I am confused by Section 1234A, the root of this uncertainty.  The most recent Tax Court opinion says, "Forfeited deposits from the termination of a contract to sell a hotel are taxed at capital gain rates if the hotel is held as a passive investment. The same forfeited deposits are taxed as ordinary income if the hotel is used in a trade or business."  So, is this rental a passive activity, and does that make a difference?  They could have avoided this problem by calling it an option, not a deposit.  So sue the lawyers who wrote the contract, for malpractice. Or more likely, the real estate agents.