A gift of equity is when someone gives equity in a home to another person, often during a family home sale. Tax implications should be considered, and a letter must be signed by both parties. It can also be used as a down payment on a loan.
A gift of equity is a situation where someone gives equity in a home to another person. Such gifts usually occur at the time a home is sold, and most commonly occur when homes are sold within a family, although they can also be given to non-family members. There are some important tax considerations that people should take into account when setting up this type of gift, and it may be helpful for people to consult an accountant or tax attorney before accepting such a gift.
In a simple example of how an equity gift might work, a child could enter into an agreement to buy a house from their parents, who own the house outright. They can agree that the value of the house is $100,000 US dollars (USD) and that this should be the sale price. Parents could offer a gift of $20,000, which means they would write more than $20,000 of equity value in the home to the child, requiring the child to raise $80,000 to cover the remainder of the price.
This type of gift can also be used as a down payment on a loan, since if it is large enough, a lender will usually accept it in lieu of a down payment. If not, or if someone wants to have more equity in the house up front, more money could be provided as part of the down payment. For people who can manage a mortgage but don’t have the funds for a down payment, an equity gift can be a great solution, since they need a minimum of cash at closing.
For one to be valid, both parties must sign a letter, stating that the principal is being awarded and noting the amount of principal being offered as a gift. Essentially, it’s like a cash gift, except instead of giving people cash to use as a down payment, people give equity in the home directly. Before the loan is approved, the bank will confirm that the home’s value has been accurately reported, and will also check the borrower’s creditworthiness to confirm that the borrower will be able to service the mortgage.
Tax implications vary, depending on an individual taxpayer’s history and the amount of the gift. An accountant or lawyer should be able to provide advice so that people can ensure that their taxes are filed honestly and properly. Tax agencies are on the lookout for situations they deem to be abusive or of questionable legality, and it is important to ensure that a gift of equity is properly processed and reported.
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