What is a gift of equity?
A gift of equity is the sale of the house to a family member or to someone related to the seller at a selling price below the present market value. The gift of equity is the difference between the actual selling price and the market value of the house.
Important things you have to remember about gift of equity:
A gift of equity needs a letter that is both countersigned by the buyer and seller. A gift of equity can have an effect on taxes as it could change the home’s cost basis for the new owner and have prime gains significance to the seller.
2. FHA Guidelines
The FHA (Federal Housing Administration) permits borrowers to receive gifts of equity provided that there is no expected or implicit repayment of the money to the donor. Those who borrow from the FHA may only get gift of equity from a family member who is transferring the house ownership to the borrower.
3. Relationship of Lender To Borrower
The borrower must have a family-type relationship with the lender. The lender must be related by blood, law, or marriage to the borrower. The lender must have a long-established family type relationship to the borrower if they are not related by the above three options, to be able to gift equity.
The lender who provides the gift of equity doesn’t need to be related to the borrower by any means as long as he is running a reasonable housing program as indicated by the FHA. The Homeownership Center (HOC) would be the one to cancel the equity credit and gift restrictions where the house is located. There are four HOC offices and they are located in Denver, Atlanta, Philadelphia and Santa Ana.
5. Tax Consequences
You may avoid a large percentage of tax depending on the number of your children and whether you are married or single. You can check IRS form 709 for more information on this.
A good rule to remember when doing gift of equity is this: the lender is allowed to gift equity to a person for up to $12,000 annually without disclosing it to the IRS. For example, parents that would like to give a gift of equity to their son would be allowed to gift 12,000 each for a total of $24,000 for their son.
- The entire debt on the parents’ house must be paid off first before a gift of equity can be used for the property.
- Parents who want to gift more than $57,000 allowed by the IRS under the yearly gift tax exemption may choose to propose the gift under the lifetime estate-tax immunity instead.
- Parents need to convince the IRS that they are selling the property to their child at its actual market value and any difference between the selling price to the actual market value will be deliberated by the IRS as a gift of equity
7. Terms of agreement between the lender and borrower
- The lender and borrower will set an agreed sales price of the property and the lender will discuss the requirements if there will be still down payments after the gift of equity. The Federal Housing Administration accepts the gift of equity to be used for the total down payment amount. The lender and borrower may have to set their own rules.
- They should agree on the amount of gift of equity. The buyer should know first how much she can get from the lender. The gift of equity will be the difference between the loaned amount and the price of the house.
8. Contact an Accountant
Contact an accountant to check if federal taxes apply on the gift of equity. The lender is the one who pays the tax for the gift. As of 2012, the lender can gift up to $13,000 yearly without paying tax and the maximum amount that can be gifted is $5,000,000 over the course of the mortgage.
9. Contact the IRS
Report the gift amount to IRS if the amount is greater than $13,000 or if you are splitting the amount with your wife. The borrower also needs to report to the IRS using Form 3520 for any amount greater than $100,000.
10. Applies to one property only
Gift of equity will only apply to one property that the buyer needs to mortgage with this money.
Buying a home with limited income should not be a problem. As long as you have a willing family member to help you out with a gift of equity, this should easily qualify you for a house loan with the FHA.