less. Whatever the number, it belongs in the agreement with clear terms for every exit.
Trust Account Rules and the Two-Banking-Day Deadline
Indiana law requires every broker company to maintain one or more trust accounts and to deposit all funds belonging to others into those accounts. The statute prohibits commingling: a broker cannot mix earnest money with personal or business operating funds. Each trust account must be clearly identified, and the broker must keep records showing how much is held for each beneficiary.1Indiana General Assembly. Indiana Code 25-34.1-4-5 – Trust Accounts
Trust accounts can be interest-bearing or noninterest-bearing. If the account earns interest, that interest belongs to the beneficiary, not the broker.1Indiana General Assembly. Indiana Code 25-34.1-4-5 – Trust Accounts Unless your purchase agreement says otherwise, any interest earned on your deposit while it sits with the broker is yours.
The deposit deadline is two banking days after the purchase agreement is fully executed. The broker can place the funds in the listing broker’s own trust account or with whatever party the agreement designates.2Legal Information Institute. Indiana Administrative Code 876 IAC 8-2-2 – Written Offers to Purchase Banking days exclude weekends and holidays, so a Friday acceptance generally means a Tuesday deposit.
The deadline is enforced. In Indiana Real Estate Commission v. Ackman, an audit showed a broker had repeatedly missed the two-day deposit rule and had also drawn advances from the escrow account before closings occurred. The Commission imposed an indefinite license suspension with no right to petition for reinstatement for six months, plus a required continuing education course in escrow account law.3FindLaw. Indiana Real Estate Commission v Ackman
If a sole proprietor broker dies, a broker company terminates, or a broker’s license is revoked or suspended, the Indiana Real Estate Commission takes custody of the trust accounts and may appoint a successor trustee to protect and distribute the funds.1Indiana General Assembly. Indiana Code 25-34.1-4-5 – Trust Accounts The deposit does not disappear with the business.
When the Buyer Gets a Refund and When the Seller Keeps It
If the transaction closes, the deposit is credited toward the buyer’s down payment or closing costs. The harder question is what happens when it does not close.
A buyer who backs out under a valid contingency written into the purchase agreement is entitled to a refund. The three most common contingencies:
- Financing contingency. The buyer applied for a mortgage and was denied; a lender’s denial letter usually serves as documentation.
- Inspection contingency. The home inspection revealed significant defects, and the seller declined to fix them or reduce the price.
- Appraisal contingency. The property appraised below the purchase price, and neither party agreed to bridge the gap.
The critical phrase is “written into.” A buyer who assumes a contingency exists without confirming the contract language is exposed. If the agreement contains no financing contingency and the buyer cannot get a loan, the seller may have grounds to keep the deposit.
When a buyer breaches without a valid contingency excuse, the seller can typically retain the earnest money as liquidated damages if the purchase agreement says so. Indiana courts enforce liquidated damages clauses when the forfeiture amount is reasonable in relation to the anticipated harm from the breach. A deposit of 1% to 3% of the purchase price generally passes this test. A clause forfeiting 10% of the price on a million-dollar property would face much closer scrutiny.
FHA and VA Loans Add a Buyer Protection
Buyers using government-backed loans get a protection that overrides whatever the purchase agreement says about forfeiture on appraisal.
For an FHA-insured mortgage, the sales contract must include (or be amended to include) an amendatory clause stating that the buyer is not obligated to complete the purchase or forfeit earnest money unless the property appraises at or above the contract price. The clause must state the actual purchase price. If the appraisal comes in low, the buyer can walk with a full refund or choose to proceed anyway. All parties, including the buyer, seller, and real estate agents, must sign the amendatory clause before the appraisal is ordered.4U.S. Department of Housing and Urban Development. HUD Handbook 4000.1 – FHA Single Family Housing Policy Handbook
VA-backed loans use a similar “escape clause” or “VA amendment to contract.” Its required language states that the buyer will not forfeit earnest money or face any penalty if the contract price exceeds the reasonable value established by the Department of Veterans Affairs. As with FHA, the buyer keeps the option to proceed even if the appraisal is lower.
