What is the Gift of Equity?
Gift of Equity is is referred to a sale transaction of a residential property to a family member at a price less than the market value of the property and is calculated as the difference between the actual market price and the selling price. For instance, say your grandfather sells you his house at $100,000 which is currently valued at US $175,000, in this case the gift of equity will be $75,000
How Does Gift of Equity Work?
In case of such transactions, the sale of a property is made to a family member at a discounted price. The difference between the selling price and the listed price is the amount of gift of equity which can be utilized to either make a down payment or pay-off the debts. In order to execute this, the seller is required to provide a gift letter to the buyer that comprises all the facts in regards to the sale of the property such as name of the seller, address, contact details, relationship between the seller and the buyer, dollar value of gift, declaration statement that “no repayment of gift value is required” and it should be duly signed by the both parties.
Further, in order to successfully execute the gift transaction, it is mandatory that the seller gets done a paid appraisal of the property and it must state the appraised market value of the property as well as the agreed selling price for the sale of the property. The appraiser is also required to mention the difference between the appraised market value and selling price as a gift of equity value.
Example of Gift of Equity
For instance, In 2019, Mr. John sold the house to his daughter for the US $ 100,000 whereas the appraised value of the house is US $1,75,000 then the gift of equity value is US $ 75,000 which exceeds the annual gift exclusion limit for 2019 i.e. US $15,000. This means the excess value of US $ 50,000 (the US $75000 – US $ 15000) will get count toward the lifetime gifting limit and Mr. John has to pay gift tax on the US $ 50,000.
Calculate Tax Impact of Gift of Equity Transactions
- It is not taxable to the recipient of the gift. However, the buyer may have to make the payment of gift tax if he exceeds the lifetime gift limit. The IRS assesses the taxability of gift of equity transaction as per estate and gift tax laws. For the year 2019, the lifetime gift value limit is US $ 11.40 million. If the buyer never exceeds the limit of US $ 11.40 million, the gift tax will not apply.
- Further, according to the estate and gift tax laws, not every gift counts for the lifetime limit of gifts. The law has prescribed an annual gift exclusion amount per recipient which may vary year on year as defined in the tax laws. The annual gift exclusion amount per recipient for the year 2019 is US $ 15,000. This means if the father gifts up to the US $ 15000 in year 1 and again the US $ 15,000 in year 2, then these both gift value will not be count in for the lifetime gifting limit.
- However, say if the father gifted the US $ 15,000 in year 1 and then make an additional gift of US $ 10,000 in year 1, then the later amount i.e. US $10,000 will gets counted towards the lifetime gifting limit. This means if the difference between the appraised market value of the property and selling price is more than the annual gift exclusion limit, then the seller has to bear the burden of gift tax on the excess amount.
Let’s discuss the following benefits.
- Low to No Down Payment: Since the sale transaction takes place between family members it reduces the requirement of making down payment to either nil or significantly lower values.
- Closing Costs: The seller may further agree to bear the closing costs related to the transaction. Closing costs include property taxes, deed drafting charges, attorney fees, payment of mortgage if any.
- Savings on Agent Commissions: Since the gift of equity transactions take place between family members, it generally does not involve any real estate agents. This enables the seller to save the commission payments which may cost around 5%.
Let’s discuss the following disadvantages.
- Legal Fees: No real agents are involved as the transaction happens between family members. However, this increases the cost of legal charges and professional attorney fees for the drafting of the contracts and legal documentation.
- Gift Tax: Just like other gifts, they are not taxable to the recipient. However, the seller may have to make the payment of gift tax in the future if the gift value increases the exclusion limits.
It is a great measure to support the family members in acquiring there home without burdening them with a large number of debts. However, due consideration is required to ensure all the legal formalities are duly considered and met and also a gift tax return in FORM 709 is filled with IRS to submit the acknowledgment of payment of gift tax made on account of sale.
This has been a guide to what is a gift of equity. Here we discuss how does gift of equity works and calculate tax impact along with an example, benefits and disadvantages. You can learn more about financing from the following articles –