When you sell a home to a relative or someone with whom you have a prior relationship for less than the market value, that's called a gift of equity. Lenders may count the equity gift towards the down payment. A gift of equity letter is required as part of the closing paperwork and may carry tax ramifications for both the buyer and the seller.
The amount that you can give as a gift is determined by the final appraisal of the property. You must contract with a licensed appraiser to conduct the appraisal and pay for the service. The equity is the difference between the balance remaining on your mortgage and the market value of the home based on the appraisal. You'll need to include copies of the appraisal with your tax return to verify the gifts and determine whether you owe taxes on the amount.
The amount you can give as a gift without incurring any tax varies from year to year. For example, from 2006 to 2008, you could give $12,000 as a gift without incurring any additional taxes. The gift tax exemption was raised in 2009 to $13,000. As of the time of publication, if both you and your spouse own the house together, you can each give $13,000 in equity as a gift for a total of $26,000 without paying taxes. You may have to pay taxes on gifts that exceed the allowed exemptions.
You must make it clear that repayment of the gift of equity is not required. A gift of equity letter should be included in the closing papers. The lender you use may have stock letters on hand or you may request that your attorney draft a letter that you can sign. The letter is simple and typically includes your name and the address of the property involved in the gift.
The U.S. tax code allows you to apply a unified code to your exemptions that include gifts of equity. You have a lifetime limit that you can apply to gifts that can be split up among separate tax returns. As of 2009, the maximum exemption you can claim in gift taxes is $345,000. When you apply the unified code to your tax return, it reduces the amount of your estate tax exemption in the final accounting of your estate. For example, if you take the unified code exemption for a gift of equity that equals $100,000, and your final estate is valued at $500,000, the amount your heirs must claim in the final estate accounting is $600,000.