Gift Funds, Gift of Equity
How does a ‘Gift of Equity’ work? For example: house worth $200,000; buyer wants to pay Parents $150,000 but doesn’t want to put anything down and doesn’t want to pay mortgage insurance and wants a good interest rate. If Parents give him a Gift of Equity of $50,000, doesn’t this mean the sale price is actually $200,000? What happens with the mortgage and their tax situation?
February 27, 2002
We actually run into this type of scenario more often than you might think. Benevolent parents are willing to give what you accurately describe as a gift of equity when they sell a property within the family. With proper documentation, we treat this as a gift in the usual sense, just as if it were dollars being handed over, and the transaction would meet most loan program requirements.
Yes, the sale price in your example would be $200,000 for our purposes, and it will be important that the lender’s appraisal support this sale price as the property value. However, I would urge your parents to consult with their accountant on how best to structure the transaction for their purposes. They may be required to use the $200,000 in their tax reporting, yet I understand any tax is calculated on the consideration paid, so $150,000 could be the reportable sale price.
They might also want to file a gift tax return, depending on their accountant’s viewpoint. Under current federal tax law, you can gift up to $675,000 during your lifetime, so I believe no gift tax would be due. However, there might be a capital gains issue for them if they have not lived in the property two of the last five years. In any event, it is wise to consult with an accountant before finalizing the figures.
As to the mortgage, the lender would be concerned that this is a bonafide, arms-length transaction, with a true value and a true gift. In your example, the mortgage being requested is at 75% loan-to-value if an appraisal will support the $200,000 sale price. Generally, most conventional mortgage programs require a 20% down payment when it is all gifted; if less, in standard programs, the borrower would be required to bring 5% of his own money to the transaction. Your example more than fits the typical program requirements.
You would escape the need for any mortgage insurance and you would have a transaction with no money down. I certainly hope it works for you.
Copyright 2002 #122
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