What is the gift of equity?
Selling a home to a family member or close friend is a gift of equity. Professional appraisals show the pricing is below market value. The equity gift differs between the home’s sales price and market value. Most lenders accept equity down payments.
How Equity Gifts Work
Home equity is a property’s worth less than secured loans—equity gifts place value in a house. The homeowner usually sells it for less than its market value. The transfer is a gift even without money due to the value differential.
If you sell a $300,000 house to a family member for $200,000, they earn $100,000 in equity. Giving a home away for free or discounting its worth is a gift of equity.
Equity gifts are shared between parents selling their house and children. These presents might involve grandparents, aunts, uncles, cousins, or siblings. The donation counts as a house-down payment with most lenders. The house might be a primary or secondary residence.
Gifts of equity lower or eliminate down payments, making mortgages more straightforward.
Mortgage Loan Qualification Requirements
Even with a gift of equity, buyers must meet financing requirements. This implies they must fulfill lender credit and income standards. They’ll also need the following documents for mortgage approval:
- A minimum of one year of tax returns
- Updated W-2s
- Recent bank statements
- Investment records
Sellers must also examine what they’re giving up with equity. They may be helping a relative buy a home who couldn’t otherwise. However, the seller may miss out on a significant house-selling profit.
You can utilize gift cash or equity for various mortgages, such as conventional, adjustable-rate, FHA, and VA loans.
Benefits and Drawbacks of Equity Gifts
Advantages
The primary advantage of gifting equity is that the buyer doesn’t need to make a down payment. Because the donation of equity can be a down payment, this saves time and money, especially because FHA mortgages need a 3.5% down payment. 3 Here are some equity donation benefits:
- Avoiding market fluctuations: In a volatile or high-interest market, a gift-of-equity sale might speed up and secure homebuying. The receiver would presumably know more about future house concerns.
- Elderly homeowners might ease estate settlements by transferring assets before death via providing equity.
- Maintains family ownership: Many believe that maintaining a house in the family is a legacy. A gift of equity can make this possible if an entire purchase is too expensive for the following generation. It might potentially be a large bequest the seller couldn’t make otherwise.
- Lower closing expenses: A lower purchase price should cut closing costs, which partly depend on the sale price.
- Reducing the purchase price makes homeownership more affordable, especially for family members who couldn’t afford it otherwise.
- Benefits: The equity gift can reduce the seller’s tax burden by applying to the yearly gift tax exclusion or lifetime gift tax exemption.
Disadvantages
Equity gifts have drawbacks:
- Closing expenses are necessary when transferring property titles.
- If the gift affects the property’s cost basis, future capital gains may be more significant when the beneficiary sells the house.
- A transfer of equity may trigger the gift tax. Thus, sellers should follow IRS gift criteria. A married couple can contribute $36,000 and a single person $18,000 to an individual in 2024 without gift tax. Property transferees must submit gift tax returns.
- Local market: Selling a home below market value with a gift of equity might affect the local real estate market. A property selling for far less than others with comparable qualities may hurt other home sales at that price point or location.
Pros
- Low or no buyer down payment
- There is no financial exchange between the giver and the recipient.
- Zero realtor commissions
Cons
- No closing cost savings
- The giver may pay gift tax.
- Due to property cost basis changes, future capital gains may be higher.
- A lower value may impact local real estate.
Equity Gift Requirements
The seller and buyer must sign a gift of equity letter explaining the sale details. The letter must state who gave the equity gift, its value, and the property. It must also state that it is a gift, not a loan.
Here are more letter requirements:
- The house seller must pay for an official appraisal.
- Home appraisals must include the value.
- The evaluation must specify the selling price of the gift of an equity residence.
- Paperwork must note the assessed value less the gift selling price.
A second letter will acknowledge the equity contribution at closing. The donor chooses how much equity to provide. Say you sell your home to an adult kid. Although the property is worth $400,000, you sell it for $200,000, giving them $200,000 in equity. You decide the sale price.
Example of Equity Gift
To qualify for a mortgage, lenders often accept gifts of equity as part of the down payment. Typically, banks want 20% down to avoid mortgage insurance. If the seller gives the buyer 10% of the home’s worth as equity, the buyer only needs to put 10% down.
A larger scenario illustrates these points:
Imagine buying a property from a relative. A 20% down payment is $120,000, considering the home’s $600,000 fair market value. If a family member sells the home for $550,000 and gives you $50,000 in equity, you only need $70,000 (11.7%) for the 20% down payment.
The mortgage type determines the down payment amount. For an FHA loan, a family member can give equity to fulfill a 3.5% down payment if the house is the principal residence.
What’s the Difference Between a Cash and Equity Home Purchase Gift?
Cash gifts are direct money transfers, whereas equity gifts include donating part of a home’s worth. A gift of equity is special to real estate transactions and eliminates the requirement for a monetary down payment or a third party in the sale of a property.
Can estate planning use equity gifts?
Yes, estate planning may include equity gifts. It allows living homeowners to transfer property to loved ones, potentially minimizing estate taxes. This may help keep the property in the family.
How does a gift of equity affect the seller?
The seller may pay taxes on equity gifts, depending on their magnitude. The seller may pay gift tax if the equity gift is below the yearly exclusion. That exclusion is $18,000 for singles and $36,000 for couples in 2024.
Do equity gifts have tax effects?
Yes. For the donor, taxes may apply. Equity donated might count against the giver’s lifetime or yearly gift tax exemption. A gift of equity is not taxable for the receiver but may increase capital gains taxes. The gift of equity lowers the buyer’s cost basis, enhancing their chances of selling the property for a profit (the future sale price minus the cost basis). All parties to a gift of equity should consult a tax professional about their tax responsibilities.
Bottom Line
A gift of equity allows sellers to assist buyers, typically family members, in buying a house. The vendor doesn’t provide the purchasers with cash for a down payment. Instead, they sell their homes cheaply. This offers the buyer immediate equity above what they paid for.
Conclusion
- It entails selling a home below market value without money.
- Family members or close friends may sell their house to a kid as a gift of equity.
- The donation counts as a house-down payment with most lenders.
- The homebuyer must qualify for a mortgage and provide a gift of equity letter.
- Equity gifts usually incur taxes for both parties.
