Gift of Equity

Gift of Equity: How It Works, Benefits, Risks, and What You Need

What is a gift of equity?

A gift of equity is when a homeowner sells a property to a family member for less than its appraised market value, and the price difference is treated as a gift. Instead of transferring cash for a down payment, the seller transfers part of the home’s equity to the buyer through a discounted sale price.

How it works

• Home equity = market value minus any mortgage or liens.
• Example: Home appraised at $300,000 is sold to a relative for $200,000 → $100,000 gift of equity.
• The buyer uses the gifted equity toward the down payment and closing costs; lenders count it as part or all of the required down payment when documented properly.
• Typical between parents and children but can involve other family members; usually applies to primary or secondary residences.

Qualifying for a mortgage

Buyers must still meet the lender’s credit, income, and documentation requirements. Common documents lenders require:
– Signed gift-of-equity letter confirming the amount and that it is not a loan
– Paid appraisal showing market value and the agreed sale price
– Tax returns, W-2s, recent bank statements, and investment account statements
– Standard mortgage underwriting paperwork

Different loan programs accept gifts of equity (conventional, FHA, VA), but program rules and required down payment percentages vary. A gift can help meet minimum down payment requirements and may help avoid private mortgage insurance (PMI) if it brings the buyer’s equity to the lender’s threshold.

Advantages

• Reduces or eliminates the buyer’s cash down payment.
• Can avoid PMI when it increases buyer’s equity to required levels.
• Keeps property in the family and can support estate-planning goals.
• Often speeds the transaction and reduces the buyer’s exposure to market fluctuations.
• Lower sale price may reduce some closing costs tied to the purchase price.

Disadvantages and risks

• Closing costs still apply and must be paid.
• The gift may trigger gift-tax reporting and could use part of the giver’s annual exclusion or lifetime exemption; the giver may need to file a gift tax return.
• The recipient’s cost basis is generally the giver’s basis (not the discounted purchase price), which can increase future capital gains tax when the recipient sells.
• A below-market sale recorded in public records can affect comparable sales in the local market.
• Lenders require strict documentation; failure to provide it can derail mortgage approval.

Required documentation

• Gift of equity letter signed by seller and buyer stating:
• The gift amount (difference between appraised value and sale price)
• Property address
• Statement that the amount is a gift and not repayable
• Paid, independent appraisal listing the market value and the agreed sale price
• Closing documents that reflect the gift and the sale terms
• Standard mortgage underwriting documentation for the buyer

Example

Fair market value: $600,000
Sale price to family member: $550,000
Gift of equity: $50,000

If the lender requires a 20% down payment ($120,000), the $50,000 gift reduces the buyer’s required cash to $70,000. For FHA loans, a gift of equity can generally be used to meet the minimum 3.5% down payment requirement, provided program rules are met.

Tax and estate-planning considerations

• Gift tax: A gift of equity counts toward the giver’s annual gift tax exclusion and lifetime exemption. If the gift exceeds the annual exclusion per recipient, the giver must file a gift tax return; further tax may be owed only if lifetime exemption limits are exceeded.
• Cost basis and capital gains: The recipient’s cost basis may be the giver’s original basis, which can increase future capital gains tax when the property is sold.
• Estate planning: Gifting equity during the giver’s lifetime can be part of estate strategies to transfer wealth and potentially reduce estate value subject to estate tax.

Consult a tax advisor or estate-planning professional to understand current gift-tax limits, filing requirements, and implications for cost basis and future capital gains.

Bottom line

A gift of equity can be a powerful way to help a family member buy a home by converting existing equity into a down payment without an immediate cash transfer. It simplifies financing for the buyer and can support estate-planning goals for the seller, but it requires careful documentation and carries tax and future capital-gains consequences. Both parties should review lender requirements and consult tax and legal advisors before proceeding.