If your family member is looking to buy a new home, you can support them in a couple of ways. You could give them money as a mortgage gift, which they can put towards their down payment. Alternatively, you could sell them your own home and offer them a gift of equity.

Gift of Equity Meaning & Example

A gift of equity is when a homeowner gives a part of their ownership in a property to someone who wants to buy it. When the buyer gets this gift, they instantly own a piece of the house they are purchasing, which means they already have some ownership value in it.

People often use gifts of equity when they sell a house to a family member. Although the seller has to report these gifts for taxes, most people don’t have to pay gift tax unless they are rich enough to do it.

For example, if your parents sell you their home for $200,000, but it’s actually worth $500,000, the gift of equity they’re giving you is $300,000. This is the extra value you’re getting because they’re selling it to you for less than it’s worth. So, a gift of equity is quite valuable.

Concerns Associated with the Gift of Equity Tax

In some cases, a gift of equity can result in higher tax bills later on for both the seller and the buyer, but this only happens in certain situations.

  • Gift Tax
    When someone gives you a gift of equity, it’s important to know about gift reporting rules. If the value of the gifted equity exceeds a certain amount, it must be reported to the IRS. For instance, in 2023, the exclusion is $17,000 per recipient if the giver is single or $34,000 per recipient if two married givers are involved.
    Reporting the gift to the IRS doesn’t automatically mean you will owe taxes. Reported gifts count toward a lifetime exclusion limit, which in 2023 is $12.92 million. If your total gifts during your lifetime exceed this amount, or if they add up to the estate you leave behind for your heirs, you may owe federal gift or estate tax.
    Since the lifetime exclusion for gifts is quite high, it’s rare for a gift of equity to push someone’s total gifts over the limit and trigger taxes. However, individuals with substantial net worth should seek advice from a financial advisor before making such gifts.
  • Capital Gains Tax
    For the person receiving a gift of equity, there’s a possibility of owing more in capital gains taxes when selling the home later on. This is because capital gains tax is based on the profit from selling a property, and a lower purchase price can lead to higher profit.
    Consider this example: If you buy a house for $400,000 and sell it for $500,000, your gain is $100,000. But if you receive a gift of equity and buy the same house for $300,000, then sell it for $500,000, your profit is $200,000.
    While calculating capital gains on real property involves more complexity, the general idea is that accepting equity and paying a lower purchase price can result in higher gains upon sale.
    However, the recipient of a gift of equity might be able to avoid capital gains taxes when selling the home if they qualify for an exclusion. The IRS typically doesn’t tax sellers on the first $250,000 in gains for a single filer. Therefore, capital gains taxes are usually more of a concern when someone accepts a gift of equity for buying a second home or if the gift is substantial.

Wrapping Up

Giving a gift of equity is a generous way to assist someone you care about in becoming a homeowner. However, if you are unsure whether this option is suitable for you, seek advice from a professional in the field.

Contact our real estate professionals at Red Door Funding for any hot real estate advice or consultation. Call us at (832) 539-1099 to reach out.

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