It’s very popular for family members like parents, grandparents, or in-laws to want to help their child with the purchase of a first home. Usually this comes in the form of cash to put towards the down payment, otherwise known as a gift down payment. However, there are other ways to transfer real estate through the existing equity of the property.
An example of this would be if Mom and Dad owned a property that they wanted to sell to their son. Instead of the son having to come up with a down payment that he would typically need for a standard real estate purchase, Mom and Dad can sell the property at a below market value sale price to their child allowing this difference in equity to be the down payment in the form of a gift transfer.
What Is A Gift Of Equity?
Equity is the total value of a property minus the total debt or loans attached to it. In other words, how much equity a borrower has in their home versus how much they still owe to own it free and clear.
In order to give gift equity on a home, the owner must sell the property under what its appraised value is. For example, if the home is appraised at $600,000, the owner can sell it for $400,000 and grant a gift of $200,000 in equity. Rather than the buyer (Son) coming in with a $200,000 down payment, the sellers (Mom and Dad) credits the buyer (Son) $200,000 from the equity that they own in the home.
Why Is This Important?
If someone sells a home below market value, the buyer immediately inherits more equity in the property than they would have if they paid full price. By offering a gift of equity, they are essentially giving time and years of appreciation. If the person inheriting chooses to sell, equity is profit they can use for anything from paying off credit card debt, to remodeling a new home, to paying for college tuition, etc.
How Do You Give A Gift Of Equity?
While the buyer goes through primarily the normal steps of buying a house, there are certain steps you must follow as a seller in order to gift equity.
First, the buyer will need to get pre-approved for the loan. Second, the mortgage lender will need to set up and structure the loan accordingly. Third, the mortgage lender will provide specific documentation to support this gift transaction with what is known as a Gift Letter between the buyer and seller.
While this Gift Letter is not reported to the IRS, it is important that the buyers get proper tax advice from their tax preparer.
For more information on equity gifts and the possible taxes that are associated with them, please reach out to us at (760) 930-0569 and one of our loan officers will be happy to help you.