A Comprehensive Guide To The Gift Of Equity In Real Estate Transactions

Mortgage Dove

A Comprehensive Guide To The Gift Of Equity In Real Estate Transactions

Getting a gift of equity can be good if you're looking to buy a house. It's when someone, often a family member, sells a house to you for less money than it's worth, sometimes way less. It's like getting money from family for your home down payment.

But how does this gift of equity work? And are there taxes you need to worry about when giving or getting one? Let's check out how these home equity gifts work and what problems you should avoid.


What’s a Gift of Equity?

A gift of equity is selling a house to a family member or someone you're close to. The price is lower than the market value, as decided by a professional appraisal. The gap between the actual selling price and the home's market value is the gift of equity. Many lenders let you use this equity for a down payment.


Why Is Equity Significant? 

When you sell your home, having more equity means more profit. You can also use your home's equity for things like home equity loans or lines of credit. These loans can be handy for various expenses, from a kitchen upgrade to settling credit card debt or chipping in for your kid's college fees. Plus, having at least 5% equity in your home is necessary if you want to refinance your mortgage at a lower interest rate.

A gift of equity is when sellers, usually family members, help buyers purchase a house. Instead of giving cash for a down payment, the seller agrees to sell the home below market value. This lets the buyer immediately access more equity without paying the total price.


How a Gift of Equity Works

Giving someone a gift of equity is pretty straightforward. Let's say your house is valued at $250,000, and your kids want to buy a home but need help with the down payment or other costs.

If you sell your house to your child for $220,000, you're giving them a $30,000 gift of equity.

You decide how much equity to give. You could even sell the $250,000 house to your child for $0, making it a generous gift of equity of $250,000.


Steps for the Seller in a Gift of Equity

Let's check out what a seller needs to do when giving a gift of equity without getting too complicated.

Gift Letter

When selling with a gift of equity, sellers need to sign a gift letter. This letter tells the amount of equity being given, mentions the property address, and notes the relationship between sellers and buyers. Importantly, it confirms that the equity is a gift and doesn't need repayment.

Home Appraisal

Sellers also have to get a home appraisal to know the current market value. This helps figure out the actual equity being given. For instance, if the home is appraised at $180,000 and sold for $100,000, the gift of equity is $80,000.


Steps for the Buyer in a Gift of Equity

Buying a home with a gift of equity follows the usual steps, even though you're getting a deal. If the gift doesn't cover the full home cost, like buying a $200,000 home for $100,000, you'll still need a mortgage. The lender checks your credit and income.

To make it easier for the lender, provide:

  • Two recent paycheck stubs
  • Last two years of tax returns
  • Last two months of bank statements
  • Last two years of W-2 forms.

Also, let them check your credit reports and FICO® credit scores with your permission.


What Type of Mortgage Can a Buyer Get With a Gift of Equity?

Buyers getting a gift of equity from sellers still have various mortgage choices. They can go for different types like 15-year, 30-year, adjustable-rate, or Federal Housing Administration (FHA) loans. It can even be used for a second home.


Do You Need to Pay Taxes on a Gift of Equity?

Sellers need to be careful because if the gift is too big, they might have to fill out a gift tax form when doing their tax returns.

According to IRS rules, you can give someone a gift of up to $17,000 in cash or property each year without having to pay gift taxes. So, if a married couple gives their child a gift of equity worth $34,000 ($17,000 from each parent), they won't have to worry about triggering gift taxes.


Gift of Equity Tax Consequences Example

Gifts of equity can have tax implications, and it's crucial to know that the gift tax applies per person receiving it. For instance, a couple could give $17,000 of equity to each of their two kids and the same amount to their kids' partners without facing a tax bill. In total, they could give $68,000 in equity without worrying about taxes.

The tax rate depends on the gift's size, with the highest rate being 40% in 2023. Even if the gift surpasses the $17,000 limit, the seller might not actually owe gift taxes right away. The excess gift amounts add up to a "lifetime exclusion total," which needs to go beyond $12.92 million (as of 2023) before the donor typically has to pay any gift taxes.


Pros and Cons of a Gift of Equity

Here's a simple breakdown of the benefits and drawbacks of a gift of equity:


  • Buyer gets to put down less or no money upfront
  • No need for cash to switch hands between the giver and receiver
  • No real estate agent fees


  • Doesn't skip closing costs
  • Giver might face gift tax implications
  • Possible higher capital gains down the road due to the impact on the property's cost basis
  • Lower value might impact the local real estate market



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

A gift of equity means giving a portion of a home's value as a gift, while a cash gift is simply giving money directly. Both can assist someone in buying a home, but a gift of equity is unique to real estate deals, removing the necessity for a cash transfer for the down payment or involving a third party in property sale.

Can a Gift of Equity Be Included in Estate Planning?

Certainly! Giving a gift of equity as part of estate planning allows homeowners to transfer property to family members or loved ones while they're alive. This might lower future estate taxes and help maintain the property within the family.

How Does a Gift of Equity Impact the Seller?

The size of a gift of equity might impact the seller's taxes. If the gift exceeds certain limits, the seller might need to pay a gift tax. In 2024, the annual exclusion is $18,000 for single individuals and $36,000 for married couples, meaning gifts below these amounts might not incur a tax.


The Bottom Line

A gift of equity is a way for a seller to assist buyers, often family members, in buying a home. Instead of giving cash for a down payment, the seller sells their home below its market value. This lets the buyer get more home equity right away.

"Mortgage Dove makes home financing convenient for every American. You can count on us to provide a home buying experience tailored to your personal needs and financial situation. We strive to give you the peace of mind that your home financing goals can be achieved.”


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