A gift of equity allows a homeowner to sell their property to a family member or close associate for less than its market value. The difference between the market value and the sale price is considered a gift, which the buyer can use as a down payment. This can be a great way to help a loved one purchase a home while minimizing out-of-pocket costs.
How It Works and Its Impact on the Seller
In this type of transaction, the seller agrees to sell the home below its appraised value, creating built-in equity for the buyer. For example, if a home is worth $300,000 but the seller agrees to sell it for $250,000, the $50,000 difference is the gift of equity. This amount can be applied toward the buyer’s down payment, reducing or even eliminating the need for a cash down payment.
Since lenders typically require a down payment, this type of financial assistance can make it easier for buyers to qualify for a gift of equity mortgage. The lender will consider the gifted equity as part of the loan application, potentially leading to better loan terms and lower overall costs.
For sellers, providing a gift of equity means they won’t receive the full market value of their home. However, there are potential benefits, including:
- Helping a buyer become a homeowner. Selling a home at a reduced price makes homeownership more accessible for a family member or close friend.
- Reducing selling costs. By selling directly to a family member, sellers may bypass agent commissions and other expenses.
- Understanding tax implications. If the gifted equity exceeds the annual IRS gift tax exclusion limit, the seller may need to file a gift tax return, though it doesn’t always result in an immediate tax payment.
Rules on Gifting Money to Family
A gift of equity must follow specific lender and tax guidelines. Here are some key rules to keep in mind:
- Who can receive a gift of equity? Lenders usually require the transaction to occur between family members, though some allow gifts from close associates.
- What documentation is required? The seller must provide a formal letter stating that the equity is a gift and that the buyer is not expected to repay it.
- What loan programs allow a gift of equity? Different loan programs, such as FHA loans and conventional loans, have unique rules about gift funds and maximum loan-to-value (LTV) ratios.
- Are there tax implications? Sellers should be aware of potential capital gains tax and gift tax considerations when gifting equity.
It’s highly recommended to consult with a qualified tax professional or financial advisor to understand how these rules apply to your specific situation and ensure compliance with all applicable tax laws.
Restrictions on Investment Properties
Most lenders do not allow a gift of equity on an investment property. This type of financial assistance is generally reserved for primary residences and, in some cases, second homes. Buyers looking to purchase a home as an investment property will typically need to provide their own down payment without relying on gifted funds.
Loan Types That Accept a Gift of Equity
Several mortgage programs permit this type of financial assistance, though each has its own specific requirements:
FHA Loans
FHA loans require a minimum 3.5% down payment and allow a gift of equity to cover this amount. This can be especially beneficial for buyers with limited cash reserves. The FHA guidelines also set a maximum loan-to-value (LTV) ratio of 96.5% when using a gift of equity, meaning the gifted equity is taken into account to help meet the down payment requirement.
Conventional Loans
Conventional loans also accept gift funds, but the rules vary by lender. Some lenders may have specific documentation requirements or limits on the amount of gift equity that can be applied. It’s important for buyers to verify with their lender how these funds will impact the overall loan structure and any potential appraisal considerations.
VA Loans
While VA loans do not require a down payment, which often makes a gift of equity unnecessary, they can still be used in certain situations to lower the overall loan amount or assist with closing costs. However, the use of a gift of equity in VA loans is less common since the program is designed to offer significant financial benefits without a substantial cash contribution upfront.
Proper Documentation for a Gift of Equity
Proper documentation is essential in this type of transaction. The following steps are typically required:
- Gift of equity letter: This formal letter must state the amount of the gift and confirm that repayment is not required.
- Home appraisal: Lenders require an appraisal to confirm the home is worth the market value stated.
- Sales contract updates: The sale contract should explicitly state the gift of equity amount.
- Tax considerations: Sellers should consult a tax professional to determine if a gift tax return is necessary.
For more information and personalized guidance on the documentation required, reach out to a mortgage expert at JVM Lending.
Frequently Asked Questions
Can an estate provide a gift of equity?
Yes, an estate can provide this type of financial assistance under certain circumstances. If a property is inherited and the heirs decide to sell their home below market value to a family member, the difference can be considered a gift of equity. However, tax and legal implications should be carefully reviewed with a professional.
Can a seller provide a gift of equity to anyone?
Typically, lenders require the recipient to be a family member or close associate. Some loan programs have specific eligibility rules.
Can a buyer use a gift of equity as a down payment?
Yes! The gifted equity can replace a traditional cash down payment, making homeownership more affordable.
Can gifted equity cover closing costs?
Yes! A gift of equity can be applied toward a buyer’s down payment and, in some cases, closing costs. Depending on the loan type, this can help reduce the buyer’s out-of-pocket expenses.
For example, an FHA gift of equity allows the gifted amount to be used for both the down payment and closing costs. Conventional loans may also permit this, but guidelines vary by lender.
Is a gift of equity taxable?
A gift of equity is subject to gift tax laws. In 2025, the IRS allows individuals to give up to $18,000 per recipient without triggering the gift tax. If the amount of the gift exceeds this limit, the seller may need to report it on their tax return. However, most people won’t owe taxes unless their total lifetime gifts exceed the federal exemption amount.
Additionally, sellers should consider potential capital gains tax when they sell their home below market value. The difference between the original purchase price and the current market value may be subject to taxation, depending on how long the home was owned and whether the seller qualifies for tax exemptions. Sellers should consult a tax professional ahead of time.
Is This The Right Option For You?
A gift of equity home loan can be a great solution for buyers who need assistance with a down payment. However, sellers must carefully consider the financial implications, including potential tax obligations.
If you’re considering this type of transaction, working with an experienced lender can help ensure a smooth process. JVM Lending specializes in helping buyers and sellers navigate the process while maximizing the benefits. Contact JVM Lending today to learn more about your options!
