What Is a Gift of Equity?

What Is a Gift of Equity?

Let me explain what a gift of equity really is. It's a way for you, as a homeowner, to help out your family by selling them your property at a price below its market value. This gives them financial relief and might even wipe out the need for a down payment. You'll often see this between parents and kids, making homeownership easier, but remember, it affects taxes and mortgage rules down the line.

Key Takeaways

Here's what you need to know upfront. A gift of equity means selling to a family member below market value, with that difference counting as a gift. It can cut down on the buyer's down payment and maybe skip private mortgage insurance, but watch out for gift taxes on the seller's side. This fits into estate planning, letting you transfer property while alive and possibly lowering estate taxes later. The buyer gets instant equity, but selling the home later could mean higher capital gains taxes because of the adjusted cost basis. You'll need a formal gift letter to prove it's a gift, not a loan, plus other docs for the mortgage.

How Does a Gift of Equity Work?

Home equity is just the value of your property minus any debts on it. When you give a gift of equity, you're selling the home below market value without expecting extra payments, so the price gap becomes the gift. For instance, if your home is worth $300,000 and you sell it to family for $200,000, that's a $100,000 gift of equity. This can happen if you're giving the home away for free or just discounting it. It's usually between parents and children, but any family works, and it's for primary or secondary homes, often acting as the down payment. Importantly, it helps buyers cut or eliminate down payment needs, easing mortgage approval.

Qualifying for a Mortgage With a Gift of Equity

Even with a gift of equity, you as the buyer have to qualify for a mortgage. That means meeting the lender's standards on credit, income, and paperwork. You'll need at least a year's tax returns, current W-2s, recent bank statements, and investment account details. As the seller, consider if helping family is worth the lost profit from not selling at full value. And note this: gifts of equity work with conventional, adjustable-rate, FHA, and VA loans.

Pros and Cons of a Gift of Equity

Let's look at the advantages first. A big one is using it as a down payment, saving you time and cash—for FHA loans, it can skip the 3.5% minimum. In a shaky market or with high rates, this makes buying faster and surer, and you learn about home issues upfront. For estate planning, it's a way for older owners to pass assets now, easing things after death. It keeps the home in the family, preserving legacy when full price might be too much. Closing costs drop because they're based on the lower sale price, and the reduced price opens homeownership to those who couldn't afford it otherwise. Plus, tax-wise, it can use annual exclusions or lifetime exemptions to cut the seller's taxes.

Now, the downsides. You still pay closing costs to transfer the title. The gift adjusts the cost basis, so future sales might mean higher capital gains for the buyer. Gift taxes could hit the seller—follow IRS rules; in 2024, married couples can give $36,000 and singles $18,000 yearly without tax, but file a return anyway. Also, selling low might drag down local property values if it sets a bad comp.

Required Documentation for a Gift of Equity

You need a signed letter from both sides stating the gift amount, property details, and that it's a gift, not a loan. Include an official appraisal showing the home's value, the sale price, and the difference. At closing, another letter confirms the gift. You decide the equity amount—for example, if your home appraises at $400,000 and you sell for $200,000, that's a $200,000 gift. This can help avoid private mortgage insurance costs for the new owner.

A Practical Example of a Gift of Equity

Lenders treat these gifts as down payments. If 20% down is required, a 10% gift means you only need 10% more. Say a home's worth $600,000, so 20% down is $120,000. If sold for $550,000 with a $50,000 gift, you only need $70,000 (about 11.7%). For FHA, family gifts can cover the 3.5% minimum if it's your primary home.

What's the Difference Between a Gift of Equity and a Cash Gift for a Home Purchase?

A gift of equity transfers part of the home's value as a gift, while a cash gift is straight money. Both help buy a home, but equity gifts are tied to the property sale, avoiding cash transfers or third parties.

Can a Gift of Equity Be Used in Estate Planning?

Yes, it can. It lets you transfer property to family while alive, possibly cutting estate taxes and keeping it in the family.

How Does a Gift of Equity Affect the Seller?

It might bring tax issues based on gift size. You could owe gift tax unless under the 2024 exclusions: $18,000 for singles, $36,000 for couples.

Does a Gift of Equity Have Tax Implications?

Absolutely. For the giver, it counts against gift tax limits. The recipient doesn't pay tax now but might face higher capital gains later due to lower cost basis. Consult a tax pro for details.

The Bottom Line

In summary, a gift of equity lets you help family buy your home below market value, using the equity as a gift to cut down payments. It has upsides like tax perks and lower costs, but watch for gift taxes and future gains. Think it through and talk to experts before deciding.