Giving Your Adult Child a Gift of Equity: How It’s Done

With a gift of equity, you can sell a home to a family member for less than it’s worth on the market. The difference between what the buyer pays and the actual market value is the gift.

So you, as the seller, make the gift. It’s your call how much equity to give. Then, if your child is approved for a home loan, your child’s lender will usually apply the amount toward the down payment.

For Example…

Your beloved family home is just too much to maintain these days, and you’re ready to downsize.

Marty, your adult child, is daunted by the local real estate prices, but doesn’t want to move away from family to find an affordable home. You’d be glad to sell your $400,000 home at a discount to Marty. The discount could take care of Marty’s down payment.

Marty is willing to take out a loan and buy the home for $320,000. The $80,000 discount—a gift of equity—can serve as Marty’s 20% down payment.

Now, Marty will be able to get mortgage approval and avoid paying private mortgage insurance (PMI), as the gift of equity becomes a 20% down payment.

As you already know, when the deed to a home is transferred to a new homeowner, the new owner is expected to pay closing costs. These costs are generally lower when the price of a home is lower. With a gift of equity, the sale price is reduced. So, Marty’s burden of closing costs should also be eased. Nice job!

There are a few limitations to know about. Most mortgage types (including government-backed and conventional loans) allow gifts only between family members (as defined by your lender). And the gift of equity can’t be counted toward the home buyer’s cash reserves.

Is This a Taxable Gift?

Every year when you file your tax return, the Internal Revenue Service looks at whether you made any gifts totaling more than the annual exclusion.

At the same time, a gift is part of the total amount you are allowed to set aside from taxes during your life: the lifetime exclusion. Currently, you can make gifts that total up to $15 million per person ($30 million for a couple). When you file, you’ll check the IRS website for updates to various caps.

Basically, it works this way, per the Internal Revenue Service’s current federal gift tax instructions:

• You, the person giving it, would report the gift to the IRS on a gift tax return.

• An individual can transfer the value of up to $19,000 in a given year without having to pay gift tax on it. A married couple can give up to $38,000. So you might not owe any taxes on the gift because of your allowable annual exclusion. You’re really just notifying the IRS that you’re taking the amount out of your lifetime gift exemption.

• For your adult child, the home buyer, the gift of equity is not taxable. But down the road, if the buyer decides to sell, there can be a bigger profit, which can increase capital gains taxes.

This is the difference between a gift and an inheritance. If you use a will or trust to pass your home to family after you pass, your beneficiary will benefit from the stepped-up tax basis.

Read more from Deeds.com on capital gains tax and gift exemptions.

Helping Your Child Get That First Deed

Are you planning to work with an agent? Some agents offer à la carte services. That is, for a flat fee, an agent might agree to guide you through pricing, the purchase agreement, and working with an appraiser and home inspector.

Say you want to handle your deed transfer without a real estate agent. When you’re ready to sell and your child is ready to buy, you can hire a lawyer admitted to the bar of your state to help you create the purchase agreement. Title companies have attorneys who work in this sphere. Your title company can find a mortgage pro, handle the settlement documents, and file the new deed with the county.

In any case, your child will need to work with a mortgage consultant. The process will be like any other purchase. The mortgage consultant will request all the usual financial documentation, vet the applicant’s credit profile, and guide the borrower through the underwriting process.

All the while, it’s critical to handle the transfer with professionalism to ensure the legitimacy of your deed transfer.

Title insurance is good for a buyer to have. The buyer should understand the difference between a lender’s policy and an owner’s policy, and whether to select standard or enhanced title insurance.

Calculating Your Gift

A gift of equity has documentation requirements. The key document is the appraisal report. You’ll need an appraiser to establish the home’s current fair market value. Subtract the agreed-upon sale price from the home’s full value to calculate the gift of equity amount.

Now, you’re ready to fill out the “gift of equity letter” form from your lender. You’ll state the property’s address, the exact amount of the gift, and your assurance that the gift doesn’t need to be repaid. You’ll also supply your name, contact details, and relationship to the borrower—who must sign the letter along with you.

The purchase contract must disclose the gift of equity. And when the borrower gets to closing, the lender-approved gift of equity will be stated as part of the sale price on the closing disclosure document.

In Short…

You might have wondered if you can help your adult child get a home. If you’re selling your own, you have one possible answer. Giving the gift of equity can make acquiring a deed possible for a loved one who couldn’t otherwise afford the down payment on a home in these inflationary times.

A gift of equity involves transferring part of a home’s value as a gift (as opposed to a cash gift, which is a direct transfer of funds). This is a simple way to keep a home in the family and to offer your child a boost onto the homeownership ladder. For your child, the whole process is like any other experience of acquiring a home with a mortgage.

Important note: Although we can share some general points that sellers and buyers should know, we cannot provide financial, tax, or legal advice to our readers. Speak with licensed advisers before making decisions regarding estate and tax matters. Keep in mind that real estate laws are largely based on state law. And you should both speak with your tax pros to understand any tax ramifications under state law as well as federal law.