Guide to Gifts of Equity: How a Gift of Equity Works in Real Estate

A gift of equity is a home-buying agreement that often takes place between family members or other close relations. The home seller sells their property to the buyer for a reduced price, and the difference between the market value of the property (or the appraised value) and the sales price is considered the gift of equity. Gift of equity provisions can be used when selling a primary residence, a second home, or an investment property. The homebuyers often use the gifted equity as part of a down payment when they apply for a mortgage either through a lender or from the FHA. This can make it easier for people who are buying homes with gifted equity to obtain a mortgage. While called a gift, there is no financial transaction between a homebuyer and seller with a gift of home equity. The gift of equity simply refers to the amount of difference between the current market value of a home and the reduced amount paid by the homebuyer. The gift of equity is typically used for a reduced-price down payment or to replace a down payment when borrowing money for a mortgage loan. The seller must draw up a gift of equity letter including the intention of gifting equity on the property, who they are gifting it to, the home’s appraisal price, and its sales price. Both parties sign the letter. This provides the lender a form of security in place of standard mortgage insurance. There is no requirement for what a gift of equity must look like. There are only things that the buyer and seller must do to carry out the agreement. Here are the things that the buyer and seller must do in order to document the gift of equity. - __The seller schedules a home appraisal__. The home seller must obtain a professional [home appraisal](https://www.masterclass.com/articles/home-appraisal-process-explained) to find out the property's value. This will determine how much equity the seller is giving to the buyer. - __The seller and buyer sign a gift of equity letter__. The gift letter must note the appraised value of the home, the sales price, and the difference between the two which will be the gift of equity. The buyer and seller must sign the gift of equity letter. It will be used in place of traditional mortgage insurance by the mortgage lender. Here are some of the potential advantages of selling a home via a gift of equity. 1. __Down payments are lower or don’t exist__. For the homebuyer, a gift of equity can greatly reduce or completely eliminate a home’s down payment when you’re applying for a loan. This can be helpful for first-time homebuyers who may not have the finances for a large down payment. 2. __No real estate agent sales commissions__. If you're selling real estate between close family members, it is likely you won't need to work with real estate agents or brokers. This eliminates commission fees and potentially reduces closing costs. 3. __You can avoid mortgage insurance__. Lenders will typically require a borrower to purchase private mortgage insurance (PMI) if their down payment is less than 20 percent of the sales price of the home. The gifted equity can make up a portion of the down payment and eliminate the need for mortgage insurance. There are some potential disadvantages to the gift of equity. 1. __You may be subject to a gift tax__. If your gifted equity exceeds the thresholds for couples or individuals, the seller may be subject to a gift tax on the amount of gifted equity. 2. __Potential legal fees__. There are legal fees associated with drawing up the gift of equity paperwork. However, it is unlikely that these legal fees would be more costly than paying a broker’s commission or fee. 3. __The buyer may incur capital gains taxes when they sell__. For the new homeowner, the gift of equity can impact the property's cost basis. This means that if they sell the home at or above [market value](https://www.masterclass.com/articles/fair-market-value-explained) at a later time—which will be higher than the reduced purchase price—they may incur capital gains taxes on the profit. All you need is a [MasterClass Annual Membership](https://www.masterclass.com) and our exclusive video lessons from prolific entrepreneur Robert Reffkin, the founder and CEO of the real estate technology company Compass. With Robert’s help, you’ll learn all about the intricacies of buying a home, from securing a mortgage to hiring an agent to tips for putting your own place on the market. Gift of equity in real estate is when two close parties exchange a home for a reduced sales price.