This type of arrangement is an essential part of many home purchases, as it allows the seller to give a portion of the property's equity to the buyer without having to pay taxes on the gift. It also benefits the buyer, as gifts of equity can often cover closing costs or even reduce the amount of the down payment.
A gift of equity involves a home buyer that is related to the seller, such as a parent, grandparent, child, or sibling. That individual contributes an amount of money or property equal to an established percent of the total value of the home. The buyer then applies for a loan and pays the rest of the cost of the home, including closing costs. As long as the amount of the gift does not exceed the amount of equity the seller has in the home, both parties benefit from the arrangement.
There are several conditions that must be met in order for a gift of equity to be allowed. First, the buyer must demonstrate that they have the financial ability to make the monthly payments on the loan and that they will be able to repay the loan over time. Second, the gift must be documented with a gift letter that outlines the amount of the gift. This letter will need to be provided to the lender when applying for the loan.
The gift of equity also requires that the buyer and the seller fill out a gift tax form, which is filed with the IRS. This form explains that the amount given to the buyer is not taxable, and it allows the buyer to deduct the amount of the gift from their income tax liability. Additionally, the gift of equity must be legitimate and not part of a loan restructuring or an attempt to evade taxes.
In summary, a gift of equity can provide a great benefit to both the buyer and the seller in a home purchase. This type of arrangement allows the seller to provide financial assistance to a family member without having to pay taxes on the transfer. In turn, the buyer can access additional funds for their purchase or reduce their down payment requirement. However, both parties must meet certain conditions in order for the gift to be accepted and avoid any potential complications.
This article was contributed on Oct 20, 2023