Key Takeaways
- Seller gifts equity by selling below market value.
- Gift equity counts towards buyer's down payment.
- Primarily used in family property transfers.
- Gift may trigger taxable gift reporting for seller.
What is Gift of Equity?
A gift of equity occurs when a property seller, often an immediate family member, sells a home below its appraised market value. The difference between the appraised value and the sale price acts as a financial gift that the buyer can use toward their down payment or closing costs.
This arrangement helps buyers reduce upfront cash needs by leveraging the property's built-in equity, verified through a professional appraisal reflecting the fair market value.
Key Characteristics
Gift of equity transactions have distinct features that impact both buyers and sellers:
- Seller-to-Buyer Relationship: Typically between immediate family members, ensuring trust and eligibility for most lenders.
- Appraised Value Basis: Requires an independent appraisal to establish the home's fair market value for accurate gift calculation.
- Loan Impact: The gifted equity reduces the loan amount needed, often eliminating or minimizing the buyer’s down payment.
- Documentation: Involves a gift of equity letter, purchase agreement at reduced price, and appraisal report to satisfy lender requirements.
- Tax Considerations: The gift may trigger capital gains tax implications for the seller, though annual gift exclusions often apply.
How It Works
To execute a gift of equity, start by obtaining a professional appraisal to determine the property’s fair market value. The seller then agrees to a sale price below this value, creating the equity difference that is gifted to the buyer at closing.
This gifted amount can be applied toward the buyer's down payment or closing costs, reducing the mortgage loan balance. Lenders typically require clear documentation, including an earnest money statement and a gift letter stating no repayment is expected.
Examples and Use Cases
Gift of equity is especially useful in family home sales and can facilitate affordable homeownership:
- Family Transactions: Parents selling a home to their children at a reduced price, enabling the buyer to cover down payment costs without additional cash.
- Supporting Homebuyers: Families can use gifted equity to help buyers avoid private mortgage insurance (PMI) by reaching a 20% equity threshold.
- Investment Alternatives: For those interested in low-cost growth, consider exploring best low-cost index funds alongside real estate gifting strategies.
Important Considerations
While gift of equity can make homeownership more accessible, be mindful of lender criteria and tax implications. Sellers should consult tax professionals about potential capital gains tax and filing requirements if the gift exceeds IRS thresholds.
Buyers should ensure they meet eligibility requirements and prepare necessary documentation, such as the gift letter and appraisal, to satisfy underwriting standards and avoid delays.
Final Words
A gift of equity can significantly reduce your upfront costs by applying the seller’s discounted price toward your down payment. Consult with your lender early to confirm eligibility and required documentation before moving forward.
Frequently Asked Questions
A gift of equity occurs when a seller, usually a family member, sells a home below its appraised market value. The difference between the appraised value and the sale price is gifted to the buyer and can be used as a down payment or to cover closing costs.
First, a professional appraisal determines the home's fair market value. The seller then sells the property at a lower price, and the difference is credited to the buyer at closing, reducing the loan amount needed and possibly eliminating the need for a cash down payment.
Gift of equity transactions are primarily between family members like parents and children. Some lenders may allow close associates or domestic partners, but the gift cannot come from interested parties such as builders or real estate agents.
Required documents include a gift of equity letter from the seller confirming the gift and relationship, the purchase agreement showing the reduced sale price, an appraisal report verifying fair market value, and the closing disclosure detailing how the gift is applied.
Yes, the seller must report the gifted equity as a taxable gift if it exceeds the IRS annual exclusion amount, currently $18,000 per recipient in 2024. However, most sellers avoid immediate gift tax due to the high lifetime exemption, and primary residence sale exclusions may apply for capital gains taxes.
No, the buyer does not owe income tax on the gifted equity. However, their cost basis in the home is reduced by the gift amount, which could increase capital gains tax if they sell the property for a profit in the future.
Gift of equity is allowed with conventional, FHA, and VA loans, subject to loan-to-value limits and lender approval. It's typically used for principal residences and sometimes second homes under Fannie Mae guidelines.
Some lenders may require a minimum cash down payment in addition to the gift of equity to ensure the buyer has some invested funds. Lenders carefully review these transactions to confirm the gift is legitimate and properly documented.
