A gift of equity is a real estate transaction where a seller—usually a family member—sells a home to a buyer at a price below the appraised fair market value. The difference between the appraised value and the sale price is considered the “gift” which the buyer can use toward their down payment or closing costs. This arrangement makes homeownership more accessible for buyers who might struggle with upfront cash.
For example, if a property appraises for $350,000 but the seller agrees to sell it for $300,000, the $50,000 difference serves as a gift of equity. Mortgage lenders recognize this as the buyer’s down payment, which can help meet loan qualification requirements and often allows the borrower to avoid paying Private Mortgage Insurance (PMI).
To complete a gift of equity transaction legally and for lender approval, the following steps are key:
- Purchase Agreement: The buyer and seller sign a contract stating the reduced sale price.
- Professional Appraisal: An independent appraisal is required by lenders to confirm the home’s fair market value and calculate the gift amount.
- Gift Letter: The seller provides a formal gift letter to the lender, confirming the gift amount, property details, appraisal value, and specifying that repayment is not required. Both parties sign this letter.
- Loan Processing: The lender verifies the appraisal and gift letter, allowing the gifted equity to count toward the down payment.
Regarding eligibility, gift of equity transactions are typically limited to family members or close relations such as parents, children, siblings, grandparents, aunts, uncles, or spouses. Various loan types like FHA, VA, and conventional loans permit gifts of equity but may define eligible relationships differently, so it’s important to check with your lender.
Tax Considerations
Gift of equity transactions typically do not trigger tax consequences for the buyer. Instead, it is the seller who may face gift tax filing requirements. The 2024 annual gift tax exclusion allows an individual to gift up to $18,000 per recipient without filing a gift tax return. Since most gifts of equity exceed this amount, sellers must file IRS Form 709 to report the gift. However, this rarely results in actual gift tax owed, as the gift amount above the annual exclusion applies against the $13.61 million lifetime exemption in 2024.
Sellers should consult a tax professional to confirm reporting requirements and any implications specific to their situation. For further details, see FinHelp.io’s glossary on Form 709 – United States Gift (and Generation-Skipping Transfer) Tax Return and information on Mortgage Gift Funds.
Benefits and Drawbacks
| Buyer Advantages | Seller Advantages |
|---|---|
| No upfront cash down payment needed | Ability to assist loved ones in buying a home |
| Immediate home equity | Potentially faster sale process |
| Avoidance of Private Mortgage Insurance (PMI) | May need to file Form 709 but likely no tax owed |
| Buyer Disadvantages | Seller Disadvantages |
|---|---|
| Lower cost basis can increase future capital gains tax | Receives less cash than market value sale |
| Requires good credit and income to qualify for mortgage | Gift tax reporting paperwork required |
Frequently Asked Questions
Do I need good credit to use a gift of equity?
Yes. The gift replaces your down payment but you still must qualify based on credit, income, and debt-to-income ratio.
Can the gift of equity cover closing costs too?
Sometimes, if the gift amount is sufficient to cover both the down payment and closing costs.
What documentation is necessary?
An appraisal and a signed gift letter are required by lenders—informal agreements won’t be accepted.
Gift of equity is a valuable tool for families to assist homebuyers but requires proper steps and documentation for smooth mortgage approval and tax compliance.
For more on down payments, visit our Down Payment glossary entry and to understand tax forms related to gifts, see Form 709 glossary on FinHelp.io.
References:
- IRS Annual Gift Tax Exclusion, 2024: https://www.irs.gov/businesses/small-businesses-self-employed/frequently-asked-questions-on-gift-taxes
- Form 709 United States Gift Tax Return: https://finhelp.io/glossary/form-709-united-states-gift-and-generation-skipping-transfer-tax-return/
- Mortgage Gift Funds: https://finhelp.io/glossary/mortgage-gift-funds/
- Consumer Financial Protection Bureau: Gift of Equity guidance at https://www.consumerfinance.gov/ask-cfpb/what-is-a-gift-of-equity-en-1251/