A “Gift of Equity transaction” can be used as a creative solution for helping cash-challenged borrowers come up with a required down payment.
Until recently, the gift of equity in transactions has been rare (I’ve done a dozen – all within the past five years,
With the aging of the “boomer” population and California’s Prop. 13 rules, these will be much more common.
So, if you have a client whose family member(s) wishing to sell (transfer) their property to another family member (that has little or no down payment) while still preserving a low-tax basis, a gift of equity is the best way to go.
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The seller (aka “donor” of the gift of equity) simply sells the property at a specific price, which is worked out between themselves and their relative(s).
For lending purposes, the (only) definitions of “family.”
A “family relationship” – is defined as “relatedness or connection by blood or marriage or adoption or domestic partnership.”
For Example, Here are the people that are classified as family members:
Children, parents, or grandparents.
A child is defined as a son, stepson, daughter, or step-daughter-parent or grandparent, including a step-parent/grandparent or foster parent/grandparent.
Spouse Or Domestic Partner of the primary borrower legally adopted son or daughter, including a child who is placed with the borrower by an authorized agency for legal adoption, a foster child of the borrower’s brother, stepbrother of the borrower’s sister,
Stepsister of the borrower, uncle of the borrower, aunt of the borrower, son-in-law of the borrower, daughter-in-law of the borrower, – father-in-law of the borrower, mother-in-law of the borrower, brother-in-law of the borrower
Lenders rarely require proof of a familial relationship, but claiming any of these (below) as a relative /family member is a fraud.
Lifelong family friends, boy/girlfriends, and fiancées are examples of those who are NOT family member; – so there is NO room for creativity.
FBI: Housing Fraud – “What We Investigate”
Lending regulations go on to state; even IF the seller (donor) is a relative – the seller “MAY NOT ” be or have ANY affiliation with the builder, the developer, landlord, real estate agent, or the appraiser.”
And to refresh your memory, if someone commits fraud and the FBI shows up with bracelets, the bracelets won’t be from Nordstrom, and the FBI agent won’t even remotely resemble Dakota Johnson (lol).
Constructing the Transaction
The difference between a property’s sales price and the “recipient” (new) loan amount; is defined as the “amount of gift equity” (gift).
Gift of Equity – When Family Sells to Family
The seller’s “Gift Equity” can be ALL or PORTION of a down payment.
If the ENTIRE down payment is a “Gift of Equity,” it must be at least 20% of the purchase price.
If the Gift of Equity is LESS than 20% of the purchase price, buyers must still have AT LEAST 5% of the price from their own funds.
Establish a Price And Loan Amount
Sellers who gift equity often only want to net a certain amount of cash.
There’s no need to sell the home at market value, as it inflates property taxes, transfer taxes, title, and escrow fees.
For example: If “Mom and Dad” have a $2 million home, they may only want to sell it for $500k to their kids, using a gift of equity.
WHY?: The parents may only want to net $250k from the transaction (in addition to paying off the current mortgage is $100k); they can structure the sale like this:
The gift of equity will be $100k; the kid’s loan amount will be $350k (just enough to give parents the $250k in cash they want AND pay off the parent’s $100k loan).
If the kids want additional cash for home improvements after COE, the parent’s gift of $100k remains the same; the kids could raise their loan amount to $400k, – and the parents can (after the close of escrow) gift back the additional $50,000.
There are tax implications with all of these options, however.
In Calif., with Prop.13, there are re-assessment exemptions when properties are transferred linearly from parent to child (or grandparent to grandchild); so, buyers and sellers should involve a CPA or a skilled tax-planner
Documentation Requirements
Gifts must be evidenced by a GIFT LETTER signed by the donor.
The gift letter must:
• specify the dollar amount of the gift;
• specify the date the funds were transferred (in this case, it’s at COE)
• include the donor’s statement that no repayment is expected;
• indicate the donor’s name, address, telephone number, and relationship to the borrower.
Verifying Donor Availability
of Funds and Transfer of Gift Funds