Everything You Need to Know About Gifts of Equity

What is a Gift of Equity?

A gift of equity is when a seller of a property transfers some of the property's equity to the buyer as a gift, typically to help with the buyer’s down payment or to make the home more affordable. This kind of arrangement is commonly used within families or among close friends, where the seller is willing to assist the buyer in achieving homeownership or making a significant financial step.

How a Gift of Equity Works:

1. Transferring Equity: The seller agrees to "gift" a portion of the home’s equity to the buyer. This can be structured in various ways but is most often used to help the buyer with the down payment or closing costs. The seller’s equity in the property is used as part of the buyer’s financial contribution.

2. No Direct Payment: Unlike a traditional sale where the buyer makes a direct payment to the seller for the full value of the property, the seller in a gift of equity transaction is offering a portion of the property's value as a non-repayable gift.

3. Family and Close Relationships: Gift of equity transactions are often seen in family settings. For example, parents may gift equity to their children to help them afford their first home, or other relatives may assist in the same way. This arrangement can help the buyer avoid hefty down payments or high-interest loans.

4. Simplified Financial Assistance: Rather than providing a loan or other financial help, the seller can simply reduce the financial burden for the buyer by offering equity in the home. This makes the process less complex compared to other forms of assistance, like a personal loan.

In a gift of equity transaction, the buyer benefits from reduced financial requirements, while the seller may have various personal or financial reasons for offering this assistance, such as simplifying inheritance or helping a loved one achieve financial stability.

Benefits of a Gift of Equity for the Buyer (Mortgage Perspective)

1. No Down Payment Needed
   The buyer doesn't have to provide a traditional down payment. The equity from the property itself can serve as the buyer's down payment, which can ease the financial burden of purchasing a home.

2. No Closing Costs
   In many cases, the seller can use their equity to cover the buyer's closing costs, allowing the buyer to avoid this additional expense and keep more cash in hand for other financial needs.

3. Ability to Wrap in Personal Debts
   The buyer may be able to use the gift of equity to cover personal debts. This means that instead of taking out a separate loan to pay off credit cards or other debts, the buyer can combine these debts into the mortgage, potentially lowering monthly payments and simplifying finances.

4. Easier Qualification for a Mortgage
   The buyer may qualify for a mortgage they wouldn't normally be able to. With the added equity, lenders might look more favorably on the buyer's financial situation, even if their credit score or income doesn’t meet the usual requirements.

5. Potential for a Lower Purchase Price
   If the seller agrees, the home can be sold for a price lower than the market value. This gives the buyer an immediate advantage, as they’re not paying the full price for the property, which can make homeownership more accessible and financially viable.

Common Pitfalls

There are several common confusions that buyers and sellers face when it comes to a gift of equity. Here are some of the key misunderstandings:

1. Tax Confusion:
   Many people believe that a gift of equity automatically triggers gift taxes. However, there are no taxes on a gift of equity up to the IRS annual exclusion limit, which is around $17,000 per person as of 2025. In fact, a gift of equity can be exempt from taxes if the total amount given falls within the lifetime exemption limit, which is over $13 million. It’s important for both parties to know the limits and consult a tax professional if the amount exceeds the exclusion.

2. Property Taxes:
   Another common confusion arises around property taxes. When the buyer accepts a gift of equity, they often believe that they will continue to pay the same property tax rate as the seller. However, depending on the state, the property taxes will be reassessed based on the purchase price (or the appraised value) of the home. This could result in higher property taxes than what the seller was paying, which can come as a surprise to the buyer after the transaction is complete.

3. Seller's Financial Impact:
   One of the biggest misconceptions is about how the seller is impacted. The seller is giving away a portion of the home’s value, which means they will receive less money from the sale. This can be a tricky aspect to navigate, as the seller might still want to ensure they come out of the transaction with a certain amount of money. Proper setup of the agreement is crucial so that the seller is clear on how much they’ll be getting from the sale, and they’re comfortable with the amount they are gifting. A poorly structured agreement could lead to dissatisfaction or potential disputes.

While a gift of equity can be an incredibly beneficial arrangement, it’s important to understand the tax implications, potential changes in property taxes, and the impact it has on the seller’s financial outcome. Proper planning and clear communication are key to avoiding confusion and ensuring that the transaction goes smoothly for both parties. 

How is a gift of equity setup? 

Setting up a gift of equity can be a bit more complicated than it might seem at first glance. One of the main challenges is ensuring that the seller receives the amount they want from the sale while also properly accounting for the equity being gifted. The seller has to decide exactly how much of the property’s value they’re willing to give up, which can be tricky if they have specific financial goals or need to receive a certain amount from the transaction. This requires careful negotiation and planning to ensure that both parties are satisfied with the financial outcome.

Additionally, the mortgage process can become more complex with a gift of equity involved. The buyer may need to meet specific lender requirements, as the gift of equity will be factored into the overall mortgage approval. Lenders typically require detailed documentation, such as a gift letter and a purchase agreement which can add extra steps and paperwork. With these factors in play, structuring the deal correctly and ensuring both the buyer and seller are comfortable can make the process more complicated than a standard real estate transaction.

It is possible that there is not enough equity in the home to allow the buyer to wrap in the down payment and closing costs. In this case we would need the buyer to bring money to the closing table to meet their financial obligations.