What is a Gift of Equity?

A gift of equity is a situation where property is sold to a loved one at a price that is less than the current market value. The actual amount of this type of gifts is determined by subtracting the purchase price from the current market value. This approach often is helpful to the recipient, since lenders are much more likely to provide favorable terms and conditions if a mortgage is written for an amount that is significantly less than the actual value of the property.

There are a number of reasons why a homeowner may choose to extend a gift of equity to a relative or other loved one. In some cases, the goal is to assist the loved one in becoming a homeowner, providing that individual with a degree of financial stability. For example, parents who have retired and plan on moving into a smaller residence that was once used as a weekend home may choose to sell a larger residence to a child.

Extending the gift of equity often means that the child does not have to provide a down payment. This is especially true when the amount of the gift means that the child needs a loan that is considerably less than the current market value. As a result, the child has a home that carries a low mortgage, will likely enjoy lower monthly installment payments, and has the ability to pay off the mortgage in a shorter period of time than would be possible otherwise.

Depending on the actual amount of the gift of equity, the recipient may have to deal with some amount of tax consequences. While many national revenue agencies do allow parents to provide financial gifts of up to a certain amount annually to their children, any gift of equity above that amount would have to be reported. This means that the gift may be considered a capital gain, and be subject to capital gains taxes. This is true even if tax laws allow each parent to provide gifts of equal value to the child.

For example, if the current ceiling on gifts is $10,000 US dollars (USD) per parent per tax year, then the two parents could sell the home to the child at an asking price that is $20,000 USD below the current market value. This could be done without generating any type of assessment of capital gains taxes. Should the amount of the gift of equity come to a total of $25,000 USD, then the difference would be considered capital gains, and be subject to taxes.