What is the Gift of Equity?

How Does Gift of Equity Work?

In the 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 that can be utilized to either make a down payment or pay off the debts. 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 the name of the seller, address, contact details, the relationship between the seller and the buyer, dollar value of the gift, declaration statement that “no repayment of gift value is required” and both parties should duly sign it.

Further, to successfully execute the gift transaction, the seller must get a paid appraisal of the property. It must state the appraised market value of the property and 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.

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Example of Gift of Equity

For instance, in 2019, Mr. John sold the house to his daughter for USD 100,000, whereas the appraised value of the house is USD 1,75,000, then the gift of equity value is USD 75,000, which exceeds the annual gift exclusion limit for 2019, i.e., USD 15,000. This means the excess value of USD 50,000 (USD 75000 – USD 15000) will count toward the lifetime gifting limit, and Mr. John has to pay gift tax on the USD 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 pay gift tax if he exceeds the lifetime gift limit. The IRS assesses the taxability of gift of equity transactions as per estate and gift tax laws. For 2019, the lifetime gift value limit is USD 11.40 million. If the buyer never exceeds the limit of USD 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 2019 was USD 15,000. If the father gifts up to USD 15000 in year one and again to USD 15,000 in year 2, both gifts will not be counted in the lifetime gifting limit.However, if the father gifted the USD 15,000 in year one and then made an additional USD 10,000 in year 1, the later amount, i.e., USD 10,000, will be counted towards the lifetime gifting limit. This means if the difference between the property’s appraised market value and the 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.

Benefits

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 a 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, and mortgage payment, if any.Savings on Agent Commissions: Since the gift of equity transactions occur between family members, it generally does not involve real estate agents. This enables the seller to save the commission payments, which may cost around 5%.

Disadvantages

Let’s discuss the following disadvantages.

  • Legal Fees: No real agents are involved as family members’ transactions happen. However, this increases the cost of legal charges and professional attorney fees for drafting the contracts and legal documentation.Gift Tax: 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.

Conclusion

It is a great measure to support the family members in acquiring their home without burdening them with many debts. However, due consideration is required to ensure all the legal formalities are duly considered and met. A gift tax return in FORM 709 is filled with the IRS to submit the acknowledgment of payment of gift tax made on account of sale.

This has been a guide to what a gift of equity is. Here we discuss how the 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 –

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