Gift of Equity Instead of Down Payment – When Family Sells to Family
Gift Of Equity
This is a reminder that sellers can “Gift Equity” as all or a portion of a down payment.
If the entire down payment is a “Gift of Equity,” it needs to comprise at least 20% of the purchase price.
If the Gift of Equity is less than 20% of the purchase price, buyers must still come up with at least 5% of the price from their own funds.
Gifts of Equity can be employed as creative solutions for helping cash-starved borrowers come up with a necessary down payment.
The “gifters” and the “recipients” technically need to be relatives in most cases, but “relative” is a pretty loose term and lenders don’t usually require proof of the relationship.
Coming Up With Price And Loan Amount
Sellers who gift equity often only want to net a certain amount of cash, but they still want to sell the property for the full market value so their generosity is on full display.
BUT, there is no reason to inflate the price to “market value” unnecessarily because it could just inflate property taxes, transfer taxes and/or title and escrow fees.
For example, if Grandma is selling a $1 million house to her grandkids with a gift of equity and she only wants to net $500,000 from the transaction, she should structure the sale like this:
Loan Amount: $500,000 (just enough to give Grandma the cash she wants)
Price: $625,000 (just enough to make the gift of equity the required 20% of the purchase price)
If the grandkids want a bit of additional cash for home improvements, they could bump the loan to $550,000 and make the price $687,500 (so the gift of equity is still 20%).
The full $550,000 will then go to Grandma – so she will have to gift (or loan) the extra $50,000 back to her grandkids.
There are tax implications with all of these options though, so buyers and sellers should also involve a CPA or a skilled tax-planner.
Note also that some states (like CA) have re-assessment exemptions when properties are transferred lineally from parent to child or grandparent to grandchild, so property taxes will not be an issue in those situations. Transfer taxes are also limited in many areas when there is a gift deed.
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