What Is a Gift of Equity?

A gift of equity occurs when a home is sold to a close relative or loved one for a price below its current market value. The difference between the home's appraised fair market value and the lower sale price represents the "gift." This gifted equity can then be used by the buyer to cover all or part of their down payment requirement, making it much easier to secure a mortgage.

How Does a Gift of Equity Work?

The process typically involves these key steps:

• Agreement: The seller and buyer (usually family members) agree on a sale price that is lower than what the home is worth.
• Appraisal: The buyer's mortgage lender will require a professional appraisal to determine the home's fair market value.
• Gift Letter: The seller must provide a formal "gift letter" to the lender. This document states that the equity is a true gift and that no repayment is expected.
• Loan Closing: At closing, the gifted equity is treated as cash from the buyer. For example, if a home is worth $400,000 and is sold for $350,000, the buyer receives a $50,000 gift of equity to use as their down payment.

Frequently Asked Questions (FAQ)

Is a gift of equity taxable?

For the buyer (recipient), the gift of equity is not considered taxable income. For the seller (donor), the gifted amount may be subject to federal gift tax if it exceeds the annual gift tax exclusion limit set by the IRS. It's recommended to consult a tax professional for advice on your specific situation.

Who can give a gift of equity?

While policies can vary by lender, a gift of equity is almost always restricted to transactions between family members. This typically includes parents, children, siblings, grandparents, and other close relatives. Transactions between unrelated parties are generally not eligible.

What is a gift letter?

A gift letter is a signed document required by mortgage lenders in a gift of equity transaction. It must explicitly state the seller's relationship to the buyer, the property address, the exact dollar amount of the gifted equity, and a declaration that the funds are a gift with no expectation of repayment.