Sellers sometimes resist these clauses because they create a free exit for the buyer if the appraisal disappoints, but the clauses are not optional. A contract missing the required language for an FHA or VA loan will need to be amended before closing.
What Happens When the Parties Disagree
When buyer and seller both claim the deposit, the escrow holder cannot unilaterally pick a winner. Resolution generally follows one of three tracks.
Mediation and Arbitration
Many Indiana purchase agreements include a mediation or arbitration clause. Mediation brings in a neutral third party to help the parties negotiate, but neither side is bound by the mediator’s suggestions. Arbitration produces a binding decision. Indiana courts can also refer civil cases to mediation on their own or on a party’s motion.5Indiana Judiciary. Indiana Rules for Alternative Dispute Resolution
Interpleader
When neither party will move and the broker wants out of the middle, the broker can file an interpleader action under Indiana Trial Rule 22. The broker deposits the disputed funds with the court, asks to be dismissed, and lets the buyer and seller fight it out.6Indiana Judiciary. Indiana Trial Rule 22 – Interpleader Interpleader is common in earnest money disputes because it protects the broker from liability to whichever side loses. The broker typically recovers costs and attorney fees for filing.
Breach of Contract Litigation
If there is no arbitration clause and mediation fails, the dispute becomes a breach of contract lawsuit. Courts look at whether contingencies were satisfied, whether a party wrongfully refused to close, and whether anyone acted in bad faith.
Indiana follows the American Rule on attorney fees: each side pays its own lawyer. A court can shift fees to the loser only when that party brought a frivolous or groundless claim, kept litigating after the claim became baseless, or acted in bad faith.7Indiana General Assembly. Indiana Code 34-52-1-1 – Costs and Attorney Fees Some purchase agreements include their own attorney fee provisions, and courts will enforce those. Without one in the contract, expect to cover your own legal costs regardless of outcome.
Penalties for Brokers Who Mishandle Deposits
Indiana’s professional licensing board can impose a range of sanctions on brokers who mishandle trust funds. The board can:
- Permanently revoke a broker’s license
- Suspend a broker’s license
- Censure the broker or issue a letter of reprimand
- Impose a civil penalty of up to $1,000 per violation
- Order restitution to any person who suffered damages
- Place the broker on probation with conditions such as continuing education or practice restrictions
When imposing a fine, the board must consider the broker’s ability to pay, and a license cannot be suspended solely because someone cannot afford a fine.8Indiana General Assembly. Indiana Code 25-1-11-12 – Sanctions for Violations
Criminal exposure is the more serious risk. A broker who intentionally converts escrow funds to personal use commits theft. Under Indiana law, theft is a Class A misdemeanor for amounts under $750, a Level 6 felony when the value is between $750 and $50,000, and a Level 5 felony at $50,000 or more.9Indiana General Assembly. Indiana Code 35-43-4-2 – Theft Most residential earnest money deposits fall in the Level 6 felony range, which carries six months to two and a half years of imprisonment.
A wronged party can also sue the broker for breach of fiduciary duty and recover actual damages. The Ackman matter shows how the pieces stack: a routine audit uncovered escrow violations, which led to indefinite suspension, mandatory education, and a professional record that makes future licensure very difficult.3FindLaw. Indiana Real Estate Commission v Ackman
Tax Treatment When a Deposit Is Forfeited
The tax result depends on which side you are on. A seller who keeps both the deposit and the property must report the forfeited amount as ordinary income, not capital gain. Because no sale or exchange took place, courts have treated these payments as liquidated damages taxed at ordinary rates and have rejected sellers’ arguments for capital gains treatment.
For buyers, purpose controls. A lost deposit on a home you meant to live in personally is not deductible. If the failed purchase involved a rental property or another business asset, the forfeited deposit may qualify as a capital loss reportable on Schedule D. Anyone who loses a substantial deposit on a business property purchase should talk with a tax professional before filing.