How to Calculate Gift of Equity?

Equity is a financial arrangement often used in real estate transactions. It happens when a property owner sells their property to someone, usually a family member, for less than its market value. The difference between the market value and the selling price is the "gift of equity." This gift can help the buyer reduce their down payment or cover closing costs. It is commonly used to make homeownership more affordable for loved ones.

The gift of equity can be an important financial tool, especially in families where property is being passed down. It allows the seller to assist the buyer without giving cash directly. This arrangement is also a way to keep the property within the family.

How Does a Gift of Equity Work?

When a property is sold below market value, the seller gives part of their equity in the home to the buyer. For example, if a house is worth $300,000 but is sold for $250,000, the $50,000 difference is the gift of equity. This gift can then be applied to the buyer’s down payment or other costs associated with the purchase.

The transaction usually involves a formal agreement. A gift letter is written and signed by the seller to confirm the gift. This letter is often required by mortgage lenders to ensure the gift is legitimate and not a loan.

Benefits of a Gift of Equity

A gift of equity has many advantages. First, it helps the buyer save money. They can use the gifted amount to reduce their down payment, which lowers the loan amount. It may also help the buyer qualify for a mortgage more easily.

For the seller, this arrangement can be a way to assist a loved one while still receiving some payment for the property. Additionally, it avoids the need for large cash transfers, which may not be feasible for some families.

A gift of equity can also simplify the homebuying process. The buyer avoids competing on the open market, and both parties save time and money.

Tax Implications of a Gift of Equity

In the United States, a gift of equity is considered a financial gift. As a result, it may be subject to federal gift tax laws. In 2025, the annual gift tax exclusion is $17,000 per individual. This means that a seller can gift up to $17,000 to the buyer without incurring gift taxes. For larger amounts, a portion of the gift may need to be reported to the Internal Revenue Service (IRS).

However, sellers can use their lifetime gift tax exemption to avoid paying taxes on larger gifts. It is essential to consult a tax advisor to understand the tax implications fully.

How to Calculate Gift of Equity?

Calculating a gift of equity is straightforward. First, determine the market value of the property. Then, subtract the agreed-upon sale price. The remaining amount is the gift of equity.

For instance, if a home is worth $400,000 and is sold for $350,000, the gift of equity is $50,000. Buyers and sellers can use tools like the Gift of Equity Calculator by Calculator Institute to simplify this calculation.

Requirements for a Gift of Equity

A gift of equity involves specific requirements. These include:

Gift Letter: A signed letter confirming the gift and stating that it does not need to be repaid.

Appraisal: The property’s market value must be determined through an appraisal.

Loan Approval: Mortgage lenders typically review the gift to ensure it complies with their guidelines.


These steps are necessary to make the transaction smooth and legally valid.

Limitations of a Gift of Equity

While a gift of equity has many benefits, it also has some limitations. The biggest challenge is the potential tax liability for the seller. Additionally, the buyer may face restrictions from the mortgage lender, such as needing a minimum down payment.

Another limitation is that this type of arrangement is usually limited to family members. Most lenders require the gift to come from a close relative, such as a parent, sibling, or grandparent.

Gift of Equity in Real Estate

In real estate, a gift of equity is often used in situations like selling a family home to a child. It helps the child afford the house while keeping the property in the family. This method is also popular in multi-generational families where the older generation wants to support the younger generation in owning a home.

It is important to remember that both parties should work with real estate professionals and legal advisors. This ensures the process is handled correctly and all legal requirements are met.

Conclusion

A gift of equity is a valuable tool for helping loved ones achieve homeownership. It benefits both the buyer and seller by making the transaction affordable and efficient. However, it is essential to understand the tax implications, lender requirements, and legal steps involved. With proper planning, a gift of equity can be a generous way to transfer property while preserving financial stability.

References

1. Internal Revenue Service (IRS). (n.d.). "Gift Tax Information." Retrieved from irs.gov


2. Calculator Institute. (n.d.). "Gift of Equity Calculator Tool." Retrieved from calculator.institute


3. National Association of Realtors. (2024). "Real Estate Transactions and Equity Gifts." Retrieved from realtor.org


4. Investopedia. (n.d.). "Gift of Equity Explained." Retrieved from investopedia.com