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A gift of equity is a situation in which someone grants equity in a home to another person. Such gifts usually occur at the time that a home is sold, and they most commonly happen 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 be aware of when establishing this type of gift, and it may be helpful for individuals to consult an accountant or tax attorney before accepting such a gift.
In a simple example of how a gift of equity might work, a child could establish an agreement to buy a home from his or her parents, who own the house outright. They might agree that the value of the home is $100,000 US Dollars (USD) and that this should be the sales price. The parents might offer a gift of $20,000 USD, meaning that they would write over $20,000 USD worth of the equity in the home to the child, requiring the child to come up with $80,000 USD to cover the rest of the price.
This type of gift can in turn be used as a down payment on a loan since, if it is large enough, a lender will typically accept it in lieu of a down payment. If not, or if someone wants to have more equity in the house from the start, more money could be provided as part of the down payment. For people who can handle a mortgage but do not have the funds for the down payment, a gift of equity can be an excellent solution, as they need minimal cash at closing.
For one to be valid, a letter must be signed by both parties, indicating that the equity is being granted and noting the amount of equity being offered as a gift. Essentially, it is like a cash gift, except that instead of handing people cash to use as a down payment, people give equity in the home directly. Before the loan will be approved, the bank will confirm that the value of the house has been accurately reported, and it will also check the borrower for creditworthiness to confirm that the borrower will be able to manage the mortgage.
The tax implications vary, depending on an individual taxpayer's history and the amount of the gift. An accountant or attorney should be able to provide advice so that people can ensure that their taxes are filed honestly and appropriately. Tax agencies are on the lookout for situations that they believe are abusive or of questionable legality, and it is important to make sure that a gift of equity is processed and declared properly.
Another common practice that can help the buyer in home sale negotiations is asking the seller to pay a portion of the closing costs.
Most states have specific limitations on how large of a percentage of the costs can be paid by the buyer.
Since people buying their first home or selling another home with no equity built up often don't have thousands of dollars available for closing costs, this can expedite the sale and give the buyer breathing room to make an appropriate down payment.