A gift of equity is when a property is sold to a loved one for less than its market value, often to help them become a homeowner. This can result in favorable mortgage terms and lower monthly payments, but may also have tax consequences if the gift exceeds certain limits.
A gift of equity is a situation where the property is sold to a loved one for less than the current market value. The actual amount of this type of gift is determined by subtracting the purchase price from the current market value. This approach is often beneficial to the recipient, as lenders are much more likely to provide favorable terms and conditions if a mortgage is taken out for significantly less than the actual value of the property.
There are a number of reasons a homeowner may choose to extend a gift of equity to a relative or other loved one. In some cases, the goal is to help your loved one become a homeowner by providing them with some degree of financial stability. For example, parents who have retired and plan to move into a smaller residence that was once used as a weekend home may choose to sell a larger residence to a child.
Extending the gift of equity often means the child doesn’t have to provide a down payment. This is especially true when the gift amount means the child needs a loan that is significantly less than the current market value. As a result, the child has a home that has a low mortgage, will likely enjoy lower monthly payments, and has the ability to pay off the mortgage in a shorter period of time than would otherwise be possible.
Depending on the actual amount of the equity donation, the recipient may face a certain amount of tax consequences. Although many National Revenue Agencies allow parents to provide financial donations up to a certain amount per year to their children, any equity gift exceeding that amount should be reported. This means that the gift may be considered a capital gain and be subject to capital gains tax. This is true even though tax laws allow each parent to give gifts of equal value to their child.
For example, if the current gift limit is $10,000 US dollars (USD) per parent per tax year, both parents could sell the house to the child at an asking price that is $20,000 USD below current market. This could be done without generating any kind of capital gains tax assessment. Should the capital gift amount total $25,000 USD, the difference would be considered capital gains and would be subject to tax.
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