How does gift of equity work and how are gift an estate taxes handled?


You may like to know how a gift of equity works if you want to sell to your son a house for $150,000 when it is worth $200,000. That will make a Gift of Equity of $50,000 which is a very generous gift.

Gift of Equity allows you to purchase the house of your parents (or any relatives) for below market price. This is usually done with the purpose of avoiding the down payment - usually the donors are willing to gift at least 20% of the real estate value to help the recipients avoid paying PMI and any out-of-pocket cash towards the house. Often the gift exceeds what would be a 20% down payment.

To make or receive a gift of equity you need a Gift of Equity Letter.

The Gift of Equity letter states the names of donor and recipient, how they are related (brother, sister-in-law, etc.) and the gift amount. The address and market value of the real estate property is also included. Also, the donor explicitly states that the gift is not to be repaid.

Tax Issues with Gift of Equity

If you are the recipient of a Gift of Equity there's no gift taxes you need to worry about. It's the donor making the gift who should know how taxes on a Gift of Equity are filed. Currently, a donor is allowed to gift $12,000 per recipient per year. If the gift amount is exceeded, IRS gift tax laws apply.

Usually, the donor pays no direct taxes but they may have to file the IRS Form 709, if the non-taxable gift annual exclusion per donor is exceeded (currently set at $12,000 per donor per recipient per year). If somehow the non-taxable gift amount is exceeded, the excess will be deducted from the unified credit for gift and/or real estate tax purposes.

Just to mention, everyone is entitled unified credit against taxable gift and real estate taxes. Here is a table showing the individual gift and real estate credit limits for 2008 and 2009.

Year Gift Taxes Limit Real Estate Taxes Limit
Unified Credit Applicable Exclusion Unified Credit Applicable Exclusion
2008 345,800 1,000,000 780,800 2,000,000
2009 345,800 1,000,000 1,455,800 3,500,000

All gifts are considered taxable, but there are also a lot of exclusions. No limits apply to gifts you make to your spouse. The limits above apply to gifts made to anyone else or an organization. Paying someone's medical bills is also considered a gift. Use the services of a tax professional to know when it is necessary to file IRS Form 709.

